When the government increases tax rates, it assumes that it will collect more tax revenue dollars. Generally, this is the case. But there may well be an important exception that occurs because of the elasticity of taxation. Despite the presence of many contaminating variables, a persistent pattern is present in numerous longitudinal and cross-sectional empirical studies suggesting that corporate income taxes in the United States are likely in the elastic (or prohibitive) range. In other words, raising corporate tax rates may yield lower total corporate tax revenue while lowering rates likely will increase revenues.
Since higher corporate tax rates are generally held to have a number of serious negative secondary and tertiary effects, such as lower levels of capital investment, wages, employment and economic growth, unless the higher rates generate more revenue, increases in corporate tax rates may create the worst of all possible outcomes. Because the stakes are so high, empirical results, though persuasive, are still inconclusive, and tax rate elasticity can vary due to a variety of influences, major changes in corporate tax rates should be made only after using macro-dynamic scoring. Fortunately, the CBO and JCT already have available most of the macroeconomic models and analytical tools to answer not only the primary-effects question of tax revenue generation, but also critical secondary and tertiary issues as well. Congress and the administration have an opportunity to transcend decades of political infighting and to begin adopting economic tools with greater predictive accuracy in addressing questions of federal tax policy.