A simple point about corporate tax reform

For the most part, the empirical literature suggests that “cash flow” drives investment more than does say the real interest rate; you can take the latter as one proxy for non-massive changes in rates of return.  So a plan to cut “back taxes” for companies still might stimulate investment, even if it doesn’t appear to alter marginal incentives in the appropriate way.  It will give corporations a higher realized cash flow over the immediately prior period, and again that has had decent predictive power over investment.  But causality?  That is tougher to say, but of course there are theories that self-financed investments are more attractive to managers than having to bring in additional outside monitors.

There is a genuine question whether you should side with the theory or the empirics here, and I am myself agnostic.  Furthermore, perhaps the cash flow of the prior periods proxies for the expected rate of return more accurately than do our available measurements for the expected rate of return.  So you don’t have to take the empirical result as documenting the importance of cash flow.

Still, if you hear someone attacking a tax reform plan as a “corporate giveaway,” just ask them how well they know this literature.  There is at least some chance that “giveaways” boost investment more than do targeted marginal changes.


You need cash flow to borrow money. You need either accumulated cash on hand or some asset to borrow against. If the government takes too much of the profits, then there is less to borrow against.

If the return on investment is taxed, the return diminishes. The higher the taxes the more return is required from the investment to make it worth while. Good investments with a decent return won't be done if the tax on the profits is too high.

Canada is going to find this out good and hard.

Profits are what is left over after doing business, like paying interest and principle, with principle initially smaller than depreciation expense on capital debt.

Taxes on profits are not what bankrupt businesses. Poor cash management, sure. Too much debt, yep. Depending on tax cuts putting money in the til, yep.

If you finance a million dollar machine with a ten year life at 5%, interest expense is $50,000 plus depreciation of $200,000 for double declining exempts $250,000 of revenue from tax, but the debt service is only about $130,000. But in year 10, depreciation is only about $5000 and interest only $7000, but debt service is still $130,000. If you think the depreciation expense is tax free profit you can spend, you are a bad manager. It needs to go into a capital account for maintenance or buying new capital equipment. Double declining accounts for either the risk you need a new machine to offer new features, or to pay to maintain an aging state of the art machine.

GAAP is at its root, a system of accounting for the current costs of investments to give managers and owners a true picture of the health of an institution. No GAAP business with no profit pays and business profit tax unless the tax code shifts taxes on profits to a future date, like when capital spending is expensed. Taxable profits are often much lower than GAAP profits for growing corporations, but higher than GAAP for businesses being milked into insolvency.

Prior to cut in the individual tax rate in the 1980s there was tax incentives for businesses to file as a C corporation and invest retained earring so owners got capital gains? However with lower individual rate the lowest total taxes was to pass though earning to owners and pay individual tax rates on them. Not surprisingly revenue from corporate taxes fell as reported corporate earning fell, as well as business savings. (As was pointed out in a previous post this contributed to the increase in income share of the top 1% Calculated from tax data.) . If we now cut corporate taxes this will reverse and will probably increase business saving and maybe even revenue, ther will larger decline in revenue from individual income taxes . See a series of plots at visualizingeconomics.com that show what happened.

I agree with Joan, they will find a way around paying taxes any way we configure the rates. I do not expect a lowering of the corporate rate to produce substantial investment gains for the American people. Globalization has diminished our return in the equation. A better investment would be to lower the payroll taxes or increase EITC benefits for the lower 80%. But as usual I expect the former will be realized if Congress can do anything substantive. Reaganomics is too ingrained in our psyche.

Cutting corporate taxes, cutting payroll taxes, ....

Shouldn't the discussion begin by identifying the incidence of each tax?

no .... the discussion should start with the premise that the purpose of taxes is to raise fiscally reasonable revenue for necessary government functions -- NOT to manipulate the private sector economy with socialist "tax policy".

Overall taxes always increase long term. Tax-Reform always results in higher taxes long term.

