Could abolishing corporate income tax boost wages?

Workers’ wages have stagnated, even as the unemployment rate has plunged to a seven-year low and the economy is bounding ahead. Some people propose raising the federal minimum wage and bolstering labor unions to address slow growth in wages.

One great way to lift pay that is not discussed often enough would be to end the corporate income tax. Not just cut it, kill it, but not in a way that’s a sop to the rich.

Sound extreme? Here’s why it’s a smart and progressive idea that would raise wages, lower employment, boost investment and give the economy enough vim so that the Federal Reserve’s Janet Yellen can increase interest rates without restless nights. And it would eliminate the incentive for companies to move their tax homes abroad (such as by doing corporate inversions) and encourage more businesses to establish their headquarters here.

Time is ripe

First off, the timing is good. Corporate tax reform is one of the few areas where we might see some legislation supported by the Republican Congress and the Democratic president. The latter may not be quite ready to go for the elimination of corporate taxes, but he should think about it.

Second, the US may have the highest marginal rates of any developed country, ranging from 23% to 35% depending on who you ask.

The actual average or effective rate companies pay on their profits, however, is about 13%, because so much of it is sitting overseas and untaxed – in addition to the many loopholes and deductions that employ small armies of accountants and lawyers. In 2013, the tax produced revenue equal to only 1.8% of GDP, a pittance compared with 8.1% for personal federal income taxes.

Where the corporate tax ax falls hardest

One of the problems in reforming corporate taxes is that in the popular imagination it is a levy on companies and their owners. But many economists, going back to David Bradford in 1978 and including myself, have concluded that the tax may actually fall hardest on workers – not the owners of corporations, which, truth be told, includes workers via their holdings of stock in their 401(k)s.

That’s primarily because while workers are relatively immobile and are unlikely to travel far for a job, capital is not and is generally free to roam far and wide in search of a better home – that is, one with less regulation and with less tax. When the capital flees, workers lose their jobs, and wages decline. Ireland was a beneficiary of this during the so-called Irish Miracle in the late 1980s when a 75% cut in its corporate tax rate led to a massive inflow of capital, the establishment of more than 1,000 corporate headquarters, and dramatic increases in workers’ wages.

The same thing would happen here

I’ve been working with colleagues through the Fiscal Analysis Center to create a large-scale computer simulation model of the United States economy to show how it interacts over time with other nations’ economies. We then used the model to see how it reacts to eliminating the US corporate income tax in conjunction with raising personal income taxes. The findings make a strong, worker-based case for reform.

The model shows that ending the corporate income tax creates rapid and dramatic increases in investment, GDP and real wages, which help self-finance the lost revenue. The rest of the money the US Treasury would lose could be replaced with higher personal income tax rates, leading to a huge short-run inflow of capital. US capital stock – machines and buildings – would increase 23%, output would climb 8% and wages would go up 12%.

Benefits also accrue if the tax is just trimmed, down to 9%, and loopholes eliminated – a revenue-neutral corporate tax base broadening. In that case, the capital stock would increase 17%, output would grow 6% and wages would rise 8%.

A boon for the future

Both policies, eliminating and trimming, create gains in welfare for all Americans, but especially for today’s youth and future workers. If other countries followed the US lead and cut their rates as well, the benefits would be smaller, but still significant.

Another way to eliminate the corporate income tax, which I’ve previously proposed, would be to force shareholders to pay income taxes on their companies’ profits as they accrue. This gives companies no tax-related reason to leave the US, while ensuring shareholders rather than workers make up for any revenue losses.

Either way, getting rid of the tax may be a difficult political pill to swallow. It sounds like a giveaway to corporate interests, but nothing could be further from the truth. Rather, doing so would give the economy and workers a tremendous boost, just what it needs to achieve escape velocity.

This article was originally published on The Conversation. Read the original article. Publication does not imply endorsement of views by the World Economic Forum.

To keep up with Forum:Agenda subscribe to our weekly newsletter.

Author: Laurence J. Kotlikoff is a William Fairfield Warren Professor at Boston University.

Image: Workers walk outside the London Stock Exchange. REUTERS/Andrew Winning.