Slashing the Corporate Rate Is the Best Part of the Tax Bill

The House and Senate versions of the recently passed tax bill have several shortcomings, including their likely effect on the deficit and failure to eliminate tax loopholes for special interests. Cutting the corporate tax rate is not one of these shortcomings.

More than any other part of the legislation, those cuts can benefit American workers, despite the widespread belief that they only help wealthy corporations and their shareholders.

It is true that the tax bills do not change individual income tax rates nearly as much as they change corporate tax rates. But neither the income tax nor the corporate tax primary effect on the economy is what some people assume it to be.

The main economic benefit of a lower corporate income tax does not come from corporations or their shareholders spending the extra after-tax income they may receive. The same is true when individuals pay less in income taxes: People may spend more, but this will be offset by additional government borrowing to make up for the loss in tax revenue. 

The true benefits of lower corporate tax rates come because corporations will anticipate being able to keep more of what they earn. This expectation of a larger payoff from each dollar invested will motivate them to invest more, and the investment will contribute to faster economic growth.

The Tax Foundation estimates that changes to corporate taxation in the House bill will increase GDP by 2.8 percent between 2018 and 2027.

More specifically, public corporations employ a substantial percentage of Americans, so how much they are willing to invest determines whether they will hire more people. The top statutory corporate tax rate in the United States, at 39.1 percent (including both federal and state taxes), is higher than that of any other developed country.

This reduces corporations’ incentive to invest here in America and encourages them to outsource operations and jobs overseas.

In today’s global economy, corporations decide where to invest by comparing expected rates of return in different countries. Lower tax rates would increase the expected rate of return from investing in the United States, assuming everything else stays the same.

The top statutory corporate income tax rate in America is currently about 10 percentage points higher than the weighted average tax rate for all G20 countries.

More corporate investment inside our own borders should also lead to more profits. The taxes on those profits will at least partly offset the lower tax revenue paid per dollar of profit.

To be clear, the effect of the corporate taxes on investment does depend on more than just the tax rates themselves. It also depends on whether corporations can deduct the costs of financing their investments from their taxes.

In America, they can deduct interest payments but not dividends or retained earnings. This gives them an incentive to finance their investments with debt rather than equity.

So, because high U.S. corporate tax rates discourage equity-financed investment, lowering rates should help alleviate the problem and even increase overall corporate investment.

There is another reason that lower corporate tax rates are likely to benefit workers. When corporations invest more, workers are more productive. As worker productivity increases, wages increase. By one estimate, more than 70 percent of the burden of corporate income taxes is borne by workers. 

Because of intense international competition for investment, cuts in corporate income tax rates are likely to have a bigger effect on economic growth than reductions in individual income tax rates. By contributing to higher wages and faster economic growth, the large cut in the corporate income tax rate should yield widespread benefits for Americans.