In a new article, Associate Professor of Law Zachary Liscow ’15 and co-author Edward G. Fox advocate higher corporate taxes that would close the deficit, fund social programs, and reduce inequality. Liscow explained the political and political challenges ahead and how the current pandemic and recession are affecting the urgency of corporate tax reform.
Q: In your paper, you find that although there is a common belief that corporate taxes should be reduced due to international competition, two recent changes speak in favor of higher corporate rates. Can you explain what these changes are?
A: First, changes in the structure of corporate tax have resulted in a certain amount of tax doing less harm to the economy. Think of your own taxes. There are at least two important characteristics of these taxes. The first is the tax rate: the proportion of taxable income that you pay tax on. The second is how you measure taxable income. A key consideration in measuring taxable income is deductions. Businesses also deduct a lot of expenses: for example, if they pay someone’s wage, they can usually deduct that wage from their taxable income.
What has changed in tax law is how businesses can deduct the amount that is spent on durable things like machinery. It used to be that when a company bought a machine, they usually couldn’t deduct much from the cost of the year in which it bought the machine. In considering whether to buy the machine, a company would weigh the fact that it was often unable to lower its taxes because of today’s purchase against the fact that it would have to pay taxes on the profits made on the machine were the future – and often didn’t buy the machine. That would sometimes hurt the economy. But now companies can usually deduct the full cost of the machine when they buy it, which reduces their taxes. When companies consider buying the machine now, they think that they will have to pay taxes on profits in the future, but they can also cut their taxes today. And since a higher corporate tax rate is critical to both future profits and the tax cuts paid today, a higher tax rate cancels out significantly. So the investment in the machine is not discouraged and the economy is not damaged. Since the tax does less harm, it makes sense to raise it to higher rates as taxes will have to be levied somehow.
Instead, the tax is now aimed at so-called “rents” or above-average profits for companies with market power. So if an internet company with market power buys a new server at a low cost and makes a lot of money on it, corporate tax is still raising money. And even a high tax rate doesn’t discourage the purchase because the new server makes so much money. Taxing these rents at high rates does little harm to the economy.
So this is the first change. The second change is that there is a multitude of indications that changes in the economy have increased rents in the economy. The first reason for higher tax rates was that a high corporate tax rate doesn’t do much harm. This second reason is that it can actually do something good. A higher corporate income tax can reduce so-called “rent-seeking” activities, in which, for example, companies try to maintain their market power. That said, the type of monopoly that comes from higher corporate tax rates tends to hurt the economy by driving up prices for consumers, and higher corporate tax rates can reduce activities like lobbying that businesses use to maintain their advantages.
Q: What are the main challenges in reversing this trend, given that corporate tax rates were only lowered significantly by federal legislation about two years ago?
A: Right. In 2017, Republican-led Congress passed a bill, signed by President Trump, that cut the corporate tax rate from 35 percent to 21 percent. Joe Biden’s plans call for a corporate tax rate of 28 percent. So a big question at this point is who will win the 2020 election.
There are also political challenges. The more we can shape the tax in such a way that the damage to the economy is reduced, the safer we can increase the tax rate. However, there are several ways you can change corporate income tax to reduce the damage it will still cause, such as: B. the potential encouragement of some companies to relocate their business or to move paper profits overseas. For example, we could tax these things at a higher rate, which would prevent relocation and allow us a higher domestic corporate tax rate.
We can also undertake a number of more technical reforms to ensure that the tax does as little harm to the economy as possible, such as: B. To ensure that other expenses are treated like the machine mentioned above: When a company buys the machine, it can reduce the income on which it pays taxes by the full cost of the machine, so the taxes that are due to the today’s deduction, largely offsetting the taxes paid on profits made due to the machine in the future. Some things (like structures and inventory) are still taxed as they were under the old system and that can be changed.
Q: According to your research, what is the biggest benefit of increasing corporate tax rates? Why is this idea so relevant especially during a pandemic and economic collapse?
A: I discussed the cost of corporate taxes. We want to minimize these costs. But we don’t want to lose sight of the advantages. The main benefit is that it is great to collect taxes with a low cost to the economy as we can cut more damaging taxes elsewhere or increase spending on key priorities. A second benefit is that these taxes are quite progressive and target the rich, which we generally think is a good thing.
It is important to remember that we are now in the midst of a pandemic and recession. That could be one reason not to hike rates today. However, the context could make the reform even more urgent as an increase in corporate taxes would make it easier to cut taxes that do more harm to the economy or taxes that target low-income people rather than wealthy people. And given that many large companies did reasonably well in 2020, despite the fact that many low-income people lost their jobs, these topics are particularly relevant.