A Brief Review of the Literature for Presidential Hopefuls

June 17, 2008

From today’s Wall Street Journal:

While Sen. McCain has argued that tax cuts—particularly on business—spur growth, Sen. Obama rejected that as flawed economics. “I’ve seen no evidence that . . . would actually boost the economic growth and productivity,” he said.

Here’s some evidence!

From the National Bureau of Economic Research: The Effect of Corporate Taxes on Investment and Entrepreneurship:

Our data reveal a consistent and large adverse effect of corporate taxes on both investment and entrepreneurship, A 10 percentage point increase in the 1st year effective corporate tax rate reduces the aggregate investment to GDP ratio by about 2 percentage points (mean is 21%), and the official entry rate by 1.4 percentage points (mean is 8%).

We find negative correlation between our measures of effective tax rates and recent growth in cross-country data. We also find that higher corporate taxes are associated with a larger informal economy.

We estimate that a 10 percentage point increase in the 1st year effective tax rate reduces the growth rate by around 1 percentage point per year.

One highly relevant piece of data, however, is that corporate taxation has a large adverse effect on FDI.

From the OECD: Taxation and Business Environment as Drivers of Foreign Direct Investment in OECD Countries:

Standard models of the [multinational enterprises] predict that corporate taxation can influence foreign direct investment (FDI) by creating a wedge between the pre- and post-tax returns on investment.

Consistent with previous findings, the regressions suggest that corporate taxation has a significant impact on FDI location choices, and that forward-looking measures based on tax codes – including bilateral arrangements and features of foreign income taxation – capture this impact more effectively than simple statutory rates.

From the U.S. Treasury Department: Approaches to Improve the Competitiveness of the U.S. Business Tax System for the 21st Century (PDF):

Taxing business income discourages investment by raising the cost of capital. The higher the cost of capital, the greater the disincentive to invest. The relatively high U.S. tax rate, compared to our trading partners, places a higher cost on investment. Business taxes play a particularly key role in the economy because they influence the incentive to acquire and use capital-the plants, offices, equipment, and software that corporations employ to produce goods and services. In general, an economy with more capital is more productive and ultimately attains a higher standard of living than economies that have accumulated less capital. Workers gain when businesses have more capital and, correspondingly, workers stand to lose when the tax system leads businesses to invest less and have a smaller capital stock.

The Treasury study also found that business tax reform could increase the size of the economy by as much as 2 to 2.5 percent! Additionally:

From the American Enterprise Institute, Taxes and Wages:

The results in this paper suggest that corporate tax rates affect wage levels across countries. Higher corporate taxes lead to lower wages. A 1 percent increase in corporate tax rates is associated with nearly a 1 percent drop in wage rates.

From the Oxford University Centre for Business and Taxation: The Incidence of Corporate Income Tax on Wages

Our central estimate is that 61% of any additional [corporate] tax is passed on in lower wages in the short run and around 100% in the long run.

From the Kansas City Fed: Passing the Burden: Corporate Tax Incidence in Open Economies:

Using cross-country panel data from the Luxembourg Income Study, I estimate that a ten percentage point increase in the corporate tax rate decreases annual gross wages by seven percent. Using U.S. data on corporate tax revenues and total wages, these estimates predict that labor’s burden is more than four times the magnitude of the corporate tax revenue collected in the U.S. (Felix, p. 3)

But if math-intensive journal articles do not suit your fancy, have no fear. There is plenty of anecdotal evidence about Ireland and other success stories about corporate tax reductions in Making Poor Nations Rich: Entrepreneurship and the Process of Economic Development by Ben Powell: Economic Freedom and Growth: The Case of the Celtic Tiger.

As the research listed above indicates (relying on the experience of developed nations over the past 20 years), there is plenty of evidence to suggest corporate tax rates “boost economic growth and productivity”—not to mention real wages and living standards for US workers.


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