Hiking Corporate Taxes Won’t Improve Economic Outcomes

Leading up to, and following, the passage of the Tax Cuts and Jobs Act (Trump Tax Cuts) I wrote a lot of analysis on:

What we know now, is that our analysis was correct. As noted, corporate behavior didn’t change, and instead of jumpstarting economic growth, tax cuts led to a wider dispersion of wealth inequality.

As I stated then:

While wages did rise marginally, due more to tightness in the labor market, rather than tax cuts, corporations failed to share the wealth. In fact, the ratio of profits to worker’s wages has materially worsened since the enactment of tax cuts.

In other words, the “devil is in the details,” as “corporate cronyism” devoured Washington politics.

So, if “tax cuts” didn’t work, how about President Joseph Biden’s plan to “increase” taxes?

Given the national debt is rapidly approaching $30 trillion, with deficits expanding rapidly, even some of the Democratic party is starting to become uncomfortable. As such, in order to get another massive spending bill passed, it will require increased taxes to “pay for it.”

While Biden’s plan includes increased estate and personal taxes, we are going to focus on corporate taxes for the purposes of this article. As shown, Biden hopes to raise $1.4 trillion in revenue from corporations, along with roughly $2 trillion in payroll and individual income tax increases.

In theory, those increased revenues will “pay for” the spending on the infrastructure plan. The problem is we aren’t talking about hiking taxes just for a single plan, but rather the gross excess spending of the Government in total. Here is the problem:

According to the Center On Budget & Policy Priorities, in 2020, roughly 75% of every tax dollar went to non-productive spending.

But there is more to the story as we discussed in “Stimulus Won’t Solve Poverty:”

Think about that for a moment and then realize the Government added another $5 trillion in deficit spending on top of the current deficit spending. Such is why it is easy to understand why increasing taxes is almost futile.

However, let’s dig in. As shown in the chart below, changes to tax rates have a very limited impact on economic growth over the longer term.

Furthermore, while it is often believed tax changes will create employment, such is not really the case. The chart below shows the corporate tax rate versus employment since 1946.

Corporate tax levels create employment change at the margin. If you look at the chart you will notice changes to corporate tax rates have a very low correlation to employment.

The difference today is that with economic and revenue growth weak, taxes and employment are two of the largest impacts to profit margins for any business.

As such, it is not surprising we see corporations opting for increases in productivity to reduce wage growth. Increasing taxes in this environment will likely accelerate that process.

Historically, what leads to stronger employment is sustainable economic growth. Such should lead to higher wages, increased aggregate demand, and higher rates of production.

In other words, employment adjusts over time to respond to the strength and direction of the economy rather than the movements in tax rates. The chart below shows economic growth versus employment.

Over the long-term, it is the direction and trend of economic growth that drives employment. The reason I say “direction and trend” is because, as you will see by the vertical blue dashed line, beginning in 1980, both the direction and trend of economic growth in the United States changed for the worse.

The differences between today’s economic and market environment could not be starker. The tailwinds provided by initial deregulation, consumer leveraging, declining interest rates, and inflation provided huge tailwinds for corporate profitability growth.

The chart below shows the ramp-up in government debt since Reagan versus subsequent economic growth and tax rates.

As noted, rising debt levels are the real impediment to longer-term increases in economic growth. When more than 100% of your current Federal Budget goes to entitlements and debt service, there is little left over for the expansion of the economic growth.

So, back to Biden’s hope that tax hikes will eventually “pay for” non-productive spending sprees.

In order for “infrastructure” to be beneficial, it should be “paid for” either through taxes or by a positive return on investment. According to the Committee For A Responsible Federal Budget, the latter is not likely.

So, if the investments themselves are not “productive,” then tax increases should not be used to pay for those expenditures. There are two reasons for this.

As discussed in “Tax Cuts Fail To Trickle Down,” corporations pay only a small fraction of the total taxes collected.

The second issue is that corporations pay much lower tax rates than “statutory” rates suggest. The first chart below shows corporate profits before and after-tax, and the effective tax rate.

When President Donald Trump cut the tax rate to 21%, corporations were paying a 14% tax rate. If we assume President Biden reverses Trump’s tax cuts, corporations will indeed pay more in taxes.

However, that revenue collection will fall far below current estimates even with the most optimistic of assumptions.

This excludes the negative impact of higher taxes on employment, growth, and wages, which lowers overall tax collections.

As I discussed in the “3-Big Lies About Tax Cuts:”

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