Congress Needs to Finish Strong on Tax Reform

Some days ago, a business news program guest offered the following poser regarding Congress reducing business tax rates: I would ask the question to the Republican leaders, what insight, what experience do they have, what evidence do they have, that the reduction in taxes for all these corporations are going to result in job growth, higher wages, or an opportunity for their people to grow. Show me the evidence.

Fair question. The simplest evidence is the obvious observation that prices matter. The real pro-growth aspects of tax reform do not follow from tax cuts in the bill, but the reforms - the changes in incentives or more specifically the reduction in the distortion to incentives imposed by taxation.

Tax policy, both the rates and the definition of what is subject to tax, alters the all-in prices individuals and businesses face for the services they offer, the items they purchase, and the investments they make. These price distortions in turn distort economic decision making and reduce the level of output and income.

In tax reform, the most important price affected is the cost of capital. Lower the cost of capital and you get more capital employed. Pretty basic. Tax reform dramatically lowers the cost of capital primarily by reducing business tax rates and moving to expensing. Consequently, the stock of productive capital will be much larger, workers will have more and better capital to work with thereby raising their productivity, and higher productivity then translates into higher wages.

These concepts are not new. They’ve been around for decades as described in the last 20 years by the National Bureau of Economic Research program on tax policy. If one prefers a more international perspective, a 2008 OECD paper argued the corporate income tax (or more generally, business income tax) is the “most harmful for growth” of all the major tax systems.

To be sure, some nationally known economists now argue business tax rate reductions don’t really matter to economic growth because lower rates wouldn’t really change incentives. Yet these same naysayers typically strongly favor tax policies like a carbon tax because they believe, and even opponents generally agree, a carbon tax would move the economy away from fossil fuels. This selective recognition of tax policy’s effects on decision making suggests more than a dose of political chicanery has seasoned their reasoning.

Is there any other evidence business tax rates matter? How about the actual corporate tax rates levied by some of America’s competitors:

• Russia – 20%
• United Kingdom – 24%
• China – 25%
• Germany – 30.2%

The United States currently imposes the highest statutory tax rate at 39.1% when the state and local tax is included. If the federal government imposes a 21% top corporate tax rate, then the combined rate would fall to 25.1% rate, just below the OECD average.

To be sure, average and effective tax rates differ from the statutory rate, but the current U.S. rate is in the top three or four by these measures, as well. Do America’s competitors keep pushing their corporate tax rates down because they don’t need the money? Nonsense. They do it because they know a country with uncompetitive tax rates is a country with increasingly uncompetitive companies.

Those who argue business tax rates don’t matter might want to check with the Chinese government. The Chinese is properly worried the U.S. tax reform legislation would give America a serious leg up competitively. So are the Europeans, who’ve steady reduced their corporate tax rates over the years while the United States slept. When your toughest competitors are worried about something you’re doing, it’s pretty strong evidence you’re doing something right.

Still not convinced? Consider Bill Clinton’s comments just over a year ago, “I think it [the corporate income tax rate] should be lowered.” Clinton went on to say the United States needed to get the corporate tax rate as close to the international average as possible to bolster competitiveness, to which congressional tax writers can now respond – bingo.

America’s workers and businesses have been held back for far too long by overly oppressive regulatory policies and an antiquated, anti-growth tax code. The Trump administration has and is moving aggressively on the former. The House and Senate have made a great start, and now it’s time for Congress to finish work on tax reform.

About the authors

J.D. Foster

Dr. J.D. Foster is the former senior vice president, Economic Policy Division, and former chief economist at the U.S. Chamber of Commerce. He explores and explains developments in the U.S. and global economies.