Why Lower Corporate Tax Rates?

Edited 1/18, 12:28pm EST

We've had a few readers ask why Congress wanted to lower corporate tax rates in the US. In particular, US corporations already have record-setting profits--why do they need more money? Should we, instead, be raising taxes on corporations?

A quick Google search shows that there's tons of commentary that believes the tax cut is simply a handout for big corporations, perhaps to help the rich, or grease the pockets of corporate donors. Indeed, plenty of articles make the case that the corporate tax cuts won't create jobs at all. 

In looking at a few, including those from the New York Times, Salon, and The Hill, they all make the case that extra profits won't be re-invested. From The Hill:

"The logic goes like this: Corporate tax cuts will increase after-tax profits, which will boost private savings. Higher profitability will spur firms’ incentive to invest and the new savings will make funds available to finance these new investments. These investments will in turn boost productivity which will boost workers’ wages.

This is a long chain of events that has to happen, and most of its links are pretty weak when tested against real-world data. After-tax corporate profits are already near historically high, and interest rates incredibly low, and yet investment has been weak.

Why would doing more of the same (i.e., fattening companies’ profit margins) all of a sudden reverse this trend? And even if investment picks up and boosts productivity, there is no guarantee that this will boost a typical workers’ wages."

It's a sound counter-argument. The problem is that these counter-arguments are all arguing against the wrong argument. The logic behind a corporate tax cut is not in fact, "more corporate profits will mean more jobs." 

If that's not the argument, what is?

Corporate Tax Competitiveness

Before the GOP tax bill, the United States had (essentially) the highest corporate tax rate in the world. There's ongoing economic debate over whether it has the highest effective tax rate in the world, an average effective tax rate, or somewhere in between. The CBO says that for equity-financed corporations (such as publicly-traded ones) the effective tax rate is very close to 35%. Effective corporate taxes in the US are fairly lumpy, with some corporations paying very little and others paying close to the nominal rate.

Note that the US actually settled on 21%. The above graph is just the best illustration I could find that I don't need to make my own darn self.

What does this mean? Essentially, if a corporation wants to do business in the US, it has to pay more of its profits to the US than if it were to do business elsewhere. With the new corporate tax cut, it pays fewer taxes in the US than in most other places

So here's the actual argument for reducing the corporate tax rate:

  1. Corporations want to maximize profits, after taxes and all other costs
  2. If they can maximize their profits by moving their HQ, their operations, or their money to another country, they will do so, because of the incentive to maximize profits
  3. If you have the highest corporate tax rate, you are creating incentives for corporations to do more of their business outside the US
  4. If you reduce the corporate tax rate, you increase the incentive for corporations to do more of their business in the US
  5. When corporations do business in the US, rather than not in the US, they produce more economic activity in the US, create more jobs in the US, and pay more taxes in the US
  6. If you're really lucky, you'll bring in so much new business that you won't lose much in the way of total tax revenue, or might even gain revenue

One can have a debate over that logic--whether it's sound, whether it will hold up--but to argue that "lowering the corporate tax rate is designed to create jobs by giving corporations more money to invest," is just a straw-man argument.

(That's not to say someone isn't making said straw-man argument. But it's not the best or most accurate argument in favor of lowering corporate taxes.)

Is this actual argument--of changing location incentives--totally bogus? Good question. However, it does seem to be that at least one very large corporation has responded to this incentive in the way that it was designed.

Example: Apple

Apple just announced yesterday that in response to the tax overhaul, it's going to bring $350B back to the US from overseas, paying the US $38B in taxes to do so, over the next five years (here's their official statement). This is in response to  the scrapping of a provision that allowed companies to defer US income taxes on foreign earnings until they returned the income to the US. 

Tim Cook also announced in the same release that Apple also plans capital expenditures of $30B in the US that it wasn't before, which would create 20,000 new jobs.

If this is a genuine response to incentives--rather than an incredibly expensive PR move--then Apple is doing what the designers of the corporate tax cut hoped: realizing that with a lower tax rate in the US, it would rather do more of its business in the US and pay US taxes, than do more business elsewhere and not pay US taxes. That is--again, if Apple is actually just rationally responding to incentives--it is deciding it would make more money doing more stuff in the US. It pays more US taxes, and the US economy grows. (NOTE: Reader "Gary" tells me that some or all of this capital expenditure was planned before the tax bill was passed--I'm doing research to confirm as of 1/19/2018.)

Apple is just an example, and it's not yet clear if this is a trend. Forbes estimates there is $3.1T total in US corporate assets held offshore, and there are of course many US-operating businesses that don't pay any US taxes and station parts of themselves overseas to lower their tax burden. (Popular offshoring methods include schemes with names as colorful as "A Double Dutch With an Irish Sandwich," which is unfortunately more about paperwork than either jumprope or boiled ham.)

How much of that money will come back to the US, and how much new economic activity will occur in the US now that would have occurred overseas without the corporate tax reduction? It's impossible to say now, and in retrospect people will only be able to estimate. 

NOTE: This article only addresses the corporate tax cut portion of the Tax Bill recently passed by Congress. It is not meant to include any arguments about any other portion of the bill. 

The ReConsider Lesson

Remember that if you hear someone say, "the argument in favor of this proposal is X, and said argument is stupid because Y," it's time to use some external skepticism. Consider whether the argument in favor is actually the best, or most accurate, argument in favor of something. If it's not, you can win a debate and earn points for it on the circuit, but you're not actually determining--for yourself or anyone else--whether the policy is a good or bad one.

Instead, look for the best argument in favor of something. If you can defeat that, then you're probably getting closer to the truth. If you can't, then it's time to do some more research and thinking!

Bonus: A Good Debate on Corporate Taxes

Want to see what smart people put together to debate corporate tax rates?

The Chisel has once again come to our aid. First, they put together a shared set of facts to work from that smart people across the political spectrum agreed to. They then put together a proposal--again, shared between people across the political spectrum--of how to most effectively reform corporate taxes in the US. While we don't endorse any particular proposal, seeing the underlying process of how a multi-partisan group came together to agree on one is really helpful. Enjoy!

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Erik Fogg

We do politics, but we don't do the thinking for you.