Corporate taxes don’t cause recessions. But do they hurt growth?

June 5, 2013

Congressional Research Service reports aren't generally the cause of political dust-ups. The agency is known for its rigorous yet completely dispassionate analysis of everything from national security threats to budget policy to Congressional procedure. At one hearing I attended three years ago, a CRS analyst recalled a time her boss was asked what he thought about a particular piece of legislation and replied, "I'm not allowed to think."

So it was surprising when Thomas Hungerford, a veteran tax analyst at the agency, issued a report last year that Senate Republicans immediately tried to revoke. The report found no correlation between the top personal income tax rate and economic growth, as illustrated in this chart:


A revised version of the report was eventually released, softening some language and citing reports suggesting negative growth effects from high taxes. But soon after,  Hungerford departed CRS for the left-leaning Economic Policy Institute.

A simple chart


Now, he's conducting similar research at EPI, this time focusing on the corporate tax rate. His latest report finds "no evidence that either the statutory top corporate tax rate or the effective marginal tax rate on capital income is correlated with real GDP growth." To bolster the point, he includes the above chart.

One issue with this chart that emerges immediately is that it doesn't control for any non-corporate tax factors that might affect economic growth, such as population growth, federal spending, Fed policy or the population's education level. All it shows is that changes in the corporate tax rate do not drive changes in economic growth, not that the rate does not affect growth. Everyone should agree to that much; I don't think there's ever been a recession prompted by a sudden uptick in the corporate tax rate.

But the chart doesn't show that the corporate tax doesn't affect growth at all. As Slate's Matt Yglesias pointed out: "Year-to-year fluctuations in GDP growth are driven by the Federal Reserve, external shocks to commodity prices, and changes in the budget deficit. But it would obviously be a big mistake to conclude that nothing else Congress does matters at all." EPI's Josh Bivens even concedes this point in a defense of the paper, noting, "It’s true that year-to-year changes in GDP are not going to be influenced much by anything beyond monetary and fiscal policy changes."

A closer look at the evidence

"Yeah, Mr. White! Yeah, social science!" - Jesse Pinkman on this topic, probably. (AMC)
"Yeah, Mr. White! Yeah, social science!" - Jesse Pinkman on this topic, probably. (AMC)

In fairness, though, Hungerford does do econometric analysis later in the paper, controlling for "the population growth rate, the change in the proportion of the population with at least a four-year college degree, and the change in federal current expenditures as a percentage of potential GDP," as other papers on the topic do when trying to measure the effects of tax policy on growth. He still finds no relationship between the effective or statuary corporate tax rate and the rate of economic growth.

Here's the problem, though: plenty of other studies do. For example, Hungerford borrows his methodology from "Tax Structure and Economic Growth," a 2005 paper by economists Young Lee and Roger Gordon. What he doesn't mention is their conclusion: "This paper finds that the corporate tax rate is significantly negatively correlated with economic growth in a cross-section data set of 70 countries during 1970-1997, controlling for many other determinants/covariates of economic growth."

Lee and Gordon are hardly the only ones to find that. Take, for example, this 2009 report from the Organisation for Economic Co-operation and Development summing its  research on the subject. It concludes, "Corporate income taxes can be expected to be the most harmful for growth as they discourage the activities of firms that are most important for growth: investment in capital and in productivity improvements."

Last year, economists Ergete Ferede and Bev Dahlby compared corporate tax policies in Canadian provinces, and found that a 1 point cut in the corporate rate is associated with 0.1 to 0.2 points faster per capita GDP growth. Also last year, Karel Mertens and Morten Ravn found that "a one percentage point cut in the ACITR [average corporate income tax rate] raises real GDP per capita on impact by 0.4 percent and by up to 0.6 percent after one year." The economists also found that raising the corporate income tax doesn't even increase revenue, because the negative growth effects are so large.

In 2011, Norman Gemmell, Richard Kneller and Ismael Sanz measured the effects of taxes that most economic theories conclude are "distortionary", including taxes on personal income and corporate profits. They concluded: "There is clear evidence that those taxes recognised by various theories as distortionary…have persistent effects on GDP growth empirically over many years." In 1996, Jason Cummins, Kevin Hassett and Glenn Hubbard compared the effects of corporate tax reforms in 14 countries and found that in 12 countries the reforms had statistically and economically significant effects on investment. Cuts produced positive effects, and increases negative ones.

In fact, the only study other than Hungerford's I could find that concluded that the corporate tax doesn't affect growth or investment was a 1983 paper in the American Political Science Review by Claudio Katz, Vincent Mahler and Michael Franz. It concludes that in the 1970s, "there [was] no relationship in either direction relating personal or corporate income taxes to rate of growth of gross domestic investment."

Perhaps most surprising, though is that Hungerford criticized the tax's economic effects when he was at CRS. In a 2008 paper co-authored with fellow CRS analyst Jane Gravelle and appearing in Tax Notes (you can see a non-paywalled version here), he concluded: "The traditional concerns about the corporate tax appear valid. While many economists believe that the tax is still needed as a backstop to individual tax collections, it does result in economic distortions."

Is simpler better?

Hungerford told me that all taxes cause distortions, and the growth consequences of the corporate tax appear to be quite small. "If the distortions of the corporate tax are in the 10 percent range, that means in relation to corporate tax revenues," he explained. "Corporate tax revenues are about 1.6 percent of GDP. Ten percent of that, times the change in the tax rate, gives a very small number, and that is what the effect on the economy could be from a change in the tax rate. The effect is too small to be noticed in the numbers."

He's also skeptical of some of the methodology in the studies showing negative effects from corporate taxes, particularly the cross-country comparisons because corporate tax structures vary a lot between countries. "If you find that, say, the corporate tax rate, the statutory corporate tax rate has an effect on economic growth, is it because of the corporate tax rate, or is it because the corporate tax rate in one country is highly correlated with all these other structural things in that country?" he asked.

Additionally, he noted that studies often flip between considering the average corporate tax rate -- which takes expenditures and other factors into account -- and the statutory tax rate. Mertens and Ravn consider the former, for instance, while Lee and Gordon consider the latter.

All told, Hungerford believes that a simple, straightforward approach, like the one his paper takes, is more reliable. "I've always been a fan of simpler methods, or really just looking at a diagram. If you don't see any particular breaks, it suggests that maybe there's nothing there," he told me. "How much are you going to torture the data to find something?" He also noted that the paper is meant as a quick look at the topic, rather than a comprehensive literature review. "If I included a literature review, you could write a 20-page article just on that, and I was writing a quick five-page thing," he explained.

That's all fair enough, and Hungerford is certainly correct that all econometric methods are not created equal. But it's hard to look at the body of research on this topic and not notice that there's something of a consensus around the idea that increases in the corporate tax rate hurt growth and cuts to it help growth.

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Timothy B. Lee · June 5, 2013