Last week President Trump’s team proposed to cut the corporate tax rate from 35% to 15%. Tax reform that cuts the tax rate and also closes loopholes is an excellent idea that would benefit all of us.
Popularity of corporate taxes
Taxing corporations is popular. Gallup and Pew Research surveys both show that more than half of Americans believe that corporations don’t pay their fair share of taxes.
I think some people support high corporate taxes out of ignorance, believing that such taxes impact only these entities we call corporations. Taxes are usually more popular when people think someone else will pay them. 🙂
Who pays corporate taxes?
The problem with that mindset is that corporations do not really pay taxes. Individuals do:
- Consumers pay corporate taxes via higher-priced products and services (consumers ultimately pay for ALL business costs because they are built into the selling prices that consumers pay).
- Workers pay corporate taxes via lower compensation or fewer jobs.
- Shareholders (the owners of the corporation) pay corporate taxes via lower stock prices and dividends.
It all flows to individuals. In reality, corporations are more tax collectors than tax payers.
To illustrate, let’s look at how a tax increase would impact individuals. All businesses will respond to a tax increase in one or more of the following ways:
- Increase prices – Companies will try to pass cost increases to their customers. In the long run, they will likely succeed in passing at least some.
- Reduce other costs – Companies will offset higher taxes by reducing the number of employees or their pay, by forcing suppliers to take price cuts, by cutting travel cost, and so on.
- Accept lower profit margins – Companies don’t want lower profit margins, but if they cannot offset elsewhere then they will be forced to accept lower profit.
Supporters of corporate tax increases prefer to think that tax increases cause only the third effect above, reducing corporate profit. That is not reality. Higher taxes will harm consumers, employees, or supplier employees. In the end, everything rolls downhill, good or bad.
Reducing corporate profit harms many
Supporters of tax increases also prefer to think that reducing corporate profit will only harm ‘the corporation’ or millionaire shareholders. This, too, is not reality.
Reducing corporate profit causes much wider harm:
First, lower profits will cause companies to reduce investment in expansions, equipment upgrades, and technology. That means less growth, fewer jobs, and less innovation. For marginal companies, it may even mean a slide into bankruptcy. Naturally, all of this harms workers and consumers.
Second, lower profits will indeed harm shareholders, but more than just millionaires. Roughly half of Americans own stock, directly or via funds, so the harm reaches into the middle-class. Furthermore, pension funds also own stock, and most pensioners are not millionaires.
In short, the damage from reducing corporate profit is not restricted to millionaire investors.
US tax rate too high
The problem is that the U.S. corporate tax rate is too high. Including the average state tax, the U.S. corporate tax rate is 39%. According to the Tax Foundation, the U.S. rate is the third highest in the world, behind only United Arab Emirates and Chad. It is THE highest rate among all developed economies. It is much higher than the global average of 23%, and the European average of 19%.
How did we get here? Over the past couple of decades many countries have reduced their tax rate while the U.S. has not.
Why high tax rate is bad
Why is a high corporate tax rate a problem? It makes the U.S. less competitive at attracting new businesses. It discourages new investment in U.S. businesses, by Americans or foreigners. It encourages U.S. businesses to move their headquarters to lower-tax countries or to keep their cash abroad.
All of this bad for economic growth, job creation, and innovation.
In a world where capital can and does move around the globe, capital will flow to where it is treated well. Among other things, this means that capital will flow to countries with lower taxes. Simplistically, a new factory with taxes of 15% is more likely to be built than a new factory with taxes of 39%.
Why low tax rate is good
A 15% tax rate would make the U.S. a more competitive and attractive place to do business. NOTE: A business-friendly environment is good not for the sake of helping businesses, but because it helps society achieve broad prosperity.
Think of it this way: Society creates or realizes new jobs, productivity gains, and innovation primarily through businesses. Therefore, it makes sense to erect the smallest possible tax barrier at the business level.
In fact, it would probably be good for overall prosperity if the corporate tax rate was zero and we instead collected all business taxes at the shareholder level. Politically unlikely, to be sure…
A low tax rate with few loopholes will do several good things:
- It will cause businesses to base decisions more on actual economic fundamentals and less on arbitrary factors in the tax code.
- It will encourage work and investment.
- It will make the U.S. more competitive.
- It will reduce crony capitalism and political corruption.
- It will reduce the unproductive time spent by businesses trying to avoid taxes and by the IRS checking complicated tax returns.
These factors will then lead to greater prosperity through some combination of faster economic growth, more jobs, productivity gains, innovation, lower prices for consumers, and higher wages for workers.
In case you’re worried about tax collections, a low tax rate with few loopholes will also collect more taxes than you probably think. Stronger growth and less tax avoidance will act to increase tax collections and at least partly offset the drop due to a lower tax rate.
So… don’t buy any hype from politicians or journalists about the horrors of a corporate tax cut. We need a tax cut just to regain competitiveness versus the world. And lower corporate taxes are good for everyone.
I encourage you to enter comments or questions below. Two rules: 1) be reasonably polite, 2) address the issue and avoid personal attacks.