Baker Institute paper: Tax reform could reduce corporate tax revenue by as much as 40 percent

Jeff Falk
713-348-6775
jfalk@rice.edu

Baker Institute paper: Tax reform could reduce corporate tax revenue by as much as 40 percent

HOUSTON – (May 1, 2018) – The Tax Cuts and Jobs Act of 2017 could lead to a total corporate tax revenue decline of about 40 percent, but nearly 20 percent of that decline will be recaptured through increased personal income tax revenue, according to an analysis by an expert at Rice University’s Baker Institute for Public Policy.

Credit: 123RF.com/Rice University

Jorge Barro, fellow in public finance, outlined his insights in a new research paper, “Long-term Macroeconomic Effects of the 2017 Corporate Tax Cuts.” His study uses an objective methodology — a dynamic general equilibrium model — to project the long-term economic impact of the corporate tax cut by simulating business decisions that determine dividend issuance and equity valuation as well as household decisions that determine equity ownership and wealth distribution.

In December, President Donald Trump signed into law the largest corporate tax reduction since the Tax Reform Act of 1986 was signed by President Ronald Reagan. The Tax Cuts and Jobs Act of 2017 (TCJA) reduced the top marginal tax rate levied on corporate income from 35 percent to a flat 21 percent, leading to speculation on the anticipated effects of the cut on key economic variables, Barro said.

Barro’s results show a modest decline in wealth inequality resulting from the decline in the corporate tax rate implemented in the TCJA. “Although total wealth remains highly concentrated among individuals in the top quintile, the model shows a small shift in the concentration of wealth toward each of the bottom four quintiles,” Barro wrote. “Other key economic variables, including wages, household consumption and corporate investment, experience a moderate increase, while total output remains roughly unchanged. The economic variables most directly impacted by corporate tax cuts are average dividend issuance and equity valuation, which increase more significantly. Total corporate tax revenue declines by about 40 percent, but nearly 20 percent of that decline is recaptured through increased personal income tax revenue.”

In addition to reducing tax revenue, the corporate tax reform in the TCJA will also change the structure and composition of the U.S. economy, Barro said.

“The results of this paper show that private consumption grows by the magnitude of the tax cut, likely offsetting the decline in government consumption as long as the tax cut is eventually financed through a reduction in expenditures,” Barro wrote. “Such a reform was shown to increase the returns to shareholders of corporate equity, leading to a reduction in wealth inequality and a reduction in the amount of indebted households. In addition to consumption and savings growth, the general equilibrium model captured the growth in personal tax revenue resulting from the decline in corporate taxation. The model showed that almost 20 percent of the decline in corporate tax revenue is offset by an increase in personal tax revenue resulting from increased dividends to shareholders.”

Barro said that while this paper contributes to the literature regarding projections of corporate tax reform in the TCJA, several opportunities for applied and academic research remain. “Specifically, this study focused on the long-term effects of the corporate tax reform component of the TCJA, leaving the short- and medium-term consequences as well as personal income tax components of the TCJA for consideration,” he wrote. “Future applied policy research should evaluate the transitory impact of TCJA in its entirety. From an academic perspective, the model’s results provide a counterintuitive projection: A decline in the corporate tax rate can reduce wealth inequality. To that extent, future academic research should focus on understanding the mechanism through which corporate tax policy affects household wealth inequality.”

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Related materials:

Paper: www.bakerinstitute.org/media/files/files/494cac72/cpf-pub-corporatetax-042418.pdf.

Barro biography: www.bakerinstitute.org/experts/jorge-barro.

Baker Institute Center for Public Finance: www.bakerinstitute.org/center-for-public-finance.

Founded in 1993, Rice University’s Baker Institute ranks among the top three university-affiliated think tanks in the world. As a premier nonpartisan think tank, the institute conducts research on domestic and foreign policy issues with the goal of bridging the gap between the theory and practice of public policy. The institute’s strong track record of achievement reflects the work of its endowed fellows, Rice University faculty scholars and staff, coupled with its outreach to the Rice student body through fellow-taught classes — including a public policy course — and student leadership and internship programs. Learn more about the institute at www.bakerinstitute.org or on the institute’s blog, http://blogs.chron.com/bakerblog.