U.S. Corporate Income Tax Relief Good for US, the World and Small Businesses

By at 9 August, 2018, 8:32 am

Small Business Insider

by Raymond J. Keating-

It’s always troubling when after reading an article, you have to go back to see if the piece appeared in the news, analysis or commentary section of the newspaper or website. That was the case with an August 6 Wall Street Journal piece titled “U.S. Corporate Tax Cuts Likely to Hit Other Countries’ Bottom Lines,” authored by Richard Rubin.

The piece focused on the findings in a paper by economists at the International Monetary Fund carrying the title “Tax Spillovers from US Corporate Income Tax Reform.”

The points made and findings served up in the IMF paper are generally sound, straightforward economics. For example, among what was noted:

● “Tax competition and declining corporate income tax (CIT) rates are not new phenomena. However, over the past 30 years, the United States has been an outlier in not reducing tax rates Combined with the worldwide system of taxation, this is widely regarded as having served as an anchor to world CIT rates. Now the United States has cut its rate by 14 percentage points to 26 percent (21 percent excluding state taxes), which is close to the OECD member average of 24 percent… Combined with the (partial) shift toward territoriality, this may intensify tax competition.”

● “Given the combination of highly mobile capital and source-based corporate income taxation, pressures on tax systems are not surprising. Tax policy spillovers are common and can be significant and sizable (IMF, 2014). For example, lowering tax rates increases a country’s attractiveness as a place for investment and reduces outward profit shifting. However, this advantage is eroded when other countries do the same, leading to renewed incentives to reduce rates and to potential losses of tax revenues.”

● “The U.S. rate cut will strengthen incentives to report profits in the United States and can be expected to lead to profit shifting out of a broad range of countries. That countries, which used to have tax rates below the U.S. rate and are now above lose part of their tax base is intuitive. However, given the tradeoff between the cost of profit shifting and the tax saving, even countries that remain above or below the U.S. rate may see a larger share of profits reported in the United States following the tax cut, because their relative position has changed.”

● “Taxation affects the net return to capital and the theory thus predicts that the U.S. rate cut should foster investments in the United States. Taxation is not the only factor driving investments, but a substantial body of empirical evidence shows that corporate taxation is important in explaining investment levels globally.”

● “The most clear-cut, and possibly largest, spillovers are still likely to be caused by the cut in the tax rate. As shown in this paper, they could lead to significant reallocations of tax bases and investment across countries. Depending on parameter assumptions, we find that reform will lead to average revenue losses of between 1.5 and 13.5 percent of the MNE [multi-national enterprises] tax base. The finding of large spillovers should not be read as a criticism of the reform. This paper does not attempt to answer the question of whether any resulting allocation is more or less ‘fair’ or efficient than the previous one—which may in any case be an impossible question to answer. It simply attempts to describe, and as best as possible, quantify the main spillover channels.”

● “The paper has also discussed the likely policy reactions of other countries. To the extent that they actually take place, and tax rates elsewhere also fall (by on average around 4 percentage points based on tentative estimates), the effects on profit shifting and relocation of investment will be more muted, as relative tax rates will change less than in the static policy scenario, but the revenue impact will be greater. Some jurisdictions may still be affected very strongly, for example low tax jurisdictions, which will find it difficult, if not impossible, to maintain their relative attractiveness.”

A last point is worth highlighting: “So far, despite falling tax rates, CIT revenues have held up relatively well.” That speaks to the growth effects of reducing income tax rates, though the study’s authors raise questions as to whether this will hold up from a tax competition standpoint if rates are pushed still lower.

As for the Journal report, several points are correct from an economics and reporting perspective, such as:

● “Companies will be more likely to put profits and real investment in the U.S. than they were before the U.S. lowered its corporate tax rate from 35% to 21%, according to the paper. That will leave fewer corporate profits for other countries to tax.”

● “‘When one country cuts tax rates, usually other countries follow,’ said Alexander Klemm, deputy division chief of the IMF’s tax policy division and one of the paper’s authors. Countries with significant activity by multinational corporations and close economic ties to the U.S. will likely experience the biggest revenue losses, Mr. Klemm said.”

● “Although the marginal tax rate doesn’t describe the actual rate that companies pay, it does affect corporate decisions about where to put profits and investment and how aggressively to avoid taxes. The U.S. left its 35% rate alone from 1993 through 2017 and watched that rate move from the middle of the pack to the top among major economies as other countries dropped their rates.”

But the primary outside point emphasized in the Journal piece focused on the critics’ notion of these tax rate cuts being a “race to the bottom.” The article closes out with a quote from Claudia Clausing from Reed College: “‘It’s a misguided race to the bottom because the responses are much smaller’ than what companies will argue, she said. ‘If there’s a good reason to have investment in Germany, it’s going to stay there.’”

Hmmm, Clausing’s point seems to be that tax rates don’t matter. That, of course, is unsound economics that stands in stark contrast to basic economics, and to the findings in the IMF and countless other studies. One might think that in a reporting piece there might be another take offered on this study and subject.

Here’s a point that I’ll toss into the mix: The IMF study is largely focused on spillover and tax policy competition issues, and those are critical. But there’s more at work for the economy when it comes to lowering tax burdens on business and investment.

Such relief not only encourages a shifting in terms of the location of business activity and investment, but it also encourages, that is, it incentivizes, an expansion of such crucial activities. That’s not only good news for the U.S. economy, but to the extent that the lower tax rate in the United States does push other nations to reduce their tax rates, that’s additional good news for their economies as well.

It’s also very good for U.S. small businesses both as suppliers and as businesses structured as C-Corps. Most C-Corps in the United States are small firms, with 86 percent of C-Corp employer firms having less than 20 employees; 96.7 percent less than 100 workers; and 99.1 percent fewer than 500 workers. The dropping of the tax rate from 35 percent to 21 percent provides a big competitive and capital boost for these small firms.

This is not a race to the bottom. Quite the contrary, it’s a race toward creating a pro-growth tax system in which every nation that participates winds up winning.


Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.

Keating’s latest book published by SBE Council is titled Unleashing Small Business Through IP:  The Role of Intellectual Property in Driving Entrepreneurship, Innovation and Investment and it is available free on SBE Council’s website here.

News and Media Releases