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As the debate in Congress shifts to tax reform, and in particular to corporate tax reform and reducing the corporate tax rate, it is worthwhile to step back and review what we know and don’t know about U.S. corporate income taxes and their impact on American workers. More than a century has passed since the U.S. first adopted a system for taxing corporate income, yet basic answers to questions still confound policymakers. Is the U.S. a high tax or low tax country? Do workers bear the brunt of corporate income taxes? What is the optimal level of the tax rate to maximize revenues? The problem isn’t that we don’t know the answers or that research hasn’t suggested some answers, but rather that the answers can be counterintuitive and are often at odds with popular opinion. That makes it harder to think about and push through the right reform ideas. Let’s take a look at some of these questions.
Q: Is the U.S. a high-tax or a low-tax country?
A: A high tax rate country with low tax revenues.
A popular belief is that the U.S. is a low-tax country when it comes to corporate tax rates. But in fact, when we look at tax rates, the data show the exact opposite. A March 2017 report by the Congressional Budget office shows that when we compare statutory, average and effective corporate tax rates in the U.S. to the rest of the G-20 countries, the U.S. is a relatively high tax country. At 39.1% when including state taxes, the U.S. has the highest statutory rate in the G-20. Tax Foundation finds that the U.S. has the third-highest corporate tax rate in the world, exceeded only by Puerto Rico and the United Arab Emirates.
Of course, very few companies pay the statutory rate. The more relevant measure is the average tax rate, total taxes paid as a share of income, which accounts for deductions and credits. Our average corporate tax rate is 29%, the third highest in the G-20. The effective marginal tax rate, which captures taxes on the marginal unit of investment, is at 19%, the fourth highest in the G-20. In my work at AEI, we constructed such rates for OECD countries and a subset of developing economies. We reached a similar conclusion; the U.S. typically taxes companies at much higher rates than the OECD average. A 2013 paper from the NBER comparing actual taxes paid by companies based in the U.S. and other countries similarly finds that U.S. effective corporate tax rates were much higher than in other countries, with the exception of Japan. Since then, Japan has lowered its statutory rate by ten percentage points.
We still debate whether the U.S. is a high-tax country because we often hear news stories about companies paying very low taxes or offshoring profits to low-tax countries. And yet, both can be true. High-tax countries create incentives for companies to engage in tax planning to minimize their tax liability. Research suggests that companies are more likely to shift capital and investment from high tax to low-tax countries, controlling for other factors. If firms don’t physically relocate to low tax countries, they can still invert to low-tax countries or shift profits overseas. The CBO estimates that corporate tax revenues for the U.S. will decline from 2.3% of GDP in 2016 to 1.8% of GDP in 2025, partly due to such erosion of the corporate tax base.
In addition, our corporate tax code attempts to tax overseas profits of U.S. multinationals by taxing any money that is repatriated to the U.S. This creates incentives to keep any cash overseas rather than have it subject to additional taxation. By some estimates, more than $2.5 trillion of corporate earnings are “locked-out” overseas rather than being brought back to the U.S. If we stopped taxing companies on a worldwide basis, it is likely that some of that cash would come back to the U.S. and be reinvested here, resulting in higher domestic tax revenues.
All of this suggests we might be able to get more revenues by reducing tax rates, reforming the system of multinational taxation, and getting companies to invest and produce more in the U.S.
Despite high U.S. corporate tax rates, we collect less in corporate tax revenues as a share of GDP than the average for the other OECD countries. Commentators see this and mistakenly conclude that the U.S. must be a low tax country if it collects so little revenue. In fact, it’s precisely the opposite—high tax rates lead to low tax revenues.
Q: Who actually pays the corporate income tax?
A: A large share is borne by workers.
Cutting corporate tax rates is hard because it is popularly assumed that high corporate taxes are paid by rich shareholders. But a growing body of evidence suggests that workers bear a significant share of the corporate tax burden.
In 2006, Kevin Hassett and I co-authored the first empirical study on the link between corporate taxes and manufacturing wages. Our paper uses data on international tax rates and manufacturing wages for a panel of 65 countries over 25 years, and we find that the incidence of the corporate income tax is significantly borne by workers. Other papers studying the incidence of the corporate income tax, with different datasets over varying time periods, have found similarly significant effects. We have reviewed these earlier. For instance, Harvard University economists Mihir Desai, Fritz Foley and James Hines use data on U.S. companies operating in approximately 50 countries over 15 years. In a stylized model in which they constrain the total burden to be at 100 percent, they find that between 45 and 75 percent of the corporate tax is borne by labor. In a paper published in the European Economic Review, Wiji Arulampalam, Michael Devereux and Giorgia Maffini find evidence that a $1 increase in the corporate tax liability reduces average compensation by $0.49. A National Tax Journal article finds that a $1 increase in corporate tax revenues reduces wages by approximately $0.60 cents.
While the academic literature on this topic finds a wide range of wage responses to corporate tax increases, all studies find that a non-negligible portion—and many find a significant portion—of the corporate tax burden falls on workers. Even though it is commonly believed that corporate taxes are a tax on the rich, in reality workers also pay for corporate income taxes through reduced wages. This is critical to keep in mind as we discuss ideas for corporate tax reform as well as in discussions of how to help workers improve take-home pay.
Many government agencies assume that a lower share of the tax burden is borne by labor than by capital for modeling purposes. The Joint Committee on Taxation assumes that capital bears 75% of the corporate tax burden while labor bears 25%, and the Treasury assumes that 82% of the tax falls on capital income and only 18% on labor. But it is important to point out that these are assumptions, not estimates derived by these agencies. As we learn more about the incidence and newer research confirms or modifies existing estimates about incidence, the agencies may change their assumptions accordingly.
Q: Can we fix the corporate income tax code?
Corporate tax reform is hard for a multitude of reasons, including complexity and resistance from entrenched interests. But we understand the numerous problems that exist with our current corporate tax code, and we recognize the negative effects of high corporate tax rates on workers and the economy. Reforming the corporate tax code could improve U.S. competitiveness in the global economy, lead to higher rates of investment and subsequent economic growth, and raise the take-home pay of workers. There are excellent ideas to reform the system, either by moving closer to consumption taxation (such as through expensing and a border adjustment) or by taxing shareholders rather than corporations directly, as my colleague Alan Viard has written (with Eric Toder). We should consider these seriously.
It’s about time we let facts get in the way of opinion. More than just the rich, average workers are hurt by high rates of corporate taxation. The sooner we can fix that, the better.
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