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How much does the corporate income tax matter?

at 09:33 AM ET, 11/18/2011

Yesterday, Ezra noted two charts from Felix Salmon showing that the corporate income tax has been declining dramatically since the 1950s — both as a share of profits and as a share of GDP. Over at Modeled Behavior, meanwhile, economist Karl Smith takes things a step further and wonders whether corporate tax rates have had much effect on either corporate profitability or investment in the United States.

His answer? They don’t seem to be hugely significant. Or, at the very least, a clear impact is difficult to detect. Here’s a graph of the corporate tax rate (in blue) compared with non-residential investment as a fraction of GDP (in red) since the 1950s. Not an obvious pattern here:

There’s a correlation in the 1950s and 1970s — lower corporate taxes went hand in hand with more corporate investment — but since then, the relationship has become more tenuous. That’s hardly conclusive evidence that the corporate tax rate is meaningless, since other factors could be at play, but it suggests that the tax doesn’t matter nearly as much as many people think.

Either way, there’s still a good case for reforming the corporate tax code — say, by ditching many of the exemptions and loopholes in exchange for lowering the overall rates. Plenty of economists think that would be more efficient and lead to fewer distortions in economic activity. But, as even Tyler Cowen (who would prefer to abolish the tax altogether) writes: “I still think the corporate rate should be zero, but the corporate income tax is one of the most commonly over-villainized institutions by the intelligent Right.”

Update: For another take, here’s a 2004 NBER paper that takes a look at survey data from PriceWaterhouseCoopers across 84 countries and concludes that “a 10 percent increase in the effective corporate tax rate reduces aggregate investment to GDP ratio by 2 percentage points.” Seems significant! But this result appears to be driven largely by developing countries — it’s not clear that the impact of corporate tax rates in the United States is nearly as powerful.

 
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