The efficiency of the business tax structure in the United States is particularly
important as other countries undertake major corporate tax reforms. Capital
is mobile across international borders, and the business tax environment is
important in ensuring that the United States continues to attract investment
from abroad, and that U.S. firms can compete effectively in foreign countries.
In the mid-1980s, the average statutory corporate tax rate (weighted by
GDP) across OECD countries was 44 percent. The U.S. tax reform of 1986,
which reduced the corporate tax rate from 46 percent to 34 percent, made
the United States a relatively low-tax country at the time of the reform. Since
that time, however, the OECD-average corporate tax rate has fallen below
that of the United States. These comparisons refer to statutory tax rates. The
United States has relatively generous accelerated depreciation provisions and
a multitude of business-level exemptions and deductions that reduce the
tax burden on investment below the statutory rate. However, the effective
marginal tax rate on corporate investment is still high: compared to other
G7 countries (France, Germany, the United Kingdom, Canada, Italy, and
Japan), the United States imposes an above-average marginal effective tax
rate on corporate investment for domestic debt and equity holders in the
top individual income tax bracket. In contrast, the U.S. average corporate tax
rate (the total amount of corporate taxes paid as a percentage of corporate
operating surplus) is low relative to other countries. This fact highlights the
inefficiency and complexity of the corporate tax system. The marginal tax rate
represents the additional tax burden a firm faces when it undertakes a new
investment; therefore, it is the relevant tax rate for new investment decisions.
This distortion is larger in the United States than in other countries. Despite
the larger distortion, the corporate tax raises less revenue in the United States
than in other countries, as evidenced by the fact that the average tax rate
is lower. The implication is that investment incentives could be improved
without a reduction in government revenue.
Two points I want to discuss:
- Is it really true that the US marginal corporate tax rate is significantly above that of other OECD and G7 economies?
- Is capital really highly mobile across borders?
For some authoritative analysis, I look to the CBO’s 2005 report Corporate Income Tax Rates:
International Comparisons [pdf]. Figures 1 and 2 present the marginal effective corporate tax rates for equity and debt, respectively. The pictures are not completely in agreement with the points in the ERP — although one must admit that there different studies will come to different results, given varying assumptions.
Source: CBO, Corporate Income Tax Rates:
Note that the calculated marginal rates differ depending on type of capital and the measure of inflation; I’ve only graphed the ones for machinery.
(Digression: On the other hand, the wide divergence between the equity and debt marginal rates confirms the assertion that the current tax code probably leads to inefficiencies and dead weight losses.)
On point 1, I don’t think the evidence I am aware of strongly supports their conclusions that the US is at the top of the tax rate distribution.
The next two figures lead me to my thoughts regarding point 2.
Source: CBO, Corporate Income Tax Rates:
What I find of interest is that while the latest US effective marginal rate is at the upper quartile of the OECD distribution, it is at the median for the G-7. To me, this is of interest because the non-G-7 OECD countries are smaller, in GDP terms, than the G-7. This suggests to me that policymakers in these non-G-7 OECD countries have lowered their marginal tax rates because capital is more mobile for these smaller economies. But for the larger G-7 economies, capital is less mobile, so there is greater scope for keeping tax rates at different levels than that in other countries.
In this age of globalization, it seems strange to assert that capital is less than completely mobile. But just a quick glance at long term interest rates, relevant for physical investment decisions, should persuade people that even financial capital is not fully mobile. Consider the right hand graph of the figure below.
Excerpt from Figure 1.3 from Chapter 1 from IMF, World Economic Outlook, October 2007.
The inflation measure used here is kind of odd, but using inflation indexed yields also confirms the fact that real interest rates are not equalized (see Chart 1.15 in this post). And that’s for government debt. Think about how heterogeneous private debt is.
The more econometrically inclined can refer to this paper. While Eiji Fujii and I find some evidence of real interest parity (RIP) holding more at longer horizons than short, the evidence is by no means conclusive that it holds exactly, when the United States is involved.
The policy implications are potentially profound. When capital is not perfectly mobile, the labor share of the burden of capital taxation can be lower than what is implied when it is assumed that capital is perfectly mobile (see this working paper). Another path to overturning the conventional wisdom would be to assume that domestic and foreign goods are imperfect substitutes (see this article).
Bottom line: One should think about marginal corporate tax rates, and how they vary across types of capital. And maybe one should worry about rates very high relative to other contries’ rates. But it’s probably not appropriate to assume perfect (physical) capital mobility for large, industrial, countries.
Separate observation: As a non-public finance economist, I wonder what this paragraph means. Suggestions welcome (p.121):
The tax cuts of 2001 and 2003 significantly lowered the tax burden on
labor and capital income and reduced distortions. The dividend and capital
gains rate cuts enacted in 2003 had an additional benefit to the economy
by improving the efficiency of the tax structure. By reducing the existing
preference for corporate debt financing over equity financing, these tax
cuts reduced the distortion of corporate finance decisions and improved
I think they must have a different idea of “corporate governance” than I have. But I readily confess my ignorance.
href="http://www.technorati.com/tags/Economic+Report+of+the+President">Economic Report of the President,
href="http://www.technorati.com/tags/Council+of+Economic+Advisers">Council of Economic Advisers,
real interest rate,