Low corporate taxes stimulate economic growth

Lowering corporate tax rates by 10 per cent can boost the annual gross domestic product (GDP) growth rate by one to two percentage points, according to a recent study in the Journal of Public Economics.

In an analysis of 70 countries between 1970 and 1997, authors Young Lee of Hanyang University in South Korea and Roger Gordon of the University of California-San Diego found:

A 10 per cent decrease in corporate tax rates is associated with a higher GDP growth rate (from 1.1 per cent to 1.8 per cent) even when taking into account country-specific factors including primary school enrolment rates, inflation rates and population growth rates.

However, other tax rates, such as the average tax rate on labour income and overall marginal tax rates, do not significantly affect GDP growth rates.

Low corporate tax rates are associated with low personal income tax revenues; one explanation is that when faced with lower corporate tax rates, individuals will be more likely to transfer from wage and salary jobs to entrepreneurial activity.

Furthermore, previous studies indicate that when corporate tax rates are lower than personal income tax rates, entrepreneurs will shift business profits and losses by reporting any losses as non-corporate, thus reducing their personal tax burden, while reporting profits as corporate income.

However, in some cases, high growth rates can bring about higher tax rates in order to finance increased demand for infrastructure, says Lee and Gordon.

Source: Young Lee and Roger H. Gordon, Tax Structure and Economic Growth, Journal of Public Economics (89), June 2005.

For more on Optimal Tax Rates for Growth: http://www.ncpa.org/iss/tax/

FMF Policy Bulletin/ 14 June 2005