Baker Institute paper: Corporate tax cuts could lead to modest decline in wealth inequality

The Tax Cuts and Jobs Act of 2017 could lead to a modest decline in wealth inequality due to the act’s corporate tax cuts, according to an analysis by experts at Rice University’s Baker Institute for Public Policy.

Credit: 123RF.com/Rice University

Jorge Barro, fellow in the institute’s Center for Public Finance, and Anne Dayton, research manager in the institute’s McNair Center for Entrepreneurship and Innovation, outlined their insights in a new issue brief, “Long-term Macroeconomic Effects of the 2017 Corporate Tax Cuts.” The brief presents the results of a dynamic model similar in nature to the macroeconomic models used by the Congressional Budget Office and Joint Committee on Taxation in evaluating the tax reform legislation.

In December, President Donald Trump signed into law the largest corporate tax reduction since the Tax Reform Act of 1986 passed under President Ronald Reagan. The Tax Cuts and Jobs Act of 2017 (TCJA) reduced the top marginal tax rate on corporate income from 35 percent to 21 percent, leading to extensive speculation on its anticipated effects, the authors said.

Unlike most models quantifying the impact of the TCJA, the authors’ model simultaneously measures the long-run effects of tax reform on equity ownership and wealth inequality. “Many models assume that the corporate income tax is simply a tax on capital,” the authors wrote. “The model used here explicitly considers profits and decision-making around issuing dividends, and thus captures how tax rates can distort the choice between issuing higher dividends and investing in production.”

While total wealth remains highly concentrated in the top quintile (one-fifth) in the model, there is a small shift toward each of the bottom four quintiles, the authors found. “Wages, household consumption and corporate investment experience a modest increase, while total output remains unchanged,” they wrote. “The economic variables most directly impacted by corporate tax cuts are average dividends issued 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.”

Although the corporate tax reduction of 2017 reduces total tax revenue by less than one percent of GDP, the long-term effects will impact every part of the economy, the authors said. “The model’s results provided a counterintuitive projection: A decline in the corporate tax rate can reduce wealth inequality,” they wrote. “Since the corporate tax burden is distributed evenly across each share of a firm’s equity, corporate tax reductions reduce the effective per-share tax incidence faced by all shareholders, regardless of a household’s location within the wealth distribution. A consequence of such a tax reduction is a relative improvement of the bottom 80 percent of households in the wealth distribution.”

In addition to private consumption and savings growth, the dynamic model captured the growth in personal tax revenue resulting from the decline in corporate taxation, the authors said. “The model shows 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,” they wrote. “Although the corporate tax reduction will reduce tax revenue, the reform will also change the structure and composition of the U.S. economy. 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 government expenditures.”

A factor that may eventually diminish the direct impact of a corporate tax cut on the U.S. economy is the growth of government debt relative to GDP, the authors said. “Although the economy has shown little sign of strain from increased levels of U.S. government debt in the periods preceding the TCJA, a decline in demand for U.S. treasury bonds may eventually place upward pressure on firms’ cost of capital,” they wrote.