(This item originally appeared at Forbes.com on September 7, 2017.)
I recently argued that a country is far better off with a simple tax system and a low rate, like Hong Kong with its 16.5% corporate tax, than an obscenely complex system with a high rate, such as the U.S. with a 40% corporate tax (including the average of state taxes). Not only does the economy perform better, but Hong Kong’s approach produces far more revenue, as a percentage of GDP.
But, what if we just cut the corporate tax rate to 15% Federal (about 20% when combined with state and local taxes), and left all the rest untouched?
Having seen what happens to real economies in real life, I tend to have a somewhat loose approach to these things. The fact of the matter is: we don’t really know what will happen. A change in tax rates like this creates all kinds of behavioral changes that cannot be easily predicted. People will engage in taxable behavior, where they might otherwise have chosen behaviors that avoided taxes. Companies that were faced with high tax payments might prosper, and thus have more revenue and profits to tax. New companies will be established that might otherwise have been located in lower-tax locales, or died on the drawing board. Existing companies, or portions of companies, that might have relocated to lower-tax jurisdictions decide to stay. Corporations with large amounts of cash overseas might repatriate it, creating all kinds of new domestic investment. All sorts of underground activity might go legit, and start paying taxes. Employment could rise and growth could increase.
Some people try to come to some kind of reasonable estimate about all these things. The problem is, it is all so unknowable that no decent conclusion can be drawn. Will growth increase by 0.3% over the next decade, or 0.7%? A decade later, would you be able to answer that question even with the benefit of hindsight?
That’s why I say, when you do things that are good for an economy, good economic things tend to result. Tax revenues tend to be rather stable, as a percentage of GDP, and GDP tends to rise, more than it otherwise would. Maybe a lot more. While analysts bicker about tenth-of-a-percentage-point differences in GDP growth, the actual effects might add three percentage points to GDP growth rates. Nobody today would be willing to even suggest such a thing is possible; but that can actually happen. So we see that even the most detailed technocratic analysis can often omit completely the actual result.
After certain Eastern European governments introduced simplified “flat tax” systems, their nominal GDP growth rates sometimes exceeded 30%. Not 3.0%. Thirty percent. I don’t think that would happen in the U.S., but you can see why I find it depressing and counterproductive to argue between 0.5% or 0.8%.
Since 15% is 43% of 35%, one might begin with the premise that Federal corporate tax revenue would fall by 57% as a result of lowering the official rate to 15%. This would mean a reduction from revenue of about 1.8% of GDP to 43% of that, or 0.77%, a decline of about 1.0% of GDP. This would mean a decline in total Federal tax revenues from about 18.5% of GDP to 17.5%, a drop of about 5%.
Even this worst-case scenario is not such a big deal. If the Federal deficit expands by 1% of GDP, compared to the 3% to 5%-of-GDP range that it has been in for decades, we can handle it.
But, we might reasonably expect growth to be better. If nominal GDP increased by an additional 1% per year as a result, we can see that our tax revenue would be the same after five years of growth, with a lower revenue/GDP and bigger GDP. After five years, it’s all gravy: more growth, from lower tax rates, produces more revenue. Plus, we would get all the other benefits of growth, such as higher wages and lower unemployment; fewer demands upon the existing welfare systems, and thus less spending.
This is a pretty nice proposition just to start. But, tax revenue/GDP might not go down. It might go up. Among recent studies, the revenue-maximizing rate among OECD countries was estimated to be around 23.2% to 29.1%. Let’s average that and call it 25%. Since our corporate tax rate is around 40% combined, that would mean that revenue from the Federal corporate tax might go up – as a percentage of GDP! – with a rate of 20% (25% combined), from 35% today. Indeed, the average OECD rate has been around 25% since 2008, and has produced about 2.9% of GDP in revenue, which is 1.1% higher than 1.8% of GDP in the U.S.
Does this mean that, instead of a 1%-of-GDP fall in revenue, that we postulated earlier, we might instead get a 1%-of-GDP rise? Plus, an increase in GDP due to growth, itself producing more revenue?
Yes, it does mean that, although I suspect that is somewhat unlikely, if no other part of the tax code changes. But, you can see that it is certainly possible that overall revenue/GDP wouldn’t change very much – which is exactly what I suggested earlier might be the result.
If revenue did disappoint, for whatever reason, we could just start eliminating deductions and exemptions. If we eliminated all of them, we would end up where Hong Kong is today, and might have corporate tax revenue/GDP around 3.5% instead of 1.8%, or about double where it is today, and also a healthier economy.
So there is hardly any losing scenario. If revenue/GDP goes up, as it very well might, then we congratulate ourselves and open the windows to let all the new money in. If revenue/GDP is flat, then we congratulate ourselves, and enjoy more revenue (due to rising GDP) than if we had done nothing. If revenue/GDP declines, then we might wait a bit and allow higher GDP growth to make up the shortfall. Or, we could take another step toward Hong Kong-style tax reform — which we want to do eventually anyway — and start simplifying the tax code.
At the same time, a healthier economy would mean that it would be easier to reduce spending. So, even if revenue/GDP declined by 1% of GDP, it might create an environment of prosperity that would make it politically possible to reduce spending by 1% of GDP. To some degree, this would be automatic as existing welfare programs became less heavily used.
Try to dig yourself out of all the technocratic argle-bargle. It’s something we have to do, but it will all be wrong. There really isn’t much risk from a move like this, and a lot of upside – maybe more upside than hardly anyone can imagine. So get busy and cut the corporate tax rate to 15%.