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Sunday, October 29, 2017

International evidence shows that low corporate tax rates are not strongly associated with stronger investment

International evidence shows that low corporate tax rates are not strongly associated with stronger investment // Blog | Economic Policy Institute

The Trump administration's Council of Economic Advisers (CEA) released a paper last week arguing that cuts in the statutory corporate tax rate would lead to gains in business investment, productivity, and wages. I noted in a piece released yesterday why this was unlikely to be true.

The key piece of evidence the CEA claimed was "highly visible in the data" and showed the wage-boosting effect of corporate tax cuts was simply a graph that showed faster unweighted wage growth in just two years in a set of "low-tax" countries relative to a set of "high-tax" countries. I noted in my paper yesterday why this was so unconvincing: a serious test of this claim would look at corporate tax rate changes (not levels), would look over a longer time-period than four years, and would not allow three countries with a combined national income that is less than 0.4 percent of American national income to drive the results.

But, the CEA report did make me curious if we would see anything "highly visible in the data" linking changes in statutory corporate tax rates to nations' capital stocks. The key theory behind claims that corporate rate cuts will boost wages is the idea that these rate cuts will lead to substantially faster investment in productivity-enhancing plants and equipment, boosting the nation's capital stock and making workers more productive. We can assess the first link in that chain of causation below, asking simply "are lower corporate tax rates associated with a larger capital stock"? Figure A shows a scatterplot of the relationship between the average statutory corporate tax rate between 2000 and 2014 the capital-to-labor ratio in 2014. The hypothesis is that low-tax countries should have attracted more capital investment and hence should have accumulated a large stock of capital relative to their workforce by the end of the period. (The data on capital stocks and employment comes from the Penn World Table 9.0.)

Figure A

As the trendline through the scatter indicates, the relationship actually goes the wrong way—countries with higher corporate tax rates over this period had larger capital stocks by 2014. This positive relationship is not particularly significant, either statistically or economically, but that's largely the point: tax cuts are an extremely weak lever with which to attempt to move capital investment.

Some might argue that looking at the average rate over a 14 year period might hide the fact that some countries went from high rates at the beginning of the period to low rates in the end. In this case, the large change in rates could likely have affected capital investment, but this would be obscured by our long-run averages. This is fair enough—though it highlights once again the CEA report's inappropriate use of averages over a short-run period. But Figure B below shows the change in corporate tax rates versus the growth rate of capital inputs into production (a measure of capital investment used in productivity analysis).

Figure B

Again, the correlation here goes the wrong way for sustaining claims that slashing corporate rates would increase capital investment; countries that saw larger reductions in the statutory rate saw slower growth of capital inputs.

The international evidence presented above just re-confirms what we already know: no binding constraint on American economic growth exists today that would be helped at all by cutting corporate income taxes. Instead, such cuts would simply boost incomes for owners of corporations—a group that is already overwhelmingly among the richest households in America. Promises of gains to investment, productivity and wage growth that will force these tax cuts to trickle down to typical American households are completely empty.


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