A Corporate Tax Hike: The Wrong Medicine?

Supporters of President Clinton's proposal to raise the tax rate on corporate profits by two percentage points argue that it will mainly affect affluent members of society. But economist Roger E. Brinner at DRI/McGraw-Hill argues that this is a shortsighted view, not only because a broad cross section of Middle America has equity stakes in U.S. corporations--either directly or indirectly through pension funds and other vehicles--but because raising business-tax rates actually runs counter to the President's goal of boosting U.S. investment and living standards.

"In today's intensely competitive global market," says Brinner, "any nation trying to extract higher profits taxes will experience capital flight, and this depresses wages and job opportunities for its citizens." The increased mobility of technology and capital across national borders and the short lives of modern capital equipment have made it imperative for multinational companies battling for global market share to constantly seek the most hospitable investment climates. And local business taxes are a key factor in such investment decisions.

Although U.S. corporate-tax rates appear to be relatively attractive compared with many other industrial countries, Brinner points out that such appearances are deceptive. According to a recent report from the Organization for Economic Cooperation & Development (OECD), nominal statutory profits-tax rates among the Group of Seven nations vary widely, with the U.S. rate of 38.3% (combining federal, state, and local levies) falling far below the 48%-plus rates of Italy, Germany, and Japan.

But nominal statutory rates are a far cry from actual effective tax rates, which reflect special provisions that may blunt their impact. In particular, the report notes that most OECD nations have taken steps to reduce or eliminate the double taxation of dividends that characterizes the U.S. system. Factoring in the effects of such steps and other measures benefiting investors, Brinner calculates that the profits-tax burden for the U.S. is actually significantly higher than those of other major industrial nations (chart). Among the G-7, only Canada has a higher effective rate.

Boosting corporate-tax rates, warns Brinner, will only worsen America's competitive tax disadvantage. Instead, the U.S. should follow the lead of other nations by reducing the double taxation of profits and placing more emphasis on broad-based consumption taxes. "If our object is to encourage more investment," he says, "raising the profit-tax rate is like shooting ourselves in the foot."