Dropping the corporate tax rate would substantially reduce the incentive for U.S. companies to move or remain overseas, but the actual effects are hard to predict, according to an accounting professor at Duke University's Fuqua School of Business.
President Donald Trump proposed slashing the corporate tax rate to 15 percent as part of his proposal to overhaul the U.S. income tax system. Both major parties have argued for reducing the corporate tax rate, but disagreements over the personal income tax rate have always prevented a deal from being struck.
"One of the most difficult things about tax reform is estimating the dynamic effect of the reforms," Professor Scott Dyreng said. "It's likely that lower tax rates would encourage investment, but it's not clear by how much. It is also possible a lower rate could encourage companies from abroad to come to the US, companies attracted to our capital or consumer markets but who have chosen to stay away because of our tax rate.
"The other possibility is that if tax collections drop -- and early analyses of Trump's proposal suggests collections would drop substantially -- and you don't get the growth and investment to make up for those revenues, now you have bigger deficits and greater need for government borrowing, potentially less investment in infrastructure and other public goods that are necessary for companies to actually want to come here," Dyreng said.
Because Trump's plans are light on specifics and not revenue neutral, it is unlikely the plan will see substantive debate without significant changes.
"To be viable, tax reform needs to be closer to revenue neutral," Dyreng said. "That means that lowering the corporate tax rate would be accompanied by the elimination of many one-off deductions. But by definition, revenue neutral tax reform creates winners and losers. The reality is that congressional representatives who want re-election are reluctant to support any legislation that might increase the tax burden to firms in their districts."
"There will be a variety of losers."
Significant tax reform, Dyreng said, could hurt lots of companies in the short-run, from green energy firms who rely on tax credits to stay afloat, to automakers with large deferred tax assets on their balance sheets.
"There will be a variety of losers," Dyreng said.
The corporate tax rate in the U.S. was dropped in 1986 from around 50 percent to 34 percent. At the time, that was lower than most other developed countries but in the 30 years since then, the average corporate tax rate of other developed economies has steadily declined, and has been lower than the statutory U.S. rate since the late 1990s.
"Since that time there has been growing pressure for the U.S. to drop its rate," Dyreng said. "The greater that disparity has become, the greater the incentive has been for firms to operate overseas where they can get a lower rate."
Reform would, in theory, also see the tax code simplified through the removal of complex deductions that companies spend so much money trying to find.
"Most economists would argue a low tax rate and a broad tax base with relatively few exceptions is the most efficient tax," Dyreng said. "It imposes fewer distortions on economic behavior."
A lower corporate tax rate with fewer exemptions would likely increase economic efficiency at firms who currently incur huge deadweight costs associated with tax planning, Dyreng said.
"Companies engage in all sorts of inefficient behaviors in an attempt to find ways to lower their effective tax rate because the statutory rate is high," he said. "If you just lower the rate, all those deadweight costs are eliminated, which would be a boon to economic efficiency."