Kevin Hassett: The case for lowering the corporate tax

Commentary

The United States is about to have the highest corporate tax rate in the developed world because our competitors have noticed that revenue goes up as rates go down.

Multinational corporations today nimbly move their profits to the friendliest environment, rewarding tax havens like never before.

It looks as if President Obama and congressional Democrats are going to miss out on the single biggest policy opportunity for the United States this year because of ideological resistance to the idea that lower rates can increase revenue, also known as the Laffer curve.

The devil was in the details of what Obama said in his State of the Union address: "I'm asking Democrats and Republicans to simplify the system. Get rid of the loopholes. Level the playing field. And use the savings to lower the corporate tax rate for the first time in 25 years -- without adding to our deficit."

A careful reading shows that Obama conditioned his support for tax reform on revenue neutrality -- that is, no net loss or gain in what the federal government collects in taxes.

The usual referee in such matters, Congress's Joint Committee on Taxation, doesn't fully incorporate what's known as dynamic scoring, or anticipating higher growth from lower taxes.

If there were any doubts about the administration's position, they were put to rest by Treasury Secretary Timothy Geithner, who said, "We're not going to ask Americans to pay higher taxes so we can lower taxes on businesses."

Obama and Geithner must not understand the fix our country is in.

Corporate taxes "are the most harmful type of tax for economic growth," according to a November 2010 report by the Organization for Economic Cooperation and Development. And in the World Bank-supported "Doing Business 2011" report, the nation's worst ranking by far was in the category called "paying taxes" -- 62nd out of 183 economies, tied with Uganda.

That needs to be fixed.

The U.S. top corporate tax rate of 35 percent in 2010 was higher than all other OECD nations except Japan, which has embarked on a 5 percentage-point cut.

If the high rate in the United States raised lots of revenue, cutting it might be bad news for the federal budget. But that's not a problem.

The United States earns less federal corporate tax revenue, as a percentage of gross domestic product, than the average OECD country. Higher rates, lower revenue.

From 2000 through 2009, the U.S. average corporate tax revenue as a percentage of GDP was 2.06 percent, according to OECD data. The average for the rest of the OECD was almost a percentage point higher, at 3 percent.

In 2009, the U.S. ratio dropped to 1.64 percent. That year, Britain, with a tax rate of 28 percent, raised 2.8 percent of GDP. South Korea raised 3.4 percent of GDP with a rate of 22 percent.

A number of studies have indicated that a Laffer curve exists for corporate taxes.

If the average OECD country set its rate at 26.4 percent, it would raise 3.8 percent of GDP from corporate tax revenue, according to my analysis of historical correlations.

If the U.S. managed to increase its corporate revenue as a share of GDP to 3.8 percent, it would yield a startling $2.8 trillion during the next decade above what the Congressional Budget Office now projects. Even less-rosy assumptions can't spoil the fun.

Let's say the United States achieves merely the average improvement of an OECD country that reduces its corporate tax rate to 26.4 percent from 35 percent. The improvement would still generate an impressive $748 billion over the next 10 years.

All of this might force Obama to reconsider his obeisance to revenue neutrality, since under these models, tax revenue doesn't remain neutral -- it soars.

Republicans have asserted for years that just about all tax cuts pay for themselves. They've almost always been wrong about that. But with regard to corporate taxes, it's true. Laffer prevails.