Corporate Laffer Curve: Column – Pacific Research Institute

Corporate Laffer Curve: Column

A corporate tax cut would produce higher revenues for Dems and lower rates for GOP.

Democrats and Republicans in Washington are at loggerheads over what to do about the deficit, the national debt, and the automatic spending cuts, which took effect last week. Those on the left seek a hike in tax rates and the debt ceiling with no attendant spending cuts, while the GOP wants to trade increases in the borrowing limit for a commitment to decrease government spending.

The two sides are far apart. But they needn’t be. There’s a way to give Democrats what they’re looking for — namely, higher government revenues — and simultaneously achieve the longstanding Republican goal of lower tax rates. Cut rates on corporate earnings.

That might seem counter-intuitive. After all, how can we raise tax revenue by taking a smaller slice of each dollar earned?

By increasing the number of dollars available to be taxed. Last year, the United States earned the depressing distinction of having the industrialized world’s highest corporate tax rates. At 39.2%, America’s rate is 14 percentage points higher than the average among developed countries. That 39.2% represents the average corporate rate after accounting for state and local taxes on top of the 35% federal rate.

Some argue that the above comparisons are for the highest statutory, marginal corporate tax brackets — and that with all the loopholes in the tax code, no corporation actually pays these rates.

Then consider average effective federal corporate tax rates. In 2010 the average effective rate in the U.S. was 29% — 8.4 percentage points higher than the average among industrialized nations and still among the highest in the world.

Regardless of the data set, the results are the same. But it’s important to remember that business investment decisions are made heavily on marginal cost and marginal revenue comparisons. So marginal tax rates matter.

Businesses are reacting to these tax burdens by leaving for friendlier environs abroad. Corporate money that moves abroad is corporate money that’s not being taxed in America. Between 1990 and 2010, as the average U.S. corporate tax rate jumped from 38.7% to 39.2%, corporate tax revenues as a share of GDP actually decreased from 1.7% to 1.2%.

Companies have many inviting countries to choose from nowadays. Between 1990 and 2010, the average tax rate among industrialized countries dove from 41.2% to 25.5%. It’s no surprise then, that some firms have moved their operations abroad. Over the last decade, the U.S. has suffered a net loss of 46 Fortune 500 company headquarters.

American corporations now generate about $1 trillion in profits abroad every year. Lowering the corporate tax rate would entice them to bring more of those dollars back to the U.S. America would become a more appealing place to do business. The pool of taxable revenues would expand dramatically, leading to a swift uptick in corporate tax revenue.

There’s ample evidence to support this theory. An Oxford University study found that while the average corporate tax rate among 20 developed countries fell between 1965-2004, total corporate tax revenues as a percentage of GDP actually rose.

Higher tax revenues? That should be music to Democrats’ ears. For Republicans, lowering the corporate rate should be equally irresistible. By conceding higher revenues, the GOP would have a better shot at achieving one of its core goals — fostering growth by lowering the tax burden on private businesses.

Both parties should be equally concerned about the sluggish trajectory America appears to be on. Excessive corporate taxation deserves part of the blame. Economists Roger Gordon and Young Lee analyzed 70 countries between 1970 and 1997 and found that higher corporate rates were associated with lower per capita GDP growth.

By scaling back corporate rates, lawmakers from both parties can bolster businesses’ incentives to set up shop and expand in America.

Policymakers from both parties have already signed onto cutting corporate taxes. All three of the major bipartisan tax reform plans of the last few years — Bowles-Simpson, Domenici-Rivlin and Wyden-Coats — included provisions cutting the corporate rate, to 28%, 27%, and 24%, respectively.

Cutting corporate taxes represents the rare policy that delivers Democrats and Republicans exactly what they want. Liberals can look forward to higher public revenues. Conservatives can hang their hats on lower tax rates and improved growth prospects.

And for President Obama, lower corporate tax rates could create the millions of new middle-class jobs he’s promised to deliver in his second term — without any new government departments, commissions or appropriations. In fact, the move would actually return money to the Treasury.

Congress and the president should make it legislative priority number one.

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.

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