A lot has been said by policy experts, commentators, politicians and business groups about President Donald Trump’s tax reform plan. One of its cornerstones is a significant cut in the corporate income tax (CIT) rate. Is a CIT cut worthy of enactment? How does the United States statutory CIT rate compare with rates of other countries? And is there an “ideal” CIT rate that could be a “win-win-win” for enterprises, employees and the economy?
CUTTING THE CIT RATE
The United States currently has the highest CIT rate in the world, at 35 percent. That rate moves even higher when both state and federal taxes are considered. President Trump’s plan aims to cut the federal rate to 15 percent. However, 15 percent may not find enough support in Congress. The final decreased rate may actually wind up being closer to 24 to 26 percent, which is essentially the effective tax rate for the S&P 500 companies and about five percentage points higher than that proposed by the House Republican leadership.
There is evidence to suggest that a CIT rate of 24 to 26 percent would be ideal because it would make U.S. corporations more competitive with their global competitors. However, beyond allowing us to be more competitive on a global scale, any lowering of the CIT rate could have many other direct positive economic impacts. For one thing, it could spark an increase in wages.
Several well-respected studies have indicated that in developed countries, the higher the corporate tax rate, the lower the wages. A 2007 study from Europe titled Passing the Burden: Corporate Tax Incidence in Open Economies, found that “a 10-percentage point increase in the corporate tax rate of high-income countries reduces mean annual gross wages by 7 percent.” Another study, by the American Enterprise Institute, concluded that “Wages are significantly responsive to corporate taxation.”
HOW CAN LOWERING CORPORATE TAXES STIMULATE ECONOMIC GROWTH?
Moreover, the Commerce Department’s most recent figures showed that GDP growth remains sluggish; and at this writing, it’s expanding at an annual rate of less than 2.0 percent. This modest economic growth, despite an overall improving economy, may be attributable to the lack of business investment, as most major corporations continue to hoard historically high levels of cash. They are neither creating jobs nor maximizing innovation, because of the high CIT rate.
By lowering taxes, it is very likely that a lot of these corporations will ramp up investment and jump-start new products and services that will create more jobs and improve the economy. This is not a new idea; in fact, it goes back all the way to 1974, when economist Arthur Laffer famously drew a curve on the back of a cocktail napkin to illustrate how cutting taxes could spur the economy, benefiting enterprises, employees, consumers and the overall economy. That napkin now hangs in the National Museum of American History, and the “Laffer Curve” has, in many ways, influenced the course of contemporary economics.
Lowering the CIT rate will likely provide more available cash flow to corporate stakeholders, both large and small. How they choose to deploy that revenue remains to be seen; however, it is reasonable to assume it will spur job creation and expansion in terms of new product lines, mergers and acquisitions, etc., all of which will spur the economy, and should lead to measurable growth in the GDP and tax revenues.
TAKING THE ADVICE OF PROFESSIONALS
Tax reform, and especially CIT reform, may well be just the fuel to put the economy in escape velocity, achieving sustained GDP growth of 3 to 4 percent. However, any changes need to be prudent ones.
That means a great deal of analysis must happen first; any changes must be implemented correctly. We hope that when it comes time to actually implement the proposed changes—including a cut to the CIT rate—the Trump administration will draw on the substantial resources of the tax and accounting community to help realize the benefits of CIT reform.