Cutting taxes is a key topic in economic policy, and understanding its implications is vital for fostering a robust economy. This article delves into the reasons why tax cuts, particularly for corporations and individuals, can be a powerful tool for economic growth, increased wages, and enhanced global competitiveness.
One primary reason for considering tax cuts lies in the distortionary effects of certain aspects of the tax code. In the U.S., the extensive use of itemized deductions can create skewed incentives, unfairly distribute the tax burden, and ultimately reduce federal income tax revenue. By lowering individual income tax rates while simultaneously streamlining or limiting these distortionary deductions, policymakers can provide tax relief to middle-income households. This approach not only benefits families but also offers supply-side advantages, stimulating economic activity. Furthermore, this strategy can help offset potential short- to medium-term revenue losses that might arise from lower tax rates.
The impact of corporate tax cuts deserves particular attention. Academic research and empirical evidence consistently demonstrate that capital is highly sensitive to changes in corporate taxation, and this sensitivity has increased over time. When corporate taxes are high, businesses are incentivized to locate production and investment outside of the United States, leading to lower domestic output. Crucially, the burden of this reduced output increasingly falls on labor, the less mobile factor of production. Economic models suggest that significant corporate tax reforms, such as reducing the top marginal federal corporate tax rate from 35 to 21 percent and allowing for the full expensing of investments in non-structure capital, could substantially boost the economy. These changes are projected to raise output by 2 to 4 percent in the long run and increase average annual household wages by approximately $4,000.
The U.S. economy and American workers have faced challenges due to the convergence of international capital mobility and the previously uncompetitive nature of U.S. corporate income taxation. The high mobility of capital means businesses can easily move investments to countries with more favorable tax environments. The U.S.’s historically high corporate tax rates, relative to the rest of the world, have hindered capital formation within the country, resulting in stagnant wage growth as capital deepening—the increase in capital per worker—slows down.
The Tax Cuts and Jobs Act (TCJA) addressed this issue by shifting away from a worldwide taxation system towards a territorial system. This change eliminates the penalty on companies headquartered in the U.S., as they are no longer subjected to additional taxes when repatriating profits earned overseas. As part of the transition to this territorial system, income already accrued offshore was subject to a low, one-time tax, removing any tax-based incentive for companies to keep funds abroad. This reform encourages businesses to bring profits back to the U.S., further stimulating domestic investment and economic activity.
In conclusion, cutting taxes, especially corporate taxes, is a strategic approach to enhance the competitiveness of the U.S. economy, encourage investment, and ultimately raise wages for American workers. By addressing distortionary elements in the tax code and aligning the U.S. tax system with global norms, tax reforms can unlock significant economic benefits and contribute to long-term prosperity.
