President Biden campaigned on a pledge to raise taxes on the rich by reversing the 2017 tax cuts. Once in office, he issued several executive orders and the American Rescue Plan, quickly followed by his infrastructure proposal that has found little support in Congress. This spending was a placeholder for his promised higher taxes on the rich (and actually most others). The spending proposal may die, but higher taxes will reappear in other spending proposals or as a stand-alone tax “reform” bill.
The reversal of the Trump administration’s tax cuts includes raising the corporate tax rate to 28 percent from its current 21 percent. Former President Trump lowered the rate from 35 percent, so Biden would take back half. Biden also proposes putting the top marginal individual income tax back to its pre-Trump level of 39.6 percent, from 37 percent, plus the 3.8 percent investment tax on income in each case, bringing the top inclusive rate back to 43.4 percent. There are other increases in corporate taxes in Biden’s plan, particularly moving away from Trump’s taxation of global income.
Congress fought for years to achieve higher taxation of foreign income of U.S. firms and realized large gains. Bloomberg reporter Lydia O’Neal explains that there was a massive surge in the repatriation of dividends from earnings abroad — about $1.6 trillion over the first three years of the Trump tax policy — while corporate earnings reinvested abroad fell to about zero over the same three years. The growth of tax havens slowed to near zero. It is unlikely Congress would want to reverse these benefits.
There are four reasons to oppose Biden’s corporate tax rate increase. First, it would make corporations less globally competitive. According to the Organization for Economic Co-operation and Development (OECD), the Biden tax rate would move us from about 21st in a 36-country pack of developed countries in 2018 to the fifth-highest tax rate. Second, the higher tax rate would raise the cost of capital to taxed corporations, reducing their incentive to invest and reducing employment and real wages of their workers and workers competing with them. Third, the tax hike would raise the wedge in the taxation of capital income between businesses that actually face the corporate income tax and those that do not. Fourth, the revenue for the increased tax rate is relatively small, especially relative to the costs of the programs to which it is tied.
Proponents of a higher corporate tax rate do not realize that the horse has left the barn: Most of corporate income does not face the corporate tax rate. Over the years, growth of corporations free of the corporate tax led to declines in government revenue from the tax — from 32.1 percent of federal revenue and 5.9 percent of gross domestic product (GDP) in 1952 to 9.0 percent and 1.5 percent, respectively, in 2016, the year before the Trump tax cut.
The corporate tax enlarges the wedge between business income and what owners receive from investment. Where there is no corporate tax, an owner pays the marginal tax rate from the individual income tax — say, 40.8 percent today. With a corporate tax rate of 21 percent on an initial dollar of earnings, the same individual would receive 79 cents on the dollar of corporate earnings and pay 32.2 cents more individual income tax, bringing the total tax on taxable corporate income to 53.2 cents. The total tax wedge with the corporate tax is 30.4 percent more than that for the owner who faces only the individual tax rate, providing a strong incentive to avoid the corporate tax by changing corporate form or moving production abroad.
Raising the corporate rate to 28 percent (and the individual rate back to 43.4 percent) would raise the taxes on a dollar of corporate earnings, leaving 72 cents on which the owners would pay 31.25 cents more individual tax. The total tax wedge would rise to 59.25 percent, about 36.5 percent more than non-corporate-taxed individuals would pay. The incentive to leave the corporate tax rolls would grow.
The Biden administration projects additional revenue from the increased corporate rate to be about $2 trillion over 15 years — 50 percent longer than the typical budget-planning window. The actual result is likely to be less than half that amount. Moreover, public infrastructure spending tends to fully crowd out private sector investment, especially in infrastructure. Biden’s spending would have little or no effect on income, but his tax hike would have substantial negative effects on real GDP, income, productivity and real wages, essentially reversing half the gains from the larger tax cut observed from 2018-2020. The small revenue it raises will be more than offset by the greater losses in the private sector.
The corporate income tax introduces inefficiency in use of capital, with negative side effects on income and growth. Edwin G. Dolan, an economist and author of several textbooks, wrote before the Trump tax cut that the optimal progressive corporate rate would be zero, integrating all corporate income back to the owners each year and taxing it at the individual tax rate. This is largely the current practice for a substantial share of U.S. income from capital. This long has been the major objection and solution for the taxation of capital income — yet no one involved in the public debate over Biden’s tax hike has uttered this objection.
Instead, Treasury Secretary Janet Yellen and President Biden have endorsed a European idea for a 15 percent minimum corporate income tax to reduce international competition between governments to attract capital inflows, basically forming an international tax cartel to avoid competition. It would end moves in the United States and Europe to integrate the taxation of corporate income, but in the U.S., it also would accelerate the shift from the taxed corporate sector to an untaxed one.
John A. Tatom is a fellow at Institute for Applied Economics, Global Health and the Study of Business Enterprise at Johns Hopkins University, and a former research official at the Federal Reserve Bank of St. Louis.