Did you know that Congress and President Biden raised your taxes? The hike masquerades as a tax hike on business, but according to the latest research, it actually hits your paycheck.
State-of-the-art economic research overwhelmingly confirms that high business income taxes harm investment, research and development, worker productivity, wages, and growth, and three new studies explain just how.
Let’s work through the basic economics. When a company pays higher taxes on its profits, it has less money left over to return to shareholders as dividends and to reinvest in the company. Those two effects have further bad consequences.
Falling dividends discourage people from saving and investing in companies. Rather than save and invest, they consume more. That means lower growth in the future.
Declining reinvestment hurts research and development and capital purchases. The new minimum tax on business income, part of the Inflation Reduction Act, makes this problem especially severe, because it punishes companies who would otherwise benefit from deductions for capital investment.
Evidence supports theory. The most recent, comprehensive review of published studies in the respected Annual Review of Economics reports decreases in wages resulting from a $1 increase in corporate income taxation ranging from 60 to 66 cents, with bigger effects for the less skilled, women, and young workers. About half of the decline in wages is passed on to landowners. They also find that when taxes increase the cost of capital by 1 percent, that reduces business investment by between 0.5 and 1 percent. Unpublished studies sometimes find no effect of corporate taxation on GDP growth, but many of these studies are of low quality, produced by activist organizations. The published literature consistently shows a negative effect of corporate taxation on growth.
The two newest studies are not covered in that literature review. Still awaiting peer review, they have been published by the prestigious National Bureau of Economic Research.
The first, by economists at the University of California–Davis, University of London, and London Business School, looks at the effects of politically driven corporate income tax cuts in the U.S. between 1950 and 2006. (They focus on politically driven cuts to improve causal identification.) They find that business tax cuts cause temporary growth in private research and development spending and permanent growth in productivity and GDP.
In the second new paper, an overlapping group of authors looks at who gains from corporate tax cuts. They find that goods producers raise capital expenditure and employment in response to a tax cut, while service sector companies increase dividends. So raising corporate income taxes cuts manufacturing investment and jobs.
State tax cuts may have even larger effects, because the investment they spur is not just new investment, but reallocation from other states, and because many states face balanced-budget requirements that should make any tax cuts that do occur more permanent. Recent research supports this hypothesis, with state tax cuts increasing both jobs and the number of establishments, in roughly equal amounts from new investment and from reallocation from other states.
New Hampshire’s recent experience supports this finding. The Granite State has been cutting business profit and wage base taxes consistently since 2015. From 2015 to 2021 (the most recent year for which data are available), New Hampshire’s real personal income grew by 24 percent, compared to 19 percent for its closely linked neighbor, Massachusetts. In the six years before the tax cuts, New Hampshire had underperformed Massachusetts in income growth, 14 percent to 18 percent. So New Hampshire’s growth sped up and surpassed Massachusetts after business tax cuts began.
All this means that Congress’s new tax increases on business couldn’t come at a worse time: right when business is still recovering from the supply-chain shocks of the pandemic and wages fail to keep pace with inflation.
According to the Institute for Supply Management, new orders and jobs in manufacturing fell in August for the 10th straight month after a 28-month-long boom. Could the Biden tax hikes already be hitting the manufacturing sector?
Congress and state legislatures should start listening to economists, not special interests. Economists may disagree about many things, but on this point they speak with one voice: If you want to help workers, especially in manufacturing, cut taxes on their employers.