The number and complexity of U.S. taxes are staggering. Focusing merely upon corporate-taxes accomplishes nothing. Compare the American tax burden in year 1900 with year 2017 -- notice any trend from the average citizen perspetive ??

Investment in productive capital produces economic growth and prosperity, so whatever induces owners of capital to invest in productive capital (which I use in a broad sense to include services as well as plant and machinery, intellectual property, etc.) should be the policy preference. But owners of capital have shifted away from productive capital in favor of assets with the promise of rising prices, including stocks and real estate, even if the underlying businesses don't produce much in the way of cash flow. Cowen is relying on theory (value equals the discounted present value of the expected annual cash flow from the investment) to support a cut in the corporate tax rate while owners of capital are more concerned with rising asset prices not cash flow. Yesterday I provided a link to a guest op/ed in the NYT by an economist at Morgan Stanley lamenting the shift in investment from one based on cash flow to one based on rising asset prices: https://www.nytimes.com/2017/09/14/opinion/trump-federal-reserve-markets.html Basing investment decisions on rising asset prices not only shifts capital away from productive capital but creates the very environment for financial and economic instability. Maybe Cowen should offer a post on what policies would cause a shift in investment motivated by rising asset prices to one motivated by cash flow of the underlying business, which would provide the kind of economic growth and stability that he and others profess they want.

The cost of corporate taxes and all the professional fees that go into compliance with the tax laws are included in the prices charged to consumers. Essentially, the corporate tax system is a giant hidden sales tax. The discussion I would like to hear about when it comes to tax reform is one where we eliminate business income taxes completely. Let's consider replacing the current system with a national sales tax on the final consumer. The big advantage is that a sales tax is far cheaper in compliance costs than an income tax. I hate to think about how much a company like Ford spends on producing tax returns that probably costs thousands of hours in tax research, opinion letters by tax pros, and voluminous workpapers to support each line item. But all this high-end professional work does nothing to help build a better car.

Somewhat, perhaps, but it doesn't change the argument that full expensing is a much, much more efficient way of encouraging investment, since it's directly aimed at cash flow.

You have a number of recent posts on tax reform arguing that "X is better than Y, but maybe people are overestimating the advantages of X." (That applies to the DBCFT, full expensing, avoiding retroactive taxes, and several other issues; your column claiming that somehow full expensing was more "cronyism" than a complicated set of different depreciation schedules and treatments was seemingly bizarre. I could only reconcile it by assuming that your real message was that the ultimate tax law may be different than the ideal drawn up, but full expensing is much harder to abuse that the inherent problems with depreciation.) That cautious argument would make more sense if idealistic tax reform were marching overwhelmingly to victory, rather than being thwarted by stout defenders of the status quo on all sides. (Depressing to watch Wyden and other Democratic Senators forthrightly defend the mortgage deduction and SALT deduction, despite those being overwhelmingly tilted toward the affluent and wealthy).

I think it's another instance of your contrariness acting against your circle of libertarian friends (counseling them to avoid making too large claims) rather than against the larger status quo of the world, and should be taken that way. It's not an entirely bad thing to do on occasion.

Frankly I think it's more likely that we get no tax reform at all, because of the way that all the existing deductions and inefficiencies are jealously guarded by politicians on both sides.

TC says: "For the most part, the empirical literature suggests that “cash flow” drives investment more than does say the real interest rate" - I doubt it. The study probably simply shows cash flow is coincident with investment. It's another example of how statistics can lead or lag based on data errors and thus fool people into inferring causality. And TC's "say does the interest rate" is not backed by any citation, besides the fact real interest rates are also hard to measure.

Move along, nothing to see here.

Since we do not seem to be near the top of the Laffer curve, it seems to me that it would more efficient to lower the corporate tax to 1-2% (or just enough to cover the social cost of limited liability) and raise the individual taxes to make up for the lost revenue.

Reminder -- Please stick to the NYT style guide, here.

For corporate taxes, cuts are "giveaways" and hikes are "loophole closures."


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