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Department of Unintended Consequences — Part IV June 16, 2007

Posted by federalist in Taxation.

Proof that you can’t arbitrarily raise taxes to create government revenue is noted by Jason Furman:

[T]the United States has the second highest corporate tax rate in the OECD but the fourth lowest corporate tax revenue as a share of GDP in the OECD.  Moreover, something is wrong when the effective tax rate on equity-financed corporate investment is 36 percent but the effective tax rate on debt-financed corporate investment is -6 percent. 



1. federalist - July 26, 2007

We should all be happy to see Treasury Secretary Paulson agitating to cut the corporate tax. R. Glenn Hubbard’s essay today makes it clear this is a wise move all around:

Economists have stressed for generations that corporate taxes distort the allocation of capital between the corporate and noncorporate sectors and that they also distort corporate investing and financing decisions. This distortion prevents the tax from “efficiently” raising revenue — that is, the tax imposes a larger cost on the economy than it raises in revenue.

In the early 1990s, both the Treasury Department and the American Law Institute recommended removing one layer of our current double taxation of corporate equity capital, which is subject not only to the corporate tax but to investor-level taxes on dividends and capital gains. In 2003, President Bush’s tax cuts reduced — though they didn’t eliminate — this double taxation.

Who bears the corporate tax burden? Some may be tempted with a quick answer, “corporations.” But that is clearly wrong. The Econ 101 admonition that people pay taxes — in this case, suppliers of capital through lower returns, workers through lower wages, and/or consumers through higher prices — remains true even when the tax is aimed at capital. … In his celebrated analysis of the corporate tax almost 50 years ago, Arnold Harberger showed, for a closed economy, that a separate tax on corporate capital would reduce returns to all owners of capital, making it a tax on saving (and, in a framework more general than Mr. Harberger’s, on investment).

In an open economy, with mobile capital, a source-based tax like the corporate tax will lead to a capital outflow, reducing investment and productivity and wages. Indeed, Mr. Harberger’s updated research on the incidence of the corporate tax concluded that labor bears not just the brunt of the tax, but a burden that may be larger than the tax itself.

In other research assuming that the world-wide capital stock is fixed, William Randolph of the Congressional Budget Office finds that labor bears about 70% of the corporate tax.

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