Aug. 30 (Bloomberg) -- Nations don’t compete with one another the way companies do. Pepsi’s gain is almost always Coca-Cola’s loss, but the same doesn’t always, or even often, hold true for national economies. Governments do compete in some respects: They want to attract capital investment to their countries, for example, to provide more jobs, higher wages and better products and services to their people.
That competition offers a reason for optimism that the U.S. Congress will eventually reform our inefficient, investment-destroying corporate taxes.
There’s already bipartisan support for such reform. John McCain campaigned on it in 2008, and President Barack Obama plumped for it in his most recent State of the Union address. Representative Charles Rangel, Democrat of New York, offered a proposal that would have pared corporate tax rates and limited deductions when he was chairman of the House Ways and Means Committee. The Bowles-Simpson fiscal-reform commission recommended similar measures, and Senators Ron Wyden, Democrat of Oregon, and Dan Coats, Republican of Indiana, have introduced legislation to reduce corporate tax rates.
But there’s still resistance. Trimming corporate tax rates is a hard sell for a lot of congressional Democrats. Businesses are divided: Some would lose more in tax breaks than they would gain in lower rates under any revenue-neutral reform.
Lots of Loopholes
And whether our corporate taxes are high or low compared with other countries is still a matter of debate. The top statutory rate is 35 percent; add the 4 percent average state tax and we have the highest rate of any developed country. But our code also has a lot of loopholes, so some observers claim that in practice our corporate taxes are low. They point out, accurately, that corporate tax revenues are a smaller proportion of the economy than in other countries, and have grown smaller over time.
But two other measures are more relevant. Earlier this year, Kevin Hassett and Aparna Mathur -- economists affiliated with the American Enterprise Institute -- calculated the effective average corporate tax rate for all advanced economies. That’s the rate that, according to an earlier study, has the most impact on where companies decide to invest. Their results: Our rate in 2010 was 29.5 percent, while other members of the Organization for Economic Cooperation and Development averaged 20.5 percent. (A similar calculation by the World Bank reached a similar conclusion.)
A Tax Outlier
They also calculated these countries’ effective marginal tax rates to determine how their tax codes affected decisions to expand investments. Again, the U.S. rate was higher than the OECD average. Our rate was 23.6, compared with 17.2 for other advanced economies.
We weren’t always an outlier. And we didn’t become one by raising corporate tax rates. Ours have been frozen while other countries reduced theirs. That’s how we went from having an average rate to having the second-highest in the developed world. Only Japan’s is higher -- and it was on track to cut its rate until the March earthquake and tsunami prompted a delay. We may soon be No. 1.
But this is a type of American exceptionalism we shouldn’t cherish. Controversy over whether our corporate taxes are high or low is matched by controversy over who pays them in the first place. This issue recently made the news when Republican presidential candidate Mitt Romney informed a heckler that people pay the corporate income tax. But which people? The Congressional Budget Office and the Treasury Department have traditionally assumed that owners of capital pay the tax. More recent models, though, emphasize that if capital can cross borders, it’s labor that gets stuck paying the tax. Capital moves to countries where it is taxed less. Less capital investment here leaves Americans with lower-wage jobs.
Empirical work on the subject has yielded a wide range of outcomes. At the low end of estimates, three economists led by Mihir Desai have found that 45 percent of the corporate income tax falls on labor. The high-end estimate comes from R. Alison Felix, an economist at the Federal Reserve Bank of Kansas City, who concluded that labor pays 420 percent of the burden: For every dollar of revenue the tax raises, wages fall by $4.20. A study by the Tax Foundation, a nonpartisan think tank, split the difference, finding that wages drop $2.50 for every dollar raised.
So it’s fair to conclude that the corporate income tax lowers wages. And that’s not the only reason to reduce the tax. As Jonathan Berk explained on Bloomberg View last week, the corporate tax is highly inefficient. It raises little revenue. It encourages debt over equity, and some types of company organization over others, for no good reason. I would add that corporate taxes, like all taxes on investment, encourage consumption today over consumption tomorrow. And its costs are going up as other countries reduce their corporate taxes.
Occasionally one hears calls for countries to “harmonize” their rates so that no nation feels any pressure to cut its tax. But this is just not going to happen. The more realistic response to the mobility of capital is the one that other countries, blessed with politicians who are generally no more far-seeing or intelligent than ours, have made: reducing their corporate taxes.
Eventually, we’ll get there too.
(Ramesh Ponnuru is a Bloomberg View columnist and a senior editor at National Review. The opinions expressed are his own.)
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