How much growth do higher taxes cost?

In a week, we will get a new budget here in the UK, and of course, everybody is wondering which taxes are going to be hiked and by how much. I mean, we don’t have to talk about the possibility of tax cuts anymore, do we? There are many taxes one can play around with, but one particularly prominent one is corporate tax rates (though this seems to be off the table in the UK this time). So let me weigh in with a comprehensive study of the growth effects of corporate tax changes around the world.

This study reviewed the fiscal multipliers for corporate income tax changes across countries and