Capital Drag

Fiscal Policy: Four more developed nations have cut their corporate tax rates this year. Yet the U.S. sticks with second-highest corporate rate among OECD nations. This puts us at a competitive disadvantage.

Only Japan, at 39.54%, has a higher corporate rate than the U.S., which at 39.1% is a bit lower than last year but still far higher than the average (26.29%) of the 30 Organization for Economic Cooperation and Development nations.

That average was brought down from 26.55% after the Czech Republic, Sweden (yes, the country where soft socialism has supposedly been perfected), Canada and South Korea cut their rates.

The Tax Foundation, which provides a priceless service by studying the impact of taxation, says the high corporate tax rate in the U.S. "should be a red flag" to lawmakers who are "worried about the country's flagging economic growth, slow wage growth, and overall global competitiveness."

The OECD itself noted in a 2008 study that "corporate taxes are the most harmful tax for economic growth." Not even personal income taxes or consumption taxes were found to cause as much economic damage.

J.T. Young, a frequent contributor to these pages who has served both at Treasury and the Office of Management and Budget, is not a lawmaker. But he's seen the red flag. He pointed out here two years ago that America's competitive advantage with other nations narrowed over the last two decades as other countries cut their corporate tax rates while we actually increased ours.

"Our competitive advantage is not inherent," Young wrote. "It has been the product of economically sound tax policy coupled with unique circumstances following World War II."

U.S. tax policy is not as sound as it was two decades back, though,when the top corporate rate, at 34%, was well below the OECD average of 44%. (See chart, in which the non-U.S. OECD average is weighted to account for differences in populations between OECD countries and is higher than the simple 26.29% rate cited above.)

High corporate rates are unwanted — or should be unwanted — because they put a drag on a nation's capital stock. An economy needs investment to increase jobs and pump productivity. High corporate tax rates repel rather than attract foreign companies and can even send domestic firms overseas. Capital flows easiest where the resistance is light.

This is not our fantasy but an outcome that's been observed in the real world. In 2003, economists Ruud de Mooij and Sjef Ederveen found that if a country cuts its corporate rates by a single percentage point, it can expect to boost capital investment by about three percentage points.

Rather than lower corporate rates and drink in the ensuing infusion of capital, the White House has proposed to tax U.S. companies on profits they make overseas, which are currently exempt from taxation until they are returned home. The administration figures this would raise as much as $220 billion in new revenue.

But at a time when American companies need investment rather than punishment, that's exactly the wrong prescription for helping balance the government's books. Taxing foreign profits will only encourage domestic firms to shift their profits to lower-tax countries. When that happens nobody wins — not the U.S. economy in need of capital nor money-hungry lawmakers and bureaucrats starved for other people's money.