Part one can be read here.
Factors Weighing in Favor of Repeal
The nominal rate structure of the corporate income tax in the USA was extremely uncompetitive prior to the TCJA. (The lower rate that followed in the wake of the 2017 tax cut act makes the country more competitive, but we still have a long way to go.) Following recent rate cuts in Germany and Japan, the then U.S. top marginal rate of 39.1% was exceeded only by Chad and the United Arab Emirates. Additionally, the United States had the highest corporate tax rate in the OECD. As a counter to these statistics, the argument is made that many large U.S. companies pay far lower real rates than the nominal rates quoted in Section 11 of the Internal Revenue Code. This argument contains accurate facts, but they do not think they prove what proponents hope they prove. The primary lesson to be learned from the fact that Apple and General Electric pay so little corporate income tax is not that high marginal rates cause little deadweight loss, but instead that high marginal rates both create deadweight loss in the resources expended to avoid them and benefit large corporations that have the resources to evade paying that rate which is quoted in the IRC.
In the past thirty years the trend in the OECD, and more specifically in Western Europe, has been to dramatically reduce corporate income tax rates. Countries who have followed this trend include many important trading partners and serve as a control group for testing the effect of lower marginal rates on corporations’ choice of location for domicile and “parking” of their assets. The very fact that many corporations are using the lower tax regimes in parts of Western Europe as integral components of their general tax avoidance strategies necessarily proves that, at the very least, lower marginal taxes attract financial assets to a country.
But evidence can be manipulated, and there are dozens of other factors that might attract investment to these countries. So, let’s look at the problem from a purely mathematical perspective. Assume Firm X has $100 in an investment and earns a 7% return (before taxes) on that investment. With a corporate tax rate of 10%, net income after taxes is $6.30. Therefore, with a relatively low corporate tax rate, the firm has a 6.3% real rate of return. This may not seem like too severe an effect, but it must be realized that, as the marginal rate increases, the real rate of return decreases exponentially. For example, a corporate tax rate of 40%, levied on the same corporation, reduces net income after taxes by $2.80. Now Firm X has after tax income of $4.20, a real after-tax return of 4.2%. The question must be asked: why would an entrepreneur want to start Firm X domestically? Additionally, why would Firm X want to place a significant part of its operation in the United States, if its expected rate of return on that investment, with a 40% marginal income tax rate, would be approximately equal to what can be expected when investing in inflation-protected (and eminently “safe”) Treasury Bills?
The fact that fewer such enterprises will be started (or moved to and expanded in the U.S.) necessarily leads to a prediction of slower economic growth, as fewer firms will choose to do significant business here and the economy will be characterized by less entrepreneurial dynamism. In other words, only those firms that are so dependent on doing substantial business in the United States (or other comparatively high-tax nations) for exploiting their comparative advantage will choose to do so. Only those businesses for which the opportunity cost of incorporating elsewhere still exceeds the marginal rate of return available to them in the United States will remain. Because the United States is an economic giant that accounts for nearly a third of the world economy, the number of firms that fit this description will necessarily be large, and so the effect of inordinately high rates may not at first appear as significant as it actually is.
This is especially true because the real rate of taxation on corporate incomes is much higher than the marginal rate applied to the corporation’s income — other taxes on corporate profits, such as those levied on dividends and capital gains, must be considered as well. In any event, the above example serves two purposes. First, it serves to show that high tax rates can have a significant effect on corporate decision-making processes. Second, it emphasizes the truth of the earlier postulate that only individuals can bear the incidence of taxation.
For example, if Firm X has enough market power that it can transfer the incidence of the tax to its customers, it will do so. In this case, consumers will bear the tax, and will have less disposable income to save or to spend on other goods and services. If Firm X does not have sufficient market power to transfer the incidence of the tax to customers, it will either attempt to cut costs, including by reducing wages (in which case workers bear much of the incidence of the tax) or reducing payments to shareholders (in which case capital owners bear the incidence of the tax). Whatever the situation, the result is the same: people, rather than the abstract entity of a corporation, pay the corporate income tax.
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