Wednesday, February 16, 2011

High US Corporate Tax Rates Are Driving Investments Abroad

From "Race to the Top of the Laffer Curve" by Aparna Mathur in the Journal of the American Enterprise Institute:
The international tax literature Roger Gordon and James Hines summarize in their 2002 article shows that mobile capital flows from high-tax to low-tax jurisdictions. In any set of competing countries, relative rates of taxation determine investment flows. In other words, America’s high corporate tax rates are driving investments abroad and causing firms to rethink expansion plans in the United States. The loss in revenues, or in effective taxes paid, should not shock us.
***
But for investment purposes, the important figure is the effective average tax rate (EATR), or the difference between the pre-tax return and the post-tax return on investment, expressed as a fraction of pre-tax economic profits. More simply, it is the tax liability that a firm may expect to incur as a fraction of pre-tax economic profits. The EATR differs from the statutory rate because it allows for other features of the tax code, such as depreciation allowances or interest rate deductions, which enable firms to ultimately pay less than the statutory rate.

A 1998 paper by Michael Devereux and Rachel Griffith shows that the EATR is the critical tax rate determining where firms locate investment. Countries with high EATRs lose, while capital flows to the low EATR jurisdictions.

EATR=Effective Avg Tax Rate:
EMTR=Effective Marginal Tax Rate 
Read the complete article here.

17 comments :

  1. Thanks for the reply. That post was very helpful. But I am still confused as to why the total corporate tax revenue has gone down in comparison to the total personal income tax revenue. If the EATR and the statutory rate are as high as the charts show, then what accounts for disproportion between corporate and personal income tax revenue? Am I right in concluding that revenue has been shouldered more by individuals since the 1940s?

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  2. You are right. Individual tax as percent of total tax revenue has been flat since 1940, while corporate tax revenue, as a percent of total, has been declining. See chart here.

    The reason is corporations are not bringing home their foreign cash due to the high US corporate tax rate. See my post, "US Companies Keep Trillions In Cash Abroad To Avoid America's High Corporate Taxes."

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  3. Thanks again for the clarification. But may I beg another question (or two)? If the corporate rate dropped from 50% in the early 1980's to around 39% in 2010, then isn't it fair to say that this alone explains the decrease in revenue? If monetary assets have been chased out of this country into foreign tax havens, then how can the US recuperate the revenues from corporations it was formerly accustomed to? I was wondering if the solution is to shift our means of generating revenue to a VAT system while reducing the corporate and individual rates. How do you hold those US companies that hoard large amounts of cash (and profits)in foreign countries accountable?

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  4. David Ricardo's Competiveness Destroyers

    In Chapter 19 of the 1817 classic On the Principles of Political Economy, and Taxation, David Ricardo mentions , in addition to war, removal of capital and a new tax as destroyers of the comparative advantage which a country before possessed in manufacturing. A Change in U.S. Corporate Tax Regulations, actually a tax reduction has led to the flight of capital from the United States. This change in U.S. Corporate Tax Regulations, dating back to 1997, which began allowing U.S. Corporation the deferral of payment of tax for foreign earnings, as long as those earnings were not returned to the United State. The result is not only the loss of U.S. tax revenue but also an incentive for the remove of capital and with capital the related jobs.

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  5. Great post and also great blog in general (I also really liked the one about health care). I'll be surely reading the entire article ("Race to the Top of the Laffer Curve") soon.

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  6. The reason behind such downturn is that they are not taking back their foreign cash .Thanks for such post.
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  10. It is really bad to know that America’s high corporate tax rates are really driving investments abroad and causing firms to rethink expansion plans in the United States.Such thing is not expectable from America at least.I think they should behave with wiseness and should reconsider such issue for their country's interests.

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  11. It is really a strange and shocking news that total corporate tax revenue has gone down in comparison to the total personal income tax revenue.You have shared great updating post.

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