The one thing on which our political leaders seem to agree is the need for corporate tax reform. Barack Obama and Mitt Romney unveiled new proposals on the same day last month, with President Obama cutting the top corporate tax rate to 28% and Mr. Romney reducing it to 25%. Rick Santorum would cut the rate to 17.5%, and to zero for manufacturing. Congressional action is bubbling below the surface as well.
This flurry of proposals is a result of increased awareness of how out of step America is with the rest of the world. The U.S. is currently an outlier within the 34-member Organization for Economic Cooperation and Development, with a combined state and local corporate tax rate that is about 15 percentage points higher than the average of our trading partners.
But amid all of the promising rhetoric there is significant cause for concern. Many proposals, particularly those of Messrs. Obama and Santorum, seem to have unlearned many of the lessons of modern economics.
Three shifts in the economic environment since the 1960s, each recognized by most economists, provide an essential guide to reform.
First, U.S. tax policy can no longer treat the U.S. as a closed economy. Capital and business activity are increasingly mobile across national boundaries and highly responsive to variation in the net tax paid across locations. Second, the word “business” is not synonymous with “corporation”—pass-through (noncorporate) businesses are almost as important in the aggregate as old-fashioned corporations. Third, economic research has stressed that both corporate taxes and investor-level taxes on dividends and capital gains contribute to the tax burden on corporate equity. Investors factor in the total capital tax, both individual and firm level, when making decisions.
A key implication of the first point is that the rapid increase in international capital mobility has significantly altered the calculus of redistributive policies. Conventional analyses of who bears the burden of the corporate tax conclude that the tax is borne by owners of domestic capital.
But an explosion of recent empirical work documents that labor bears much of—and, in some analyses, all of—the burden of the corporate tax. This is because the corporate tax depresses investment in the domestic economy, reducing productivity and ultimately workers’ wages.