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The Corporate-Tax Conundrum

BERKELEY – The United States now has the highest statutory corporate-income tax rate among developed countries. Even after various deductions, credits, and other tax breaks, the effective marginal rate – the rate that corporations pay on new US investments – remains one of the highest in the world.

In a world of mobile capital, corporate-tax rates matter, and business decisions about how and where to invest are increasingly sensitive to national differences. America’s relatively high rate encourages US companies to locate their investment, production, and employment in foreign countries, and discourages foreign companies from locating in the US, which means slower growth, fewer jobs, smaller productivity gains, and lower real wages.

According to conventional wisdom, the corporate-tax burden is borne principally by the owners of capital in the form of lower returns. But, as capital becomes more mobile, relatively immobile workers are bearing more of the burden in the form of lower wages and fewer job opportunities. That is why countries around the world have been cutting their corporate-tax rates. The resulting “race to the bottom” reflects intensifying global competition for capital and technological knowhow to support local jobs and wages.

Moreover, a high corporate-tax rate is an ineffective and costly tool for producing revenues, owing to innovative financial transactions and legal tax-avoidance mechanisms. A company’s legal residence and geographic sources of income can be and are manipulated for such purposes, and the incentives and scope for such manipulation are especially large in sectors where competitive advantage depends on intangible capital and knowledge – sectors that play a major role in the US economy’s competitiveness.