The recently concluded tax reform conference report draft includes a one-percentage-point increase in the corporate tax rate above what both the House and the Senate passed, with some of the revenue savings being used to keep a portion of the deduction for state and local taxes as well as forego delaying its implementation until 2019, as the previous bills proposed. There remains a chance the rate may tick up yet again before negotiations are concluded, especially if other targeted tax breaks get some traction in the Congress over the next few days.
However, even this small diminution in the rate reduction is a mistake: while a one point increase may seem to be a trifle, each uptick in the corporate tax rate represents a large opportunity cost that Congress won’t be able to easily rectify in the future.
My former colleague Gordon Gray and I examined the tax code that emerged from the 1986 tax reform, as well as the various changes Congress made to the code in the subsequent thirty years, in a study published in Tax Notes, to see if we could discern some broad patterns regarding what sorts of changes proved ephemeral and which ended up being permanent.
As to the former, the list stretches a mile wide: Congress has changed the top personal tax rates four times since 1986 and seems poised to change it again. It has also tinkered with tax rates on dividends and capital gains numerous times. It has also inserted a litany of tax credits, subsidies and the like over that period as well, in order to encourage us to conserve energy, pollute less, or save more for retirement, or health care, education, or a funeral. A few years ago Rep. Thaddeus McCotter even proposed a tax break for pet expenses.
On the corporate side, Congress has done nearly as much tweaking. For instance, it tends to change the tax treatment of capital investment every business cycle, and a few years ago it created a special tax rate for manufacturers (and other industries with enough juice to be labeled as such). Congress has also modified how overseas income is taxed several times, and altered the code repeatedly to encourage environmentally sound behavior.
What hasn't changed over the last thirty years? The corporate tax rate. A mere one point increase in 1993 marks its only alteration since the 1986 reform. In the context of our government’s predilection to conduct a wide manner of economic policy through taxes, its stickiness is remarkable.
We suspect the durability of the corporate tax rate owes to the fact that the benefits to reducing the rate can be difficult for voters to comprehend. Opponents of tax reform can simply shout that it is nothing but a giveaway to big business and that has often proven to be enough to get congressmen to back away.
Of course, it is anything but a giveaway. During the three decades of U.S. corporate tax rate stasis, literally every country in the OECD has reduced its tax rate numerous times. In 1987 we had one of the lowest corporate tax rates amongst the group, but today we have the highest by far, which has made it more difficult for U.S. companies to compete against their foreign competitors. From 2000-2012, there were 85 different corporate rate tax reductions in the OECD, I found.
The high U.S. corporate tax rate is especially pernicious, because it is a lousy way to collect tax revenue. Since a good fraction of it is borne by the workers in the form of lower wages, it’s not nearly as progressive as most people assume, and it achieves that progressivity at an extremely high opportunity cost in terms of foregone economic growth. Nobel Laureate Robert Lucas once said that eliminating the corporate tax was the closest thing to a free lunch that he has ever observed in economics.
History has shown that many other changes in the tax reform plan may be unwound in the near future, no matter what the final legislation contains. For better or worse, Congress cannot tie the hands of a future congress. But whatever happens with the corporate tax rate in the final bill will likely remain the law for the foreseeable future, so above all else we should strive to get it right.
And the right rate is the lowest rate possible.