(This item originally appeared at Forbes.com on August 24, 2017.)
The U.S. tax code is famously overcomplicated; it has been estimated at 75,000 pages long. The original 1913 U.S. income tax code was about 400 pages. It grew to about 8,200 pages by the end of World War II, and 26,300 pages in 1984.
What is in these 75,000 pages? The answer is: nobody knows. Some people specialize in certain areas of the code that most professional tax specialists do not know even exist.
However, I can summarize it for you. The first page has a set of tax rates. The following 75,000 pages say what income is exempt from those rates. Some of the more well-known exemptions include ones for hybrid vehicles, turning corn into gasoline, replacing home windows, adopting children, putting them in daycare, purchasing school supplies, going to college, investing in historic buildings, spending on research, and so on. Corporate tax exemptions can get much more complicated than this. Much more.
The Federal corporate tax rate today is 35%. Additional State tax rates can add nearly 10% more to this. Combined, it is one of the highest corporate tax rates in the world. However, the Federal government’s revenue from the corporate income tax is rather low, around 1.6% of GDP.
Let’s compare to Hong Kong: Hong Kong’s tax code is famously simple. It contains about 200 pages, and hasn’t changed much in fifty years. The top corporate rate is 16.5%. For a long time, it was one of the lowest rates in the world, although there are now several governments with a 10% rate. This 16.5% corporate tax rate produces revenue of about 5.6% of GDP. This very high number probably reflects Hong Kong’s status as a city-state and major financial center. It was 3.5% of GDP in 1990, with about the same tax rate. Nevertheless, the lesson is clear – you can get more tax revenue, as a percentage of GDP, with a low rate and simplified tax system, than a high rate and a massively overcomplicated tax system.
Plus, you get more GDP. The low rate and simple tax system tend to allow much more economic expansion. Hong Kong’s system is clearly better. Most everybody knows this, which is why the Trump administration is trying to copy Hong Kong’s example.
We should be happy that the tax code is so long, and revenue so poor. Without these exemptions, and today’s high rates, American business would probably be a lot less healthy than it is. High tax rates inevitably create political pressure to create exemptions in the tax code, plus all manner of “unofficial exemptions,” such as outright tax evasion or, finally, leaving the country altogether, as many U.S. companies have done by become non-U.S. companies. This has always been true, everywhere; governments that have tried to stop it have failed.
At a 50% tax rate, you make just as much money from exempting a dollar of existing income from tax as you do from making an additional dollar of income. But, making an additional dollar of income is hard. It might require millions in capex, hiring of thousands of workers, competition and substantial business risk. The return on lobbying, and supporting politicians with campaign contributions (a euphemistic form of bribery) is far higher. Money pours into Washington DC, instead of pouring into new ventures and expanded employment.
Politicians and lobbyists love this. They run a booming business in handing out favors. The last attempt at simplifying the tax system, and applying lower rates – the 1986 tax reform — produced an enormous backlash from Congresspeople and lobbyists, wonderfully expressed in Showdown at Gucci Gulch: Lawmakers, Lobbyists and the Unlikely Triumph of Tax Reform (1988), by Alan Murray and Jeffrey Birnbaum.
Big companies tend to love it too. Over many years, and with many millions of lobbying dollars invested, they have managed to exempt much of their income from tax. But what about a new business? It might be in an industry that didn’t even exist before. It might be trying to compete with big businesses by doing things a different way. It hasn’t been able to accumulate an arsenal of tax breaks. It might not be able to afford lobbyists’ and politicians’ price tag. It might end up actually paying that 35%+ rate; and, consequently, never becoming a big company.
Politically, it looks good. Socialistic agitators might become enraged by headline tax rates that they deem “unfair.” But, these people, and their followers, have no idea how business is really done. If a corporation is paying half the tax at triple the rate, everybody is happy.
With a tax rate of 15%, you get $0.85 from making a new dollar in income, and only $0.15 from exempting a dollar of existing income. Businessmen focus on building businesses. Money, power and influence flows away from Washington, to the benefit of everyone who is not a Swamp Thing.
What if you just lower the tax rate, and do nothing about the tens of thousands of pages of exemptions? Many businesses that were essentially evading taxes would go legit. It’s not worth the risk only to save $0.15 on the dollar. Existing businesses that might leave would stay in the U.S., and new businesses that might have been started elsewhere will instead be started in the U.S. Businesses that weren’t protected by exemptions might grow and flourish, producing more profit and more revenue.
This is all good. But, better yet, it creates an environment where the tax code can be simplified later. When there is no more need to avoid excessively high rates with tax code complexity, the political resistance to reform melts away. Most corporations would probably be pretty happy to do an honest business without having to bribe the slimy Washington class simply for the privilege to live and breathe.
Cut the corporate tax rate to 15%. It will allow businesses to prosper and create high-value jobs. It might even be – as it is in Hong Kong – a big moneymaker.