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Thursday, January 16, 2020

Corporate Tax Will Destabilize Revenue

Our legislators want to stabilize tax revenue. The last thing they should do, then, is to create a corporate income tax.


Back in November I reported:
A review of data from the states with a corporate income tax, for the years 2015-2017, suggests that:a) When the economy is doing well and GDP is growing strongly, there is little to be gained in terms of tax revenue from corporations; and
b) When GDP is stagnant or in decline, there are significant drops in corporate income-tax revenue.
In other words, creating a corporate income tax is a waste of legislative effort. It will alienate businesses and redirect their investments elsewhere. 
That review compared Census data on state and local government tax revenue with Bureau of Economic Analysis (BEA) data on state GDP growth. Here comes another review with a similar result. This one is based on aggregate state-local government tax revenue data from the BEA. Covering quarterly data from 1970, it reaches the same conclusion:

If you want to destabilize government revenue, then by all means, go ahead and create a corporate income tax.

To begin with, let us review the raw data on annual, current-price changes in tax revenue from the corporate income tax, personal current taxes, and indirect (sales and gross receipts) taxes. As Figure 1 explains, revenue from the corporate income tax (blue) fluctuates violently compared to the other two:

Figure 1
Source: Bureau of Economic Analysis

The most stable source of revenue is actually the one that taxes consumer spending, such as sales and excise taxes. There is another reason why this tax is preferable to income taxes, one we will get back to in a moment.

First, let us look a bit more closely at the volatility in revenue itself. Figure 2 reorganizes the data from Figure 1, such that the annual-change rates for each tax are reported from large to small (left to right). Since the time period is 1970 through the third quarter of 2019, we have 199 observations, hence the numbering on the horizontal axis. We then let Excel calculate the polynomial trend lines for each tax; this type of trend line, in the third order, gives us a reasonably good visual of the volatility. We can also use the equations for these trend lines for forecasting future tax revenue - a laborious project I would love to sink my teeth into when time permits.* 

There is really no contest here:

Figure 2
Source of raw dataBureau of Economic Analysis

To further distill the differences in volatility, Figure 3 reports a slight recalculation (for display purposes) of the linear trend lines for each of these tax categories:

Figure 3

There is one tangible wisdom to be learned from both Figures 2 and 3: when changes in the business cycle lead to a lower growth rate in revenue from sales taxes, corporate income-tax revenue falls into negative territory. Even personal current taxes hold out longer - revenue continues to grow - than the corporate income tax.

In plain English: the corporate income tax is a boneheaded way to stabilize tax revenue for any government, a state government in particular. With this irrefutable evidence at hand, our state legislature only has one reason left to create the tax: they want more revenue and they don't care what scorched earth they have to leave behind getting it.

Sales taxes are preferable from a stability viewpoint, but they are also better for another important reason. Consumer spending is the best indicator of where an economy is in terms of the business cycle; when consumers make more money and are more confident in the future, spending increases and durable products such cars and homes become more important in their budgets. By contrast, consumers are quick to respond in the opposite direction, sending almost live-stream signals (by macroeconomic standards) back to government about where the economy is heading.

Once we get to the point where we can do a tax reform here in Wyoming, these are valuable lessons to bring with us. I am not recommending a tax reform at this time: we need to see substantial spending reforms first, and that legislative conversation has not even started yet. However, once a limited government has emerged from the spending reforms, we should consider a tax reform that:

a) reduces the total tax burden, and
b) makes government more vulnerable to business-cycle swings.

The last point is completely contradictory to the prevailing narrative, especially from the majority of the Revenue Committee. There, the idea is to find a way to shield government from the business cycle. However, such a tax reform would automatically raise taxes on the economy in recessions, thus aggravating an already problematic situation for taxpayers. It also means that our legislature will jack up spending to entirely unsustainable levels, which is precisely where we are today. 

With a government more in tune with the business cycle, our legislators will be much more inclined to keep government limited.

To sum up, there are three steps to a good tax reform:

1. An absolute, uncompromising no to any new or higher taxes.
2. Structural spending reforms that permanently reduce the size of government, to where it is fiscally sustainable even in recessions.
3. A tax system that makes our new, limited government directly dependent on the ups and downs in the tax-paying sector.

*) This forecasting method is actually fairly reliable, and much cleaner than your garden variety econometric forecast. I would recommend that CREG try it.

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