International evidence shows that low corporate tax rates are not strongly associated with stronger investment

The Trump administration’s Council of Economic Advisers (CEA) released a paper last week arguing that cuts in the statutory corporate tax rate would lead to gains in business investment, productivity, and wages. I noted in a piece released yesterday why this was unlikely to be true.

The key piece of evidence the CEA claimed was “highly visible in the data” and showed the wage-boosting effect of corporate tax cuts was simply a graph that showed faster unweighted wage growth in just two years in a set of “low-tax” countries relative to a set of “high-tax” countries. I noted in my paper yesterday why this was so unconvincing: a serious test of this claim would look at corporate tax rate changes (not levels), would look over a longer time-period than four years, and would not allow three countries with a combined national income that is less than 0.4 percent of American national income to drive the results.

But, the CEA report did make me curious if we would see anything “highly visible in the data” linking changes in statutory corporate tax rates to nations’ capital stocks. The key theory behind claims that corporate rate cuts will boost wages is the idea that these rate cuts will lead to substantially faster investment in productivity-enhancing plants and equipment, boosting the nation’s capital stock and making workers more productive. We can assess the first link in that chain of causation below, asking simply “are lower corporate tax rates associated with a larger capital stock”? Figure A shows a scatterplot of the relationship between the average statutory corporate tax rate between 2000 and 2014 the capital-to-labor ratio in 2014. The hypothesis is that low-tax countries should have attracted more capital investment and hence should have accumulated a large stock of capital relative to their workforce by the end of the period. (The data on capital stocks and employment comes from the Penn World Table 9.0.)

Figure A

Corporate Tax Rate and Capital/Labor Ratios, 2000-2014

K/L ratio Statutory Corporate Rate, 2000-2014
Australia 182.8329 30.26667
Austria 262.5172 28
Belgium 298.089 35.358
Canada 191.871 32.74267
Chile 75.21385 17.5
Czech Republic 193.119 24.13333
Denmark 267.3966 27.16667
Estonia 128.1263 23.06667
Finland 235.0594 26.4
France 300.7382 35.71778
Germany 260.2171 35.79182
Greece 246.2434 28.96667
Hungary 137.8224 18.422
Iceland 173.7514 19.73333
Ireland 293.9928 14
Israel 107.7759 30.1
Italy 318.5824 35.23188
Japan 162.3044 39.55467
Latvia 197.6737 27.06
Lithuania 127.8631 17.06667
Luxembourg 284.8344 30.56867
Mexico 60.78366 31
Netherlands 282.5934 29.10667
New Zealand 110.3023 31.06667
Norway 330.132 27.93333
Poland 64.21466 21.46667
Portugal 240.299 29.86
Slovakia 134.9736 21.6
Slovenia 224.178 22.2
Spain 283.7168 32.5
Sweden 232.1265 26.74667
Switzerland 242.5745 22.29283
Turkey 101.9937 24.8
United Kingdom 227.7329 27.86667
United States 201.734 39.2318
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Source: Data from the Penn World Tables 9.0

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As the trendline through the scatter indicates, the relationship actually goes the wrong way—countries with higher corporate tax rates over this period had larger capital stocks by 2014. This positive relationship is not particularly significant, either statistically or economically, but that’s largely the point: tax cuts are an extremely weak lever with which to attempt to move capital investment.

Some might argue that looking at the average rate over a 14 year period might hide the fact that some countries went from high rates at the beginning of the period to low rates in the end. In this case, the large change in rates could likely have affected capital investment, but this would be obscured by our long-run averages. This is fair enough—though it highlights once again the CEA report’s inappropriate use of averages over a short-run period. But Figure B below shows the change in corporate tax rates versus the growth rate of capital inputs into production (a measure of capital investment used in productivity analysis).

Figure B

Change in corporate tax rates and growth in capital investment, 2000–2016

Corporate Rate Change, ppt K-input growth, annual average
Australia -4 5.194586
Austria -9 2.920065
Belgium -6.18 3.429054
Canada -15.73 4.572116
Chile 9 9.167386
Czech Republic -12 4.909908
Denmark -10 3.134218
Estonia -6 9.23701
Finland -9 2.696865
France -3.33289 2.84293
Germany -21.8582 2.491258
Greece -11 2.157958
Hungary 1 3.158774
Iceland -10 2.291742
Ireland -11.5 6.363882
Israel -11 4.719524
Italy -9.95725 1.83682
Japan -10.9 2.655529
Latvia -10 4.118653
Luxembourg -8.23 4.080175
Mexico -5 4.914032
Netherlands -10 2.704329
New Zealand -5 3.435582
Norway -3 4.035207
Poland -11 5.908913
Portugal -5.7 2.828004
Slovak Republic -7 4.514473
Slovenia -8 6.150589
South Korea -6.6 7.134175
Spain -10 4.320096
Sweden -6 3.260237
Switzerland -3.77691 4.490509
Turkey -13 7.26266
United Kingdom -10 2.230193
United States -0.41607 3.855656
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Source: Author's analysis of data from OECD.Stats interactive database (statutory corporate tax rates) and the Conference Board Total Economy Productivity Database.

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Again, the correlation here goes the wrong way for sustaining claims that slashing corporate rates would increase capital investment; countries that saw larger reductions in the statutory rate saw slower growth of capital inputs.

The international evidence presented above just re-confirms what we already know: no binding constraint on American economic growth exists today that would be helped at all by cutting corporate income taxes. Instead, such cuts would simply boost incomes for owners of corporations—a group that is already overwhelmingly among the richest households in America. Promises of gains to investment, productivity and wage growth that will force these tax cuts to trickle down to typical American households are completely empty.