Tax us too much and we'll leave.

Photographer: Roy Rochlin/Getty Images

Clinton and Trump Are Both Wrong on Corporate Taxes

Paula Dwyer writes editorials on economics, finance and politics for Bloomberg View. She was London bureau chief for Businessweek and Washington economics editor for the New York Times, and is a co-author of “Take on the Street: How to Fight for Your Financial Future.”
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Hillary Clinton thinks corporate taxes are too low. Donald Trump thinks corporate taxes are way too high. They're both wrong, and the economic consequences could be huge if either nominee's tax proposal becomes law.

Trump would slash the rate to 15 percent and allow millions of partnerships and single-owner firms set up by hedge fund managers, lawyers and other well-heeled taxpayers to also pay the 15 percent rate once they pass earnings through to their personal income taxes. Clinton would hold the existing corporate tax rate steady at 35 percent but would close a variety of loopholes, which amounts to a tax increase. 

The problem is that corporations don't really pay taxes. They just pass them along to employees, shareholders and customers. Raising corporate taxes takes money out of people's pockets and encourages companies to send operations overseas, where corporate tax rates are lower. Corporations don't suffer but the economy does.

That makes Trump's tax-cutting proposals seem sensible, but there's just as much danger in cutting too much. Most economists say that a cut to 25 percent would let companies pay higher wages while reducing the incentive to move abroad. (President Barack Obama for years has proposed 28 percent, with a special 25 percent rate for manufacturers). The U.S. would see little revenue loss because economic output would grow and companies would pay more tax at lower rates. Workers receiving higher wages would also pay more tax.

The arithmetic doesn't work, though, when the tax is as low as Trump's proposed 15 percent. Federal tax revenue would fall too much, and under existing budget rules Trump would have to find offsetting spending cuts.

Trump would also go too far by allowing the pass-through companies to pay the 15 percent rate. While it might seem fair to give them the same rate as traditional corporations, it would make inequality a lot worse by lowering taxes for some of the wealthiest Americans.

He would also invite abuse: Just about anyone could qualify with some simple paperwork. The resulting tax cuts for millions would send tax revenue plummeting.  

What about Clinton? She makes a big deal of calling on corporations to pay their "fair share" of taxes. It pleases the Democratic Party's left wing, yet it's illogical.

She dismisses reams of new research showing that workers bear most of the cost of corporate taxes in the form of lower wages. She also waves off the fact that corporate taxes make up about 2 percent of gross domestic product -- about the average for the last 50 years, according to the Congressional Budget Office.

And while it's true that the U.S. in 2015 collected only about 10 percent, or $344 billion, of federal revenue from corporations, that number is deceptive. Democrats argue that it was a much higher 30 percent in the early 1950s, evidence they say that unsavory lobbying and campaign contributions by special interests are what drove it down.

What they don't say is that Social Security and Medicare payroll taxes expanded rapidly from the 1950s through the 1970s, making smaller the percentage contribution of other taxes to the national till. They also ignore the fact that by 1980, corporate taxes had already declined to 12.5 percent of total U.S. tax revenue.

Clinton also fails to mention another big shift since the 1980s -- the huge jump in the number of pass-through companies, such as partnerships, sole proprietorships and limited-liability corporations, which also lowered corporate tax receipts. Earnings by these entities, which account for about 95 percent of all U.S. firms and more than half of all business revenue, flow through to the owners' individual taxes. None pays corporate tax.

Tax Inversion

Clinton gets it right when she blames the ability of U.S. companies to invert, or relocate their tax headquarters in low-tax countries, for driving down corporate tax receipts. But at about $4 billion a year in lost revenue, according to the Joint Committee on Taxation, it's not a huge contributor. Keeping the top rate at 35 percent -- the highest in the developed world -- won't fix the problem. Nor would it raise much money, once companies search out new loopholes to avoid higher taxes.

Her pledge to make inverters pay exit taxes and other penalties only adds to the incentives companies have to shift tax costs to workers, harming the middle-class voters she says she most wants to help.

To understand why, it helps to think about how corporations and capital behave. In 1962, University of Chicago economist Arnold Harberger wrote that the providers of capital, not workers, bore the cost of corporate taxes in the form of lower investment returns. But that was when the U.S. operated in a closed economy.

Today, capital can easily move across borders to seek out lower-tax countries and maximize profits. When that happens, investment leads to more modern plants and equipment and better-trained workers, which improves productivity and pushes up wages. If taxes are high, the opposite happens: Investment suffers, productivity doesn't improve and wages stagnate or fall. Even Harberger came around to believing that labor usually bears the cost of corporate taxation. 

The debate these days isn't whether wages are affected, but how much. Academics provide a variety of estimates, but the consensus seems to be between 50 percent and 75 percent of taxes paid, says Kevin Hassett, the American Enterprise Institute economist who did some groundbreaking work on this issue. His Aug. 14 op-ed says the answer to today's wage stagnation is lower corporate taxes.

Both candidates have obvious political reasons for their tax positions. For Clinton, a tough Democratic primary contest against the socialist Bernie Sanders would have made a corporate tax cut suicidal. Trump's motivation seems to be winning over the corporate executives and tax-cutters who dominate the Republican establishment. They may think they've got the politics right, but they're wrong on the policy.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Paula Dwyer at pdwyer11@bloomberg.net

To contact the editor responsible for this story:
Jonathan Landman at jlandman4@bloomberg.net