Are Corporate Tax Cuts Needed?

With President Obama suggesting in his Tuesday’s State of the Union address the possibility of a corporate tax cut I was left wondering; is it needed and will it help.

First, let me state that I believe the federal burden in this county is too high. Serious structural changes need to be made to correct our long-term fiscal trajectory. In general, I believe government spending is too high and taxes as well. This philosophical framework aside, I had to ask myself are corporations the best entities to target for tax cuts.

The data shows that corporate taxes rates have been generally declining for decades. The current rate of 28% (calculated as taxes on corporate income ÷ corporate profits before tax[1]) is the second lowest level since 1947. See chart below.

Furthermore, it does not appear lower corporate tax rates result in higher GDP. Real GDP has trended down slightly since 1947 while corporate tax rates have declined significantly. Obviously there is more to the slowdown in the GDP growth trend than corporate taxes but even when looking at year-over-year change in the tax rate there does not appear to be a boost to GDP. The correlation between the year-over-year change in corporate tax rate and GDP is a weak, but surprisingly positive, .35. Since 1947, an increase in corporate tax rates has been positively correlated to GDP and only slightly negatively correlated to unemployment rates (-.27).

While I am nearly universally opposed to tax increases it does not appear corporate rates are a good target for cuts. At most, it appears that a tax cut would boost corporate net incomes and therefore potentially equity valuation but it should not be viewed as a silver bullet to robust GDP growth and maximum employment.

[1] Taxes and profits are from line 18 and 17 respectively in the BEA NIPA table.


One response to “Are Corporate Tax Cuts Needed?

  1. Randy Rogers February 2, 2011 at 3:51 pm

    Interesting post, but unfortunately statistics can be manipulated graphically to make any point, as is done all to often in the media. Corporations don’t evaluate corporate tax rates in comparison with our GDP as you have done here. They base their operations where corporate taxes are reasonable as compared with those of other countries, thereby reducing their operating expenses and allowing for competitive pricing of their products in the global marketplace.

    You can’t legitimately evaluate a tax rate vs GDP trend over a 70 year timeframe without acknowledging the structural changes in the global economy, mainly in the last 10-20 years. Also, your use of linear regression glosses over the drastic changes in the tax rates and the resultant GDP increase with each significant tax reduction (i.e. the 1950’s, 1980-82 and 2000-02). The benefits are apparently short-lived with subsequent administrations raising the tax rates.

    The US has the highest tax rate as compared to all other developed countries, the only relevant comparison in this case. Tax rate reduction is necessary for American and foreign corporations to consider the USA as an economically suitable home for their operations.

    Otherwise, tax revenues (and GDP) will continue to decline or, at best, stagnate as corporations relocate to more business-friendly countries and our regime will try to raise tax rates to compensate, which would exacerbate the problem and prolong the recession.

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