Simulating Corporate Income Tax Reform Proposals With a DCGE Model
Tuesday, September 29, 2015
by K. Bhattarai , J. Haughton , M. Head and D.G. Tuerck
U.S. corporate tax reform has emerged as a dominant issue in the political season now upon American voters. Tax reform proposals have been put forward by President Barack Obama and several candidates for president.1 The political campaign for president offers an opportunity to revisit the rich academic literature, which seeks to explain the burden corporate taxes places on investment. This paper aims to provide information useful to both the political debate and to the academic literature.
The debate over corporate taxes ties into the broader debate over how best to satisfy the two major goals of sound tax policy: efficiency and equity. The tension between the two objectives is inseparable from policy debates, but there is a growing consensus that the existing U.S. tax system is highly inefficient. Mirrlees et al. (2010), writing about the United Kingdom, speaks of a hopeful consensus among most economists observing that "there are taxes that are fairer, less damaging, and simpler than those that we have now. To implement them will take a government ...willing to put long term strategy ahead of short term tactics." As early as 1985, Hall and Rabushka (2007) in the U.S. expressed the urgency for tax reform, by declaring “it is time for another Declaration of Independence, this time from an unfair, costly, complicated federal income tax. The alternative is a low simple flat tax.”
The purpose of this paper is to assess the effects of corporate tax reform on the U.S. economy. This analysis is the first based on the dynamic computable general equilibrium model we are building for the National Center for Policy Analysis – Dynamic Computable General Equilibrium (NCPA-DCGE). The purpose of the NCPA-DCGE Model is to examine U.S. tax policy changes for their effects on major economic indicators, including:
- The level and distribution of household income;
- GDP, capital investment, and private sector employment;
- Government tax revenues, employment and spending; and,
- Short-term and long-term consumer welfare.
Dynamic CGE models are the most appropriate tools for assessing the impacts of taxes. Our earlier study found significant benefits from the implementation of the FairTax in terms growth and redistribution in the US economy (Bhattarai, Haughton and Tuerck, forthcoming 2015). This paper focuses on the impacts of changes in corporate income taxes, and the model uses the micro-consistent data from a Social Accounting Matrix (SAM2015) for benchmarking.
There are three main reasons why we focus on corporate tax reform here. First, as shown in Figure 1.1, the United States has the highest statutory tax rate among OECD countries. In their survey of the literature, Angelini and Tuerck (2015) find U.S. corporate rates to be relatively high and to impose a substantial burden on the U.S. economy. While several other countries, including Japan, Germany and the UK, have reduced corporate taxes substantially, the United States still has a combined federal, state and local corporate tax rate of greater than 39 percent. Overesch and Rincke (2011) provide an analysis of the declining rate of corporate taxes across the OECD economies. Leibrecht and Hochgatterer (2012) and Zellner, Ngoie and Kibambe (2015), attribute these falling rates of corporate taxes in OECD countries to the pace of globalization and tax competition.
Second, the high U.S. corporate tax rate appears to represent an inefficient source of revenue. Despite a lower average tax rate (ATR), the marginal tax rate is quite high in the corporate income in the US. This creates distortions. As shown in Figure 1.2, U.S. corporate tax revenue has represented only two percent of GDP in recent years, and is small in comparison to the average of the OECD economies. The U.S. corporate tax contributed about 10 percent of total tax revenue, compared to 8.5 percent across OECD countries. Finally, and as we show below, the existing corporate tax rate imposes a substantial burden on the U.S. economy.
Third, tax reform is back on the political agenda, and features prominently in the policy platforms of several of the leading candidates for the presidency.