Reply to Tax Policy Center on Corporate Tax Rates and Revenue

Len Burman, director of the Urban-Brookings Tax Policy Center, suggests  I was “careless” in a recent Wall Street Journal article when I said, “the Tax Policy Center (TPC) estimate of corporate rate cuts … is also nonsense because it’s entirely static. The estimate assumes raising or lowering corporate tax rates has no effect on corporate decisions about where to locate production, income or costs, and no effect on the economy’s performance.”

Burman says, “That is simply untrue (as we would have told Mr. Reynolds had he asked). If corporate tax rates were 10 percentage points below the top ordinary income tax rate, there would indeed be increased reporting of corporate income. But individual income tax revenues would fall too, quite possibly by more than the pickup in corporate revenues… . Investors would have had a huge incentive to channel their income through closely-held corporations instead of reporting it on their individual tax returns. Many S-corporations and partnerships, which are taxed at individual rates, would have chosen to be taxed as C-corporations at a lower rate… .I know the Wall Street Journal editorial page tries not to let facts get in the way of its tax-cut narrative, but those facts do matter.”

Was it “simply untrue” for me to say the Tax Policy Center’s corporate income tax estimates are static?  The footnote to their Table T08-0167 about “Senator John McCain’s Tax Proposals” could not be more clear: “Corporate income tax estimates are static (they do not include a behavioral response). Official estimates from the Joint Committee on Taxation would likely differ.”

Burman attempts to justify static revenue estimates by asserting that “quite possibly” there is no behavioral response to corporate tax rates, aside from shifting business income to and from the individual tax system.  But that just proves he is assuming, as I correctly said, that lowering corporate tax rates wold have literally “no effect on corporate decisions about where to locate production, income or costs, and no effect on the economy’s performance.” If that static assumption made any sense, then doubling corporate tax rates would double revenues (though more of the loot would show up on individual tax returns). That is certainly not what the economic literature suggests. Many countries in which income switching is impossible or trivial have cut their corporate tax rates to 25% or less with no loss in revenue as a share of GDP.

Trying justify static estimates on the basis of undocumented conjectures about the scale income shifting looks like an ad hoc rationalization. Guessing what might “quite possibly” be true has nothing to do with “facts.”  It amounts to abandoning economic theory and evidence in favor of a dubious hunch.

Under both the Obama and McCain plans the corporate tax rate would be 5-7 points below the individual tax through 2013.  Yet the Tax Policy Center mentions income shifting only in connection with the McCain plan.  If bias does not explain that, what does?

If income switching was as huge as Burman speculates, then the Tax Policy Center’s estimates of individual tax revenues from the Obama plan (which include a very modest behavioral response) are much too large, though corporate receipts would be somewhat higher.  In fact, that is exactly what I estimated in the 60-page paper cited in the byline to my op ed, which is mainly an empirical critique of Tax Policy Center methodology. I estimate that corporate income tax receipts under the Obama plan would be larger than the Tax Policy Center expects (because they ignored income shifting in Obama’s case).  But I also found their estimates of added receipts from higher tax rates on individual income, capital gains and dividends to be unbelievably rosy.