Last week President Donald Trump proposed slashing the corporate tax rate to 15% as the centerpiece of a tax plan designed to boost economic growth.
He is in good company. Between 2000 and 2016, most of the U.S.' largest trading partners cut their corporate rates. But their experience offers a reality check. There is little compelling evidence any enjoyed substantially faster growth as a result, and certainly not on the scale of Mr. Trump's ambitions; he wants to push the U.S. long-term growth rate from its current 2% to 3%.
This doesn't undermine the case for a lower corporate rate: All else equal, it almost certainly will help. But it is a warning to administration officials who are counting on rate cuts to generate so much growth that they pay for themselves. Many forces operate on the economy, including demographics, the business cycle, technology and regulation. Taxes are just one factor and they are often less potent than advocates advertise.
The theory is straightforward and uncontroversial. A tax cut makes it cheaper to finance investment in new projects. More spending on equipment, buildings and intellectual property should contribute to growth in the short run and create lasting payoffs by boosting worker productivity in the long run.
In 2000, the U.S. federal rate of 35% combined with state taxes was in the middle of the advanced-economy pack. Today, it is the highest in the 35-nation Organization for Economic Cooperation and Development because so many other countries have cut theirs.
Britain reduced its corporate rate from 30% in 2007 to 19% now. A 2013 study by the British Treasury predicted the tax cuts since 2010 would eventually boost the level of gross domestic product by 0.6%. That is certainly worth having, but spread out over, say, six years, would boost the growth rate by a barely noticeable 0.1 percentage point.
British investment as a share of GDP is actually lower than before 2007 and productivity growth -- the ultimate determinant of living standards and where higher investment should leave its mark -- averaged 0.6% from 2010 to 2015 according to the OECD, one of the worst among major countries. Treasury noted that Britain has been hit by the euro crisis, the financial crisis and surging oil prices, all of which likely delayed the benefits of the corporate tax changes.
Canada cut its corporate rate from 28% in 2000 to 21% in 2004. While growth from 2000 to 2004 was about half a percentage point faster than the prior decade, it has since slowed. Canada's annual productivity growth since 2000 has been about 1%, slower than in the 1990s.
Jack Mintz, a tax expert at the University of Calgary, says Canada would have grown more slowly without the tax changes. Aging alone, he says, has knocked a percentage point off underlying growth since the 1990s. Nonetheless, Canada's lackluster performance flummoxes him. "One of the puzzles we are facing is, with all the textbook reforms -- better fiscal policy, trade policy, tax policy, research and development incentives, education reforms -- we haven't been able to see better results."
Several studies do find that tax cuts boost investment. One study of Canada's tax cuts teased out the effect by comparing service industries, which benefited from the cuts with manufacturing, which already enjoyed a low rate and thus had less to gain. Services investment was highly responsive.
A 2004 study of 85 countries by Andrei Shleifer of Harvard University and four others suggests that a 10-percentage-point reduction in the effective corporate tax rate raises investment's share of gross domestic product by 2 percentage points. Another study, co-written by Kevin Hassett of the American Enterprise Institute, who has been nominated chairman of Mr. Trump's Council of Economic Advisers, found that in 12 of 14 countries that enacted tax reforms, including the U.S. in 1986, investment rose significantly for the firms that saw the biggest reductions in taxes.
Still, while these studies suggest lower corporate taxes have the predicted effect on investment, they don't show national growth rose as a result.
Of course no two tax cuts are alike. Other countries may not provide a reliable road map for what awaits the U.S. Many raised other levies, such as the value added tax, to pay for corporate rate cuts. Mr. Trump hasn't proposed significantly raising any taxes other than limiting some personal tax breaks, and indeed would cut personal income-tax rates, which in theory incentivizes more work.
His plan comes with another caveat: It would be paid for with a dramatic increase in government deficits, which in theory should raise interest rates and crowd out the private investment, neutralizing some of the benefits of lower taxes. Interest rates haven't responded to massive government deficits lately because private investment has been so lackluster. If those dynamics change, Mr. Trump's growth plans could face yet another impediment.
Write to Greg Ip at email@example.com
(END) Dow Jones Newswires
May 01, 2017 08:43 ET (12:43 GMT)