A proposed amendment of the income tax law by the Susilo Bambang Yudhoyono government would cut the corporate income tax rate to a flat rate of 25 percent from between 10 and 30 percent at present.
Discussions about lowering taxes on businesses invite several objections. The first is that a lower tax burden on companies has limited benefits that accrue only to business owners.
This contention reflects either an allergy to logic or is disingenuous. The truth is that workers and consumers also benefit from tax reforms that attract more investment that can lead to the creation of new and better jobs. It does not help workers if high business tax rates chase away capital that is the basis of their employment and pay packages.
Another criticism is that lower corporate income tax rates lead to projected losses in tax revenues. But this assertion reflects misleading extrapolations and faulty assumptions. As it is, projections of declining revenues are overstated by not accounting for dynamic adjustments from higher business spending and investment.
As it is, lower corporate tax rates with fewer loopholes lead to higher tax revenues since full business income is more to be likely reported and there is less incentive to use avoidance tactics.
The only way for government revenues to fall is if economic growth remains unchanged. But theory and historical evidence show that economic growth rates rise when businesses can direct more of their earnings into productive investments.
Cutting the tax burden on companies reflects a global move. At least 25 countries with developed economies lowered corporate income tax rates since 2001, pushing the global average to 29 percent from 50 percent about 25 years ago.
Britain cut corporate income taxes in the mid-1980s by reducing its rate from 52 percent to 35 percent, followed by the US reduction from 46 percent to 34 percent. In the European Union, the average corporate tax rate is down from 38 percent to 24 percent since 1996.
From 2000, Russia cuts its rates from 35 percent to 24 percent while Israel reduced its rates from 36 percent to 29 percent, Panama from 37 percent to 30 percent, Turkey from 33 percent to 20 percent, Vietnam from 33 percent to 28 percent. In 2005, Egypt reduced the corporate rate from 40 percent to 20 percent.
Numerous studies show that income from rising investment generates offsetting tax revenue over the long run. And reduced tax rates tend to lead to higher overall tax revenues by altering the real and financial responses of businesses that tend to report higher profits or take fewer evasive actions.
Other arguments against lower corporation income tax rates invoke issues of equity as though the benefits only accrue to companies or taxpayers in higher income brackets. Even so, corporations, per se, do not pay taxes because only individuals ultimately pay taxes.
It is fantasy to imagine that corporations pay higher taxes without impacting on shareholders. Since higher taxes tend to reduce the capacity of companies to invest in R&D or expand their workforce, the impact of business taxes also falls on workers and other resource owners. And to meet their obligations of higher tax levies, businesses may try to increase their own revenues by raising prices.
It turns out that taxes on corporate income are the least efficient and least defensible of government levies since they cause significant distortions in economic behavior. Only part of the incidence of corporate income taxes falls on shareholders. If taxing corporate income drives some firms out of business, there will be less demand for labor so that workers may receive lower wages and find fewer jobs. Meanwhile with fewer goods being produced, consumers will face higher prices.
Since high tax rates hinder entrepreneurial risk taking, there will be less new investments and slower economic growth with overall living standards lower than they could be. Combining permanent cuts in tax rates and reducing regulation will release the creative power of entrepreneurs for the benefit of most of the community.
It is often emphasized that tax reforms are needed to attract foreign investors. But it is even more important that reforms make it more attractive for domestic investors and businesses to keep their capital in the country.
While cutting tax rates on corporate income is a good idea, it would be better to abolish the tax altogether. By treating net revenues of corporations as pro rata income, earnings of owners and shareholders could be taxed directly.
By inducing shareholders to reinvest their income to avoid taxes, the capital base would expand and raise the marginal productivity of labor leading to more and better-paying jobs. It is difficult to think of a more labor-friendly policy than that.
A low, single tax rate in Indonesia will streamline the tax system bureaucracy and allow better supervision with less corruption. When corporate tax rates are lower and there are fewer loopholes, tax revenues from business incomes tend to rise.
The writer is Research Scholar at the Centre for Civil Society in New Delhi and Visiting Professor of Economics at Universidad Francisco Marroquin in Guatemala.
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