The other day I endorsed President Obama’s new offer of a corporate tax cut in exchange for some temporary jobs measures in infrastructure and manufacturing. My endorsement was a bit grudging, though, because it’s not obvious to me that we need a big corporate tax cut while it is obvious that revenue neutral proposals like this one can be problematic.
How so? First, if we’re going to meet the challenges we face down the road, from retirement security to the safety net to investments in kids’ mobility to productive public goods, we’re going to need new revenues. There’s no other way we can get there from here while maintaining a sustainable budget, absent unacceptable spending cuts (see House budget).
Second, this lower-the-rates-broaden-the-base tactic raises the specter of the tax-reform trap. More on that in a moment.
Counter to that is that idea that our corporations’ competitiveness is being hurt by the relative high US corporate tax rate of 35% (the President’s proposal would take the statutory rate down from 35% to 28%). I’d take that more seriously if the effective corporate rate wasn’t a lot lower than the statutory rate—around 28% overall and a lot lower (18.5%) for profitable Fortune 500 companies. Still, it would surely be better simplify the corporate code, close some loopholes, and depending on how much we broadened the base, give back some points on the rate.
So I get the competitiveness argument in theory. But in practice, it really looks like US corporations are a) uniquely profitable and b) contributing historically low shares of revenue to the national coffers.
The first figure shows federal corporate tax receipts as a share of GDP (left axis) along with a kind of proxy measure of their effective tax rate: tax receipts over pretax profits (right axis). There’s bips and bops along the way, but the trend is clearly down. Taxes as a share of profits are down by about half, from 40% to 20%; revs/GDP are down from about 4.5% to about 2%.
The next figure shows after-tax profits as a share of GDP to be near an all-time high. In fact, the extent to which corporate profits bounced back from the financial crisis is quite remarkable, especially compared to so many other parts of the economy that are still just slogging along.
Clearly, these are very tough times for political compromise, wherein you’ve gotta give something to get something. But I think these pictures would lead an objective onlooker to be more than a little skeptical of revenue neutral corporate tax reform.
A final point: the tax reform trap is what you get stuck in when policy makers sign off on an alleged neutral deal but end up with a lower rate, a base that is only slightly expanded, and less revenue. My CBPP colleagues are looking into this, but it’s really expensive to take seven points off the rate. There may well be loophole, deduction, and credit-closure proposals that would fill a revenue hole of that magnitude, but that’s still to be seen.
Like I said, I’m sure our companies waste far too much valuable time both complying with and skirting a messy corporate tax code. But on competitive, revenue, and fairness grounds, it’s hard to see a compelling and urgent case for revenue neutral reform.