Does The Corporate Tax Really Matter?

by: Modeled Behavior

By Karl Smith

Felix Salmon notes that effective Corporate Tax have been falling for decades.

I’d just like to add that its not immediately clear that the corporate tax actually matters in anyway. So, one potential effect of the corporate tax would be to increase investment in corporation and therefore increase the total profitability of the corporate sector.

Economists readers, note that we are dealing with aggregate accounting profits here. Not firm level economic profits. So, even in perfect competition we would expect an expanding sector with increased investment to show a rise in aggregate accounting profits.

However, lets check the tape

FRED Graph

There is not a whole lot of obvious action here. From 1955 to 1980 corporate taxes were falling and corporate profits as a fraction of GDP were falling.

Then in the 80s and 90s the trend corporate taxes stabilized and corporate profits as a percentage of GDP rose slightly.

The in the 2000s corporate taxes fell again and corporate profits as a percentage of GDP rose.

We can also very quickly compare the corporate tax rate to non-residential investment as a fraction of GDP.

FRED Graph

There we do get at least the right correlation during the 50 and 70s but it breaks down their after.

It short, the effect of the corporate tax, at minimum, is not extremely large on what we might first guess would be the target variables. Its not a prime driver of either aggregate corporate accounting profitability or non-residential fixed investment as a fraction of GDP.

Now clearly I see this as support for my long thesis that most things don’t really matter, but some things do. That is to say, when dealing with a robust evolutionary-designed equilibrium systems like a capitalist economy, or the human body, or the human social network, most of the things you do to it are not going to make a difference precisely because it has evolved many layers of feedback and buffering.

However, evolution leaves little holes where certain shocks can make a massive difference. That’s why you can put an animal through all kinds of physical abuse. For some worms, even chop them into pieces, they will heal and you can barely tell the difference. But, the tiniest, microscopic drop of a neuro-inhibitor will kill the whole organism within seconds.

Same thing with an economy. Smack it around. Impose a bunch of taxes. In the case of Japan , literally carpet bomb the whole thing, launch an actual nuclear strike, slaughter millions of people and annihilate the capital stock. What’s the long run effect?

Basically nothing. Within 10 years its growing at a double digit pace. Within 25 years it’s the second largest economy in the world.

However, let nominal interest rates get to zero and the whole thing keels over in a 20+ year paralysis that shows no signs of ending anytime soon.

Most things don’t matter, but some things do.