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As the United States experiences another year of lackluster financial growth, economists are looking at corporate tax rates as a cause.  But is a high US corporate tax rate to blame for the weak economy?

Professor Urooj Khan from Columbia Business School, along with Suresh Nallareddy from Duke University and Columbia Business School PhD student Ethan Rouen, tackled this question by examining the impact of US tax rates on business and the economy in their research titled, The Role of Taxes in the Disparity between Corporate Performance and Economic Growth.

“Our findings show that because of the relatively higher corporate tax rates in the US, fewer profits of American firms are being channeled in to domestic investments, which leads to a lower economic growth rate,” says Professor Khan.

Among countries in the Organization for Economic Co-operation and Development (OECD), the US has the highest corporate tax rate, 39.1 percent, compared to the average of 24.1 percent. As the gap between the United States’ tax rate and the average rate of other OECD countries widens, the imbalance between the growth in corporate profits and the overall economy increases.

According to the research, higher US tax rates create incentive for firms to reduce the after-tax cost of investment by diverting them to other jurisdictions with lower corporate taxes. This means that corporate profits are not invested in the US, contributing to the disparity between business performance and economic growth. This decline in domestic investment puts the US economy at a serious disadvantage relative to other OECD countries.

“These findings have implications for policy-makers, fueling the political discussion of reforming the corporate tax rules to kickstart the economy,” says Professor Khan.  The research notes that President Donald Trump has proposed reducing the US corporate income tax rate.

President Trump has repeatedly called for comprehensive tax reform, and along with Congress, plans to release a detailed reform plan shortly. While there are many ways to tackle tax reform, reducing the corporate tax rate will position the US economy for faster growth in the years ahead.

The Research

The researchers analyzed data from Bureau of Economic Analysis (BEA) from the first quarter of 1975 to the fourth quarter of 2013. The authors then compared the average corporate tax rate of the US to that of other countries in the OECD to understand the relationship between corporate profits and economic growth.  The study also conducted cross-sectional and cross-country analyses to examine the impact of taxes on the relation between corporate profits and economic growth.

The research exposes potential issues with the current taxation system and explains that a reduction in the US tax rate –  and a move to a territorial tax system from a worldwide system – can positively impact US economic growth.

Source: Columbia Business School