Contributed by: Jaclyn Jackson
The probability of tax reform is increasing with the White House proposing to reduce the corporate statutory federal tax rate from 35% to 20%. Even though most companies don’t actually pay at the 35% tax rate (26% median effective tax rate for the S&P 500), the tax cut is projected to lift S&P earnings by 8%. While S&P projections sound good, economic benefits are not a sure thing as implications could have varying outcomes based on historical data.
To illustrate the complexity of implications, I’ve outlined core arguments that prove and disprove the benign effects of lowering the corporate tax rate.
- Incentivizes US companies to stay in the US, expand business, and increase employment.
According to a study done by J.P. Morgan, 60% of the cash held by 602 US multi-national companies is in foreign accounts. They concluded that $663 billion would be invested into business expansion and job growth in the United States, if an income tax cut were offered to companies that repatriate.
- Higher corporate income taxes lower worker wages, diminish consumption, and increase unemployment.
Using data from 1970-2007, a Tax Foundation study found that for every $1 increase in state and local corporate tax revenues, hourly wages would drop an estimated $2.50. Theoretically, lower wages decrease one’s ability to buy goods, resulting in lower income for businesses thereby creating a net increase in unemployment.
- Job growth is inhibited by the current corporate income tax rate which is over the rate that maximizes revenue to corporations and the US government.
Based on studies of the Laffer curve, the corporate income tax rate that maximizes revenue to both corporations and the US government is 30%.
- Repatriation doesn’t ensure more jobs in the US.
Congress passed a tax holiday in 2004 that allowed companies to bring back earnings made abroad at a 5% income tax instead of at 35%. Fifteen of the companies that most benefitted cut more than 20,000 net jobs.
- Historically, unemployment rates were the lowest in US when federal corporate income tax rates were the highest.
From 1951 (top marginal corporate income tax rate rose from 42% to 50.75%) to 1969 (rates reached 52.8%), the unemployment rate moved from 3.3% to 3.5%. From 1986 to 2011 (top marginal corporate income tax rate declined from 46% to 35%), the unemployment rate moved from 7% to 8.9%.
Majority of economists don’t link employment to lower tax rates. When 53 American economists were polled, 65% attributed employers not hiring to lack of product/service demand.
- High corporate profits don’t guarantee low unemployment rates.
In 2011, corporate profits made up 10% of US GDP (highest since 1950), but corporate income tax revenue only brought the US federal government the equivalent of 1.2% of GDP (lowest in recorded history). In 2011, the US unemployment rate was 8.9% compared to the OECD (Organization of Economic Cooperation and Development) average of 8.2%.
*Data summarized from https://corporatetax.procon.org/.
While most would agree lowering corporate tax rates deserves serious consideration, it is not a given that lowering corporate tax rates will improve employment nor consumption. Today, US corporate profits are high (sitting on nearly $2 trillion in cash), yet wages and job creation hasn’t gone up significantly. There are many other factors to consider with comprehensive tax reform, not to mention the tough tradeoffs involved in this process. Frankly, tax reform is a huge, convoluted undertaking; time will tell whether the current administration is up to the task.
Jaclyn Jackson is a Portfolio Administrator and Financial Associate at Center for Financial Planning, Inc.®
The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Jaclyn Jackson and not necessarily those of Raymond James. Past performance is not a guarantee of future results.