Eliminate Corporate Taxes and Spur Economic Growth

By Ron Robins, Founder & Analyst, Investing for the Soul

Blog Enlightened Economics; twitter

First published April 7, 2011, in his weekly economics and finance column at
alrroya.com

What should overly indebted developed country governments do to spur economic

activity and reduce deficits and debt? Should they spend more, or less? Should taxes
be increased, or lowered? A number of recent studies collectively suggest that
government stimulus spending provides no stimulus at all beyond the amount spent.
But where there are large deficits, spending should be cut. However, the best way to
stimulate the economy is through lower taxes—and especially to cut corporate taxes!
But what a political bombshell these policies would be in many countries.

Increased government spending, say numerous economists trained in traditional

Keynesian economic theory, should have a ‘multiplier’ effect that increases overall
economic activity by an amount larger than the sum spent. However, some recent
empirical research disputes that assumption.

In a prestigious US National Bureau of Economic Research (NBER) study, Identifying

Government Spending Shocks: It’s All in the Timing, by Valerie A. Ramey, published
in October 2009, she found that, “… none of my results indicate that government
spending has multiplier effects beyond its direct effect.” That is a dollar of
government spending contributes only about a dollar to economic activity.

Furthermore, the same conclusion was noted by Harvard University’s Economics

Professor Greg Mankiw while reviewing new research in his blog post, “Spending and
Tax Multipliers” on December 11, 2008. He stated “…Bob Hall and Susan Woodward
look at spending increases from World War II and the Korean War and conclude that
the government spending multiplier is about one: A dollar of government spending
raises GDP by about a dollar.”

So, these studies indicate that increasing government spending does not increase
economic activity by anything more than the original sum spent.

By contrast, cutting taxes may have a much larger economic multiplier effect.
Quoting Professor Mankiw again, he says, “…research by Christina Romer and David
Romer looks at tax changes and concludes that the tax multiplier is about three: A
dollar of tax cuts raises GDP by about three dollars…” (Incidentally, Christina Romer
was chairman of President Obama’s Council of Economic Advisers in 2009-2010.)

Furthermore, Professor Mankiw adds that, “…these findings are inconsistent with the
conventional Keynesian model. According to that model, taught even in my favourite
textbook, spending multipliers necessarily exceed tax multipliers… How can these
empirical results be reconciled? One hypothesis is that compared with spending
increases, tax cuts produce a bigger boost in investment demand. This might work
through changing relative prices in a direction favourable to capital investment--a
mechanism absent in the textbook Keynesian model.”
Reviewing the spend and tax empirical data for most developed countries suffering
from large deficits and debt is this study, Large Changes in Fiscal Policy: Taxes
Versus Spending, by Alberto F. Alesina and Silvia Ardagna—another NBER paper,
dated October 2009. They state, “we examine the evidence… of fiscal stimuli
[stimulus] and in… fiscal adjustments [reducing deficits] in OECD countries from
1970 to 2007. Fiscal stimuli based upon tax cuts are more likely to increase growth
than those based upon spending increases. As for fiscal adjustments, those based
upon spending cuts and no tax increases are more likely to reduce deficits and debt
over GDP ratios than those based upon tax increases. In addition, adjustments on
the spending side rather than on the tax side are less likely to create recessions.”

So if cutting taxes gives the best boost to economic activity, are there particular
taxes to cut that provide the most economic stimulus? The answer is yes, according
to the OECD study, Tax Policy Reform and Economic Growth, November 3, 2010. The
reviewers say that, “…corporate taxes are the most harmful type of tax for economic
growth, followed by personal income taxes and then consumption taxes, with
recurrent taxes on immovable property being the least harmful tax.”

Corroborating these findings is another recent peer reviewed study supporting lower
corporate taxes: The Effect of Corporate Taxes on Investment and Entrepreneurship,
published in the American Economic Journal in July 2010. It stated, “in a cross-
section of countries, our estimates of the effective corporate tax rate have a large
adverse impact on aggregate investment, FDI [foreign direct investment], and
entrepreneurial activity... The results are robust to the inclusion of many controls.”
(The authors were from the World Bank: Simeon Djankov, Caralee McLiesh and Rita
Ramalho. And from Harvard University: Tim Ganser and Andrei Shleifer.)

Based on this evidence, some observers argue to significantly reduce or even

eliminate corporate taxes entirely! In fact, many countries and jurisdictions are
reducing corporate taxes significantly, exactly because of such studies. Though no
country has yet eliminated them altogether.

Most of these respected studies variously infer that one optimal solution to spur
economic growth in developed countries is to cut taxes, while to reduce onerous
government deficits and debt, Alberto F. Alesina and Silvia Ardagna suggest cutting
spending. Moreover, some of these studies clearly demonstrate that to promote
economic growth, governments should most especially cut corporate taxes. Of
course this is advocated by some US ‘Tea Party’ leaders, though it is a problematic
issue for electorates in many developed countries.

However, shouldn’t at least one country try eliminating corporate taxes entirely? Now
that would be one country to study!

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