With polling data indicating that the U.S. economy is becoming the most pressing topic for voters, the Wall Street Journal offered an important editorial yesterday on corporate tax rates: http://online.wsj.com/article/SB119673397691112663.html (subscription required). The article focuses on a growing body of research on the economic effects of high relative corporate tax rates, citing a recent NBER study:
The authors conclude that "corporate taxation reduces the return on capital and thus discourages investment" and "reduces the cash flow of the firm" in such ways as to reduce the after-tax capital available for reinvestments.
That would be good enough, but the editorial board included a critical observation on the proposed tax reforms coming out of Congress, where lower corporate tax rates are proposed, but alongside higher personal tax rates. This is despite the fact that many forms of business, especially among small to medium size firms (including ours), are subject to the personal income tax schedule, and not corporate taxes. The obvious implication is that, using Chairman Rangel’s proposal as an example, the business tax burden would be tilted away from large corporations and onto smaller businesses (hardly a populist prescription). Furthermore, it is highly questionable whether the Rangel proposal lowers corporate tax rates to a level that would meaningfully improve America’s competitive position in business taxes. In all, the net economic effects of the Rangel plan do not appear to be desirable in the least, as its hoped-for redistributive effects simply can’t work in a competitive global financial economy:
…raising the U.S. personal income tax rates would also stunt small business entrepreneurship…In Mr. Rangel’s case, the benefits of his cut in the corporate tax…to 30% would be offset…by raising the top marginal tax rate on individuals and small businesses to as high as 44%. The NBER research suggests this could discourage hundreds of thousands of small businesses from being formed in the next few years.
Of course, the WSJ is outlining the extreme case here–few new businesses are likely to incur the top marginal tax rate right away, after all. And most would simply reorganize once they start approaching that level of profitability. However, imposing such a necessity on highly productive enterprises is an undeniable misallocation of capital, with dead weight costs for the national economy.
Summing it up, there are at least three critical takeaways. Ideally, our tax code would not extract income from productive activities, but as long as it does, the following objectives would help to ensure the best long-term economic results:
(1) level the playing field between the U.S. and all other economies with respect to business taxes
(2) level the playing field between large and small businesses in the U.S.
(3) make the choice of corporate organization independent of the tax code
An additional benefit that is rarely ever mentioned in regards to the tax code, is that these objectives would also support the value of the U.S. dollar, another issue that promises to play a role in the 2008 elections.