Will our Corporate Tax Cuts get Trumped?

Theresa May's decision to pledge that Britain will have the lowest Corporate Tax Rate in the G20 is undoubtedly good news. If we're to make a success of Brexit (another thing Theresa May has pledged), then preserving and building upon Britain's competitive tax code is essential. But, I suspect Theresa May hasn't quite grasped just how significant Trump's tax cuts will be.

Most of the media has focused on the headline tax cut from the absurdly high 35% to 15% in the tax plan on Trump's campaign website, but this is misleading. First, very few US corporations actually pay that 35% rate. There's a labyrinthine set of exemptions and deductions that mean the average US corporation pays a much lower effective rate of 12.6%. Trump's plan funds his headline tax cut through eliminating almost all (except the R & D tax credit) of these distortionary exemptions from the current system. This means in effect US corps won't be paying substantially lower taxes, even if they'll benefit from less distortionary and more efficient tax code.

Second, and more significantly Trump's tax plan isn't necessarily the tax plan that'll be put forward in the House of Representatives (where Speaker Paul Ryan and Ways and Means Chairman Kevin Brady hold the cards). The Ryan-Brady plan dubbed "A Better Way" differs from Trump's framework in a few key ways (for even more detail read Cameron Arterton and Lisa Zarlenga's excellent overview).

First, they cut the headline rate by much less. Under the Ryan-Brady plan, the headline tax rate only falls to 20%.

Second, they border adjust it. That means that imports are taxed, but exports aren't. To readers of this blog, that might sound worryingly mercantilist - but as AEI's Alan Viard points out it won't have this effect. Such a reform does however resolve some of the transfer pricing problems that plague modern corporate taxes.

Third, and this is the big one, the Ryan-Brady plan proposes unlimited immediate expensing of all wages and new capital investments (tangible and intangible). This turns the Corporate Income Tax into what economists call a business cash-flow tax. This isn't just tinkering with rates, this is fundamentally changing the structure of business taxation in the US. It removes entirely the tax burden on capital and shifts it to consumption. Economists generally believe that taxes on capital are excessively harmful because capital is incredibly mobile and even low capital tax rates translate to incredibly high taxes on future consumption. As my colleague Ben Southwood points out, even though it's meant to raise taxes from wealthy investors, it ends up leading to much lower wages for ordinary workers.

In essence, the Ryan-Brady plan turns one of the most inefficient taxes into one of the most efficient. Typically, Republicans (and libertarians) oppose such moves because they think making taxes more efficient will encourage the Government to spend more and only a painful, inefficient tax code will put the brakes on out of control spending. As Will Wilkinson points out, that's bunk. The Ryan-Brady plan breaks with that dogma.

What does that mean for Britain? Well, cutting corporation tax just ain't good enough. Theresa May and Phillip Hammond need to be more radical if they don't want to be Trumped by the Donald. Let's abolish corporation tax and replace it with a simpler, more efficient business cash-flow tax.