Want to help the middle class? Don’t kill corporate taxes

January 21

This is a guest post from Juan Carlos Suárez Serrato, an economist at Stanford University, and Owen Zidar, an economics doctoral candidate at the University of California-Berkeley.

“In recent decades, American workers have suffered one body blow after another.” So writes economist Laurence Kotlikoff, who has just the policy prescription to help those ailing workers: abolishing the corporate income tax.

You can expect to hear this proposal a lot more often as the nation’s debate over widening income inequality heats up. But know this: Our new research suggests that Kotlikoff is wrong – that eliminating corporate taxes would help shareholders more than workers, likely making inequality worse.

Kotlikoff argues that high taxes drive companies away and that companies need to be willing to operate in a local area for workers to have jobs. He cites Boeing’s successful campaign to lower its tax and labor costs in Washington state as an example of the importance of low taxes in attracting firms and jobs. However, if corporate taxes were as important for location decisions as Kotlikoff suggests, it is hard to see why California, with a state corporate tax rate of nearly 10 percent, is home to more than one out of nine establishments in the United States. Indeed, firms are not rapidly leaving for next-door Nevada, which has no corporate tax rate at all.

Our research suggests that not all places are created equal in the eyes of corporations — their particular form of production might be more productive in particular cities. For example, many technology firms choose to locate in Silicon Valley despite its high wages and high taxes. While taxes are indeed an important consideration for firms, not all firms are willing to relocate to chase lower taxes since relocation might require a less productive location. This idea – that some firms may be especially productive in certain areas – is missing in the large-scale simulation that Kotlikoff uses.

In addition, Kotlikoff, like many other economists, ignores the reality of today’s historically high corporate profits. In reality, many firms earn profits that exceed the “normal level” assumed in his model. Some firms, like Boeing, have paid out higher and higher shareholder dividends after winning tax breaks and labor concessions. Kotlikoff’s model assumes that doesn’t happen – and therefore, exaggerates the distortionary effects of corporate taxes.

Whether abolishing the corporate income tax will mostly benefit shareholders or workers is an empirical question. It requires a careful measurement of the sensitivity of firms’ location decisions with respect to taxes and how this sensitivity affects the profits they earn. Through our work at the University of California, Berkeley and the Stanford Institute for Economic Policy Research (SIEPR), a nonpartisan research institute, we have developed a study to answer these questions and determine who benefits from cutting corporate taxes. Importantly, our work measures the empirical rate at which firms leave following an increase in taxes as well as the additional profits they earn following a tax cut.

This research analyzes every change in state corporate taxes since 1980 and measures the responsiveness of businesses to tax changes. We find that, across the country, most firms choose to pay higher taxes and locate where their productivity is highest, rather than chase tax incentives. That is, technology firms will still want to locate in Silicon Valley even if California were to raise its corporate rate modestly. We also measure what happens to wages and firms’ profits after states cut corporate taxes, and find that firm shareholders benefit more than workers from state corporate tax cuts. Moreover, workers are left with the bill to pay these generous incentives to firms in the form of lower corporate taxes.

To be clear, our results are from tax changes across states and not countries. Workers are more likely to move to a different state than to a different country, so workers would benefit more from cutting corporate taxes at the national level than they do at the state level.

With that said, across-the-board corporate tax cuts provide direct transfers to many companies that would be willing to locate here anyway. As a result, the bang-for-the-buck of across-the-board corporate tax cuts is not as attractive as Kotlikoff suggests. Eliminating corporate taxes may also exacerbate income inequality since shareholders are typically high-income individuals. Thus, on both efficiency and equity grounds, Kotlikoff overstates the case against the corporate income tax.

We agree with Kotlikoff on many policy issues, including the need to mitigate the plight of the American worker, and have lent our support for other policies he has championed, such as the INFORM Act. We applaud that his research brings attention to this topic but find the need to point to new empirical evidence showing that corporate tax breaks benefit firm owners in ways not possible in his model.

Policymakers do not necessarily need to lower taxes to attract companies; they can do so through other means such as enhancing productivity. There is good evidence that it would be in the nation’s interest to improve infrastructure and workforce skills. For example, the development policies of the Tennessee Valley Authority led to increases in productivity, growth and wages. Higher productivity can result in substantial profitability, and thus can be much more important component of business location and hiring decisions than taxes. Building a foundation for future productivity growth through infrastructure investments, especially when it is cheap to do so, is quite attractive. It would be a smarter way to compete for businesses – and to help long-suffering workers.

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