Mark Gritter (markgritter) wrote,
Mark Gritter

Corporate Tax Rate Analysis

The Strib ran a commentary today from Kevin Hassett: the case for lowering the corporate tax. He argues, based on empirical studies done by himself and Alex Brill, that the U.S. would raise greater revenue with a somewhat lower corporate tax rate. (The beauty of such an empirical study is that, should a link be found, it relieves you of the burden of explaining where the additional revenue actually comes from--- greater compliance, movements of profits, economic growth, etc. And his commentary does not.)

So I looked up the AEI working paper he published in 2007, since this seems to be the source of his claim. The authors offer a reasonable model (although the Laffer curve, if it can be said to exist at all, is *certainly* not quadratic) but I found several points that concerned me.

The paper suggests that the revenue-maximizing rate is somewhere between 29.5% and 37.1%. Or, using a 5-year lagged model (with provides the best fit), somewhere between 30.6% and 34.1%. So why suggest, in his commentary, a rate of 26.4%? (Could it be that we are not actually on a Laffer curve but just a "race to the bottom"? If so, why not just shortcut down to zero?)

The authors report R^2 values. The best fit is about 0.15; that is, about 15% of the variation in revenue is accounted for by corporate tax rate. I don't know what the standard is for economic results, but this does not seem to me a particularly good showing from a public-policy perspective. That is, are there other factors which could better explain or more dramatically affect the remaining 85% of revenue variability? On the other hand, I could believe that the government funds plenty of activities with less justification! But, it is clear that Hassett's assertion that lowering tax rates would provide "$748 billion over the next ten years" is vastly overstating what he actually demonstrated.

The measures of significance provided do show that the result is real--- i.e., statistically significant. However, I am less pleased that they do not carry through an analysis of the error on the prediction of revenue-maximizing rates.

From table 4:
beta_1 = Tax rate (5 year lag) coefficient = 0.175 w/ 0.018 standard error
beta_2 = Tax rate^2 coefficient = -0.286 w/ 0.030 standard error
alpha = Constant coefficient = 0.007 w/ 0.002 standard error

Their calculation:
revenue/GDP = 0.007 + 0.175*x + -0.286*x^2
y maximized at 0.175 - 0.572x = 0
x = 0.306

If instead, we plug in the standard errors on the coefficients, we get a recommended tax rate anywhere from 0.248 to 0.377. So, in fact, the corporate U.S. tax rate may already be at the revenue-maximizing point (though they present anecdotal evidence to suggest otherwise.)
Tags: economics, statistics, taxes
  • Post a new comment


    default userpic

    Your reply will be screened

    Your IP address will be recorded 

    When you submit the form an invisible reCAPTCHA check will be performed.
    You must follow the Privacy Policy and Google Terms of use.