Are Corporate Tax Cuts Needed?

by: Seeking Delta

With President Obama suggesting in his Tuesday’s State of the Union address the possibility of a corporate tax cut I was left wondering; is it needed and will it help.

First, let me state that I believe the federal burden in this county is too high. Serious structural changes need to be made to correct our long-term fiscal trajectory. In general, I believe government spending is too high and taxes as well. This philosophical framework aside, I had to ask myself are corporations the best entities to target for tax cuts.

The data shows that corporate taxes rates have been generally declining for decades. The current rate of 28% (calculated as taxes on corporate income ÷ corporate profits before tax [1]) is the second lowest level since 1947. See chart below.

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Furthermore, it does not appear lower corporate tax rates result in higher GDP. Real GDP has trended down slightly since 1947, while corporate tax rates have declined significantly. Obviously, there is more to the slowdown in the GDP growth trend than corporate taxes, but even when looking at year-over-year change in the tax rate there does not appear to be a boost to GDP.

The correlation between the year-over-year change in corporate tax rate and GDP is a weak, but surprisingly positive, .35. Since 1947, an increase in corporate tax rates has been positively correlated to GDP and only slightly negatively correlated to unemployment rates (-.27).

While I am nearly universally opposed to tax increases, it does not appear corporate rates are a good target for cuts. At most, it appears that a tax cut would boost corporate net incomes and therefore, potentially equity valuation, but it should not be viewed as a silver bullet to robust GDP growth and maximum employment.

[1] Taxes and profits are from line 18 and 17 respectively in the BEA NIPA table.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.