The Tax Cuts and Jobs Act of 2017 slashed the headline corporate tax rate from 35 percent to 21 percent. Now, the legislation’s effect has proven even more dramatic—the average business has seen its tax burden fall by more than half, from 26 percent to 12.6 percent of pre-tax profits. Based on first quarter data, the tax bill’s windfall for businesses could exceed $100 billion this year, which could boost corporate profits by approximately 10 percent.
The benefits from tax reform, however, likely will extend far beyond shareholders’ dividends. By improving transparency, removing distortions and building the nation’s productive capacity, the lower corporate tax rate is eventually expected to benefit all Americans.
Corporate taxes have a transparency problem—it is unclear who ultimately bears the burden. A business, after all, is made up of a group of diverse stakeholders. The corporation’s shareholders own the operation, but its workers are dependent on its success, too. Most large companies also have bondholders and other creditors who effectively own a share of future revenues.
A business’s tax burden could be carved out of any or all of these groups’ shares of revenue, or it could be passed on to customers through higher prices. Extensive research by the Congressional Budget Office concluded that corporate taxes are largely paid by labor, especially in a world where capital can easily be moved offshore. Princeton University professor Uwe Reinhardt reached the same conclusion in an independent research paper in 2010.
This means a reduction in the corporate tax rate should eventually lead to a larger share of revenue going toward wages. The shift away from corporate taxation should also make the nation’s tax code more transparent, allowing for tax policy that more effectively incentivizes production and discourages consumption. Transparent taxes can be targeted in ways that promote long-term sustainable growth and shared prosperity.
For the moment, the tax bill has boosted corporate bottom lines, pushing after-tax profits to a near-record high of 9.5 percent of gross domestic income (GDI). But in a competitive economy, corporate profitability naturally seeks an equilibrium, and a one-time change in the tax code is unlikely to shift the balance for long.
In today’s market, a business that chooses to send its tax windfall back to shareholders will soon find itself struggling against competitors who used their savings to make investments in labor-enhancing technologies. Since worker compensation is closely tied to productivity gains, workers stand to benefit from a surge in capital investment.
The tax cut will also remove some of the distortions that steered businesses toward inefficient decisions in the past. Now that the US corporate tax rate is in alignment with the rest of the industrialized world, businesses will no longer have a strong incentive to move their headquarters overseas or hoard their profits abroad.
Some observers are concerned that the tax cuts will increase the federal deficit and worsen the nation’s fiscal outlook for years to come. Although cutting taxes reduces federal receipts in the near term, it will only harm the nation’s long-term fiscal outlook if it fails to spur growth.
If tax reform succeeds in encouraging capital investment, stronger demand for labor could bring millions of discouraged workforce dropouts back into the labor market. A booming domestic economy should also lead to more immigration, which would help offset the demographic decline from the nation’s aging population. This is how stronger economic growth would improve the nation’s long-term fiscal outlook.
Ultimately, a more transparent tax code that leaves more money in the private sector should encourage investment and growth. The economy’s supply-side gains will help workers as wages rise in tandem with productivity, and sustainable growth will make the federal deficit more manageable for future generations. By lowering the tax burden on businesses, the tax bill should ultimately create beneficiaries throughout the economy.
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