Do Corporate Taxes Impede Economic Growth?

June 8, 2005

In theory, higher corporate tax rates should decrease economic growth rates. Why? Because they reduce incentives to take risks, accumulate capital and engage in entrepreneurial activity, making us less wealthy over time.

But is the theory correct in practice? According to a new paper from Young Lee and Roger H. Gordon in the June 2005 issue of the Journal of Public Economics, the answer is yes.

Examining twenty seven years of cross-country data, the authors find lowering corporate tax rates can substantially boost economic growth. Here’s the abstract:

In this paper, we explore how tax policies in fact affect a country’s growth rate, using cross-country data during 1970-1997. We find that statutory corporate tax rates are significantly negatively correlated with cross-sectional differences in average economic growth rates, controlling for various other determinants of economic growth, and other standard tax variables. In fixed-effect regressions, we again find that increases in corporate tax rates lead to lower future growth rates within countries. The coefficient estimates suggest that a cut in the corporate tax rate by ten percentage points will raise the annual growth rate by one to two percentage points. (Full paper in MS Word).

Currently the U.S. has the fourth highest corporate income tax rate in the world. If Lee and Gorden are right, by cutting the U.S.’s combined federal and average state corporate tax rate from roughly 40 percent to 30 percent we could boost U.S. economic growth by around 1.1 percent per year—enough to double our nation’s wealth every 63 years.

For more on the economics of corporate taxes check out our Corporate Income Tax section.


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