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Corporate Taxes and the Laffer Curve
During the debate about the Trump tax plan, proponents made three main arguments in favor of reducing the federal corporate tax rate from 35 percent to 21 percent.
- A lower rate would be good for workers, consumers, and shareholders.
- A lower rate would boost American competitiveness.
- A lower rate would produce some revenue feedback for the IRS.
The last item involves the “Laffer Curve,” which is a graphical representation of the non-linear relationship between tax rates and tax revenue.
Put in simple terms, entrepreneurs, investors, and business owners have more incentive to earn moneywhen tax rates are modest.
High tax rates, by contrast, discourage productive behavior while also giving people a bigger incentive to find loopholes and other ways of avoiding tax.
This does not mean that lower tax rates produce more revenue, though that sometimes happens.
The main takeaway is the most modest observation that lower tax rates will lead to more taxable income, which means some revenue feedback.
In other words, tax cuts don’t lose as much revenue as predicted by simplistic models (and tax increases don’t generate as much revenue as predicted).
I’ve shared many, many real–world examples of this phenomenon.
And here’s another. Look at how corporate tax revenues in the United States are increasing at a faster rate than projected.
The chart comes from Chris Edwards, and he helpfully explains what has happened.
The revenue surge came as a surprise to government economists. The chart…compares the new Office of Management and Budget March 2022 baseline projections to prior baseline projections from the OMB in May 2021 and the Congressional Budget Office in July 2021.
…congressional estimators figured that the government would lose an average $76 billion a year the first four years… Corporate tax revenues were down from 2018 to 2020, but then soared in 2021. Revenues in 2021 of $372 billion (with a 21 percent tax rate) are 25 percent higher than revenues in 2017 of $297 billion (with a 35 percent tax rate). …we’re learning that a lower corporate tax rate is consistent with strong corporate tax revenues. …lower rates…broaden bases automatically through reduced tax avoidance and higher economic activity. Other nations have learned the same lesson. Keeping the corporate tax rate low is a winner for businesses and workers, but it can also be a winner for government budgets.
The Wall Street Journal has a new editorial on this topic. Here are some relevant excerpts.
…the 2017 tax reform that cut corporate tax rates…has been a winner for the economy and federal tax coffers. …Corporate revenue was supposed to fall to historic lows
as a share of the economy. Big business supposedly got a windfall and government was robbed. It hasn’t turned out that way. …the big news now is that more corporate tax revenue is flowing into the Treasury at record levels even with the lower rate. …In June 2017, before tax reform passed, CBO predicted corporate tax revenue of $383 billion in fiscal 2021. But in April 2018, after reform passed, CBO lowered its estimate to $327 billion.
So what happened in the real world?
Actual corporate income tax revenue in 2021 was $372 billion—nearly as much at a 21% rate as CBO expected at the 35% rate that was among the highest in the world.
Fiscal 2022 is turning out to be even better for the Treasury. Corporate tax revenue for the first six months was up 22% from a year earlier to $127 billion. …What accounts for this windfall for Uncle Sam…? …the Occam’s razor policy answer is that corporate tax reform worked as its sponsors predicted: Lowering the rates while broadening the base by eliminating loopholes created incentives for more efficient investment decisions that paid off for shareholders, workers and the government.
Notice, by the way, that corporate tax revenues have increased faster than projected in both the 2017 forecast and the 2021 forecast.
All of which shows that I may have been insufficiently optimistic when I wrote about this issuelast year.
P.S. The goal of tax policy (either in general or when looking at business taxation) is not to maximize revenue for politicians, but rather to maximize prosperity for people. Indeed, if better tax policy leads to a lot of revenue feedback, that’s an argument for further reductions in tax rates.
P.P.S. Both the IMF and OECD have research showing that lower corporate tax rates do not necessarily lead to lower corporate tax revenues.
March 3, 2021
President Biden c/o The White House
1600 Pennsylvania Avenue NW
Washington, DC 20500
Dear Mr. President,
______________________________
Dan Mitchell shows how ignoring the Laffer Curve is like running a stop sign!!!!
Can You Spell L-A-F-F-E-R C-U-R-V-E?
July 12, 2013 by Dan Mitchell
I’m thinking of inventing a game, sort of a fiscal version of Pin the Tail on the Donkey.
Only the way it will work is that there will be a map of the world and the winner will be the blindfolded person who puts their pin closest to a nation such asAustralia or Switzerland that has a relatively low risk of long-run fiscal collapse.
