July 17, 2017

MBAF's Emilio Escandon discusses the ideal federal tax rate with CFO magazine.

President Trump’s plan calls for cutting the federal corporate tax rate to 15%. However, 15% may not be feasible.

A rate of 21% — whether applied strictly to business entities that are taxed at the corporate level or also applied to pass-through entities, such as S corporations and partnerships — would be ideal. At that level, the effective corporate tax rate would be 25.74%, assuming a 6% state rate. That would be just below the 26% average worldwide rate and would make U.S. corporations more competitive with their global counterparts.

Lowering the corporate tax rate could have many other direct positive economic impacts. A 25.74% effective rate would represent an overall cut of slightly more than one-third. At the reduced rate, each $1 million of income generated by a U.S. corporation would result in $131,600 of additional available cash. The cash could be targeted for increased hiring, increasing current employees’ wages, or investment in new capital assets (i.e., manufacturing and technology assets).

There have been several well-respected studies indicating that in advanced countries, the higher the corporate tax rate, the lower the wages. A 2007 study from Europe found that “a ten percentage point increase in the corporate tax rate of high-income countries reduces mean annual gross wages by seven percent.” Another study, performed by the American Enterprise Institute, concluded that “wages are significantly responsive to corporate taxation.”

Lowering Taxes and Economic Growth

The Commerce Department’s most recent figures indicate that GDP growth remains sluggish, expanding at 1.4% for the first quarter of 2017. This lack of robust economic growth, despite an overall improving economy, is a bit perplexing. Boosting productivity will be difficult when the unemployment rate is at a 16-year low and while middle-class average household income has remained stagnant.

Lowering corporate tax rates should incentivize corporations to increase spending and develop new products and services that will create more jobs and improve the economy. This is not a new idea; in fact, it goes back all the way to 1974, when economist Arthur Laffer drew a curve on the back of a cocktail napkin to illustrate how cutting taxes could spur the economy. That napkin now hangs in the National Museum of American History, and the “Laffer Curve” has, in many ways, changed the course of contemporary economics.

Clearly, some form of tax reform — involving tax-rate reductions — together with a comprehensive infrastructure spending bill should spur capital spending and create new jobs.

Lowering the corporate tax rate would no doubt provide more available cash flow to corporate stakeholders, both large and small. How they choose to deploy that available cash flow would remain to be seen. However, it is reasonable to assume it will be in adding jobs and expansion in terms of new product lines, mergers and acquisitions, etc., all of which should spur the economy, which theoretically, should lead to measurable GDP growth.

Potential Effect on Deficit

Total U.S. GDP in 2016 was approximately $18.569 trillion. Of the approximate $3.4 trillion of tax revenue collected by the, $294.3 billion (or 8.8%) came from corporate income taxes. Reducing the highest federal tax rate from 35% to 21% would result in a reduction of tax revenue of billions of dollars per year, which would require increased GDP to replace the lost tax revenue.

Emilio Escandon is principal-in-charge of national operations for the tax and accounting department at accounting firm Morrison, Brown, Argiz & Farra (MBAF).

Click here to read the article on CFO.com.