Cut the Harmful US Corporate Profit Tax!

Second in a series of postings on the European economic and budget situation. I am grateful to Natalia Aivazova for valuable research assistance. See also A Reassuring Choice for the Central Bank of Russia.

Corporate profit taxes have fallen like stones throughout Western Europe in the last three decades. At the same time, their revenues as a share of GDP have risen universally. Tax revenues have surged most of all in places where corporate tax rates are particularly low. With regard to corporate taxes, the Reagan era economist Arthur Laffer was perfectly right: Lower rates do yield higher revenues. In sharp contrast, the United States maintains the highest corporate profit tax in the world for no good purpose.

Empirical evidence on taxes is rarely as simple and straightforward as it is for corporate profit taxes. The evidence on the west from the Organization for Economic Cooperation and Development (OECD) is ample. A comparison between the 15 old members of the European Union (EU-15)1 with the United States is particularly illuminating. These numbers include both central government and local government taxes.

In the EU-15, the average corporate profit tax rate plunged by 21 percentage points from an average of 48.0 percent in 1981 to 26.6 percent in 2012. The variation also decreased. In 1981, the highest EU profit tax rate was 61.5 percent (Finland) and the lowest 33 percent (Spain). In 2012, France topped with 34.4 percent, while Ireland had merely 12.5 percent. The United States is a complete outlier. In 1981, it had a corporate profit tax of 50 percent, close to the EU-15 average, but it has only fallen to 39 percent, leaving the United States with a much higher rate than any EU country (figure 1).

Figure 1 Corporate tax rates EU-15 vs. United States, 1981 and 2012

figure 1

Source: Organization for Economic Cooperation and Development (OECD) Tax Database. Acessed on March 12, 2013. Available at: www.oecd.org/dataoecd/26/56/33717459.xls.

Revenues from corporate profit taxes have always been small. A standard assumption has been that they would fall with the tax rate, but the opposite has happened. In 1981, the EU-15 countries collected an average of 2.0 percent of GDP in corporate profit tax, while in 2007, just before the global financial crisis, these revenues peaked at 3.5 percent of GDP, marking a rise of 74 percent. During the financial crisis, these revenues declined somewhat but they were still 2.7 percent of GDP in 2011.

Nor do countries with high tax rates collect more tax revenues. Significantly, Ireland, with a corporate profit tax rate of 12.5 percent, collected 2.3 percent of GDP in revenues, while Germany’s ┬átax rate of 30 percent collected 1.7 percent of GDP. Presumably, this reflects vigorous tax competition. Either companies or their profits move to European countries with low taxes. Figure 2 shows the corporate tax revenues as a share of GDP in 1981 and 2010. Tax revenues have risen almost universally (in 12 out of 15 old EU countries), while rates have plummeted. The correlation between the nominal tax rate and tax revenues is clearly negative.

Figure 2 Corporate tax revenues EU-15 vs. United States, 1981 and 2012

figure 2

Note: For Greece and the Netherlands 2010 data is used. For Portugal data from 1989 and 2010 is used.

Source: Organization for Economic Cooperation and Development (OECD) Tax Database. Acessed on March 12, 2013. Available at: http://stats.oecd.org/Index.aspx?DataSetCode=REV.

The United States, by contrast, has barely seen any increase in its corporate tax revenues since it has insisted on a suboptimally high tax rate. With a tax rate that is almost twice as high as the average profit tax in the EU-15, it collects a smaller share of GDP in revenue.

The simple conclusion is that it makes no sense to have a high corporate profit tax. They are entirely harmful both to enterprise and tax revenues. As in so many other cases, the reformers in Eastern Europe have shown the way. They have cut their standard tax rate for corporate profits to 15 to 19 percent, while abolishing almost all loopholes and thus simplifying taxation.

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