That won’t be an easy game to win since we have data from the BIS, OECD, and IMF showing that government is growing far too fast in the vast majority of nations.
We also know that many states and cities suffer from the same problems.
A handful of local governments already have hit the fiscal brick wall, with many of them (gee, what a surprise) from California.
The most spectacular mess, though, is about to happen in Michigan.
The Washington Post reports that Detroit is on the verge of fiscal collapse.
After decades of sad and spectacular decline, it has come to this for Detroit: The city is $19 billion in debt and on the edge of becoming the nation’s largest municipal bankruptcy. An emergency manager says the city can make good on only a sliver of what it owes — in many cases just pennies on the dollar.
This is a dog-bites-man story. Detroit’s problems are the completely predictable result of excessive government. Just as statism explains the problems of Greece. And the problems of California. And the problems of Cyprus. And theproblems of Illinois.
I could continue with a long list of profligate governments, but you get the idea. Some of these governments are collapsing at a quicker pace and some at a slower pace. But all of them are in deep trouble because they don’t follow my Golden Rule about restraining the burden of government spending so that it grows slower than the private sector.
Detroit obviously is an example of a government that is collapsing sooner rather than later.
Why? Simply stated, as the size and scope of the public sector increased, that created very destructive economic and political dynamics.
More and more people got lured into the wagon of government dependency, which puts an ever-increasing burden on a shrinking pool of producers.
Meanwhile, organized interest groups such as government bureaucrats used their political muscle to extract absurdly excessive compensation packages, putting an even larger burden of the dwindling supply of taxpayers.
But that’s not the main focus of this post. Instead, I want to highlight a particular excerpt from the article and make a point about how too many people are blindly – perhaps willfully – ignorant of the Laffer Curve.
Check out this sentence.
Property tax collections are down 20 percent and income tax collections are down by more than a third in just the past five years — despite some of the highest tax rates in the state.
This is a classic “Fox Butterfield mistake,” which occurs when someone fails to recognize a cause-effect relationship. In this case, the reporter should have recognized that tax collections are down because Detroit has very high tax rates.
The city has a lot more problems than just high tax rates, of course, but can there be any doubt that productive people have very little incentive to earn and report taxable income in Detroit?
And that’s the essential insight of the Laffer Curve. Politicians can’t – or at least shouldn’t – assume that a 20 percent increase in tax rates will lead to a 20 percent increase in tax revenue. They also have to consider the degree to which a higher tax rate will cause a change in taxable income.
In some cases, higher tax rates will discourage people from earning more taxable income.
In some cases, higher tax rates will discourage people from reporting all the income they earn.
In some cases, higher tax rates will encourage people to utilize tax loopholes to shrink their taxable income.
In some cases, higher tax rates will encourage migration, thus causing taxable income to disappear.
Here’s my three-part video series on the Laffer Curve. Much of this is common sense, though it needs to be mandatory viewing for elected officials (as well as the bureaucrats at the Joint Committee on Taxation).
The Laffer Curve, Part I: Understanding the Theory
Uploaded by afq2007 on Jan 28, 2008
The Laffer Curve charts a relationship between tax rates and tax revenue. While the theory behind the Laffer Curve is widely accepted, the concept has become very controversial because politicians on both sides of the debate exaggerate. This video shows the middle ground between those who claim “all tax cuts pay for themselves” and those who claim tax policy has no impact on economic performance. This video, focusing on the theory of the Laffer Curve, is Part I of a three-part series. Part II reviews evidence of Laffer-Curve responses. Part III discusses how the revenue-estimating process in Washington can be improved. For more information please visit the Center for Freedom and Prosperity’s web site: http://www.freedomandprosperity.org
Part 2
Part 3
P.S. Just in case it’s not clear from the videos, we don’t want to be at the revenue-maximizing point on the Laffer Curve.
P.P.S. Amazingly, even the bureaucrats at the IMF recognize that there’s a point when taxes are so onerous that further increases don’t generate revenue.
P.P.P.S. At least CPAs understand the Laffer Curve, probably because they help their clients reduce their tax exposure to greedy governments.
P.P.P.P.S. I offered a Laffer Curve lesson to President Obama, but I doubt it had any impact.
___________________________
Thank you so much for your time. I know how valuable it is. I also appreciate the fine family that you have and your commitment as a father and a husband.
Sincerely,
Everette Hatcher III, 13900 Cottontail Lane, Alexander, AR 72002, ph 501-920-5733,
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Thomas Sowell
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