The cut in the corporate tax rate from 35 percent to 21 percent is the centerpiece of the Tax Cut Package that took effect this year. This put the United States in line with the rest of the developed world, which has a 24.1 percent average corporate tax rate.
Since corporations are just groups of people, the corporate tax has to be passed on to some other group to be paid. A popular belief is that the corporate tax is equivalent to a tax on the rich, but there is no guarantee that the tax is passed through to the rich. The groups who pay the corporate tax are, instead, likely to be consumers through higher prices, rank-and-file workers through lower wages, and shareholders through lower returns in the stock market. Cutting the corporate tax should improve these indicators.
The corporate tax also has a high compliance cost, estimated by the nonpartisan Tax Foundation to be $147 billion annually, while only raising $300 billion in tax revenue. Compliance costs – the costs associated with hiring accountants, lawyers, and processing paperwork – are wasteful. Reducing this waste is an additional economic benefit.
Though it is early, the effects of the corporate tax cut look promising. Inflation continues to remain low, despite the economy being at full-employment. Wage growth, which has been disappointing through the economic recovery, is now averaging 2.9 percent per year – its best pace since 2008. A corporate tax cut increases the return to capital, since corporations keep a larger share of the profits derived from its capital stock. Consistent with this, the stock market is up by five percent for 2018. A corporate tax cut was widely expected following the 2016 election, and this expectation was likely priced into the stock market prior to the tax cut being enacted. This helps explain the 45 percent rise in the stock market between Election Day and now.
A corporate tax cut increases the return on business investment in equipment and capital goods. Business fixed investment has increased by $200 billion since the beginning of 2017 after remaining flat since 2014. Some of this increase is likely due to the expectation of a corporate tax cut.
The biggest downside to the tax cut is the impact it is having on the U.S. budget deficit. The budget deficit has increased from $665 billion in 2017 to an estimated $833 billion in 2018 – a deficit equivalent to four percent of Gross Domestic Product. This is a grossly irresponsible deficit for the government to be running when the economy is at full-employment. At worst, this invites a serious fiscal crisis. At the very least, when the next recession hits and tax revenues fall, the deficit will get even larger and the government will have few fiscal tools available to stimulate the economy. The deficit needs to be addressed, and soon.