Wednesday, June 04, 2008


Greg Mankiw (link) recently wrote an article (link) published in The New York Times (link) discussing the possibility of a cut in the corporate tax rate as recently proposed by the economic advisers of John McCain. While John McCain has some doubtful and economically questionable proposals, such as the extension of gas-tax holidays, his economic advisers recently proposed a cut in the federal corporate tax rate from 35 percent to 25 percent. While the suggested proposal has been harshly criticized by economists such as Brad DeLong (link), the proposal deserves an open discussion about the consequences of the corporate tax rate.

The most frequent mistake that has been grasped repeatedly by the mainstream media and intellectual elites is that corporate tax is actually paid by the corporation itself. Despite the soundness of the argument, it is false. Corporations are likely to be tax-collectors than taxpayers. Why? For example, if you own equities and securities, than corporations shift the burden to consumers, hired labor and stockholders. An increase in the corporate tax rate potentially reduces capital investment. In turn, a corporation levies the burden by cutting total costs of labor and services. Consequentially, corporate equities and stocks are hampered by a higher relative weight on potential returns. Also, a significant amount of empirical research, including Randolph's 2006 study (Congressional Budget Office), has confirmed that the major share (70 percent) of the corporate tax burden is beared by the labor force. Researchers at Oxford University (Arulampalan, Devereux, Maffini) examined the effect of the corporate tax in 50,000 European companies in nine European countries. They found that, in the long run, a $1 increase in the tax bill reduces the real wage at the median by 92 cents.

The opposition to the cut in corporate tax rate often includes arguments such as the loss of tax revenue and the reduction of real wages. However, none of these arguments is based on empirical observations. In the short run, there are numerous static assumptions claiming that the revenue may fall precisely. However, the reduction in corporate tax burden would result in a stronger and less volatile stock market. In turn, that would boost capital investment respectively which would lead to higher productivity growth. A basic consequence of productivity increase is the increase in real wages and a drop in consumer prices. True, part of rhe revenue loss may be covered by an increase in other taxes such as gasoline taxes. But have there been any confident estimates showing that the revenue may really decline?

An additional and truly important measure to decrease the corporate tax burden is lowering government expenditure, both in absolute in relative terms. According to experience, the net effect of lower government spending is an increase in the growth of real productivity as well as stronger stock market that would boost investment and reduce volatility of the stock market itself. Also, lower government spending would result in higher output growth as well as it would have significantly positive welfare effects on prices, wages and employment.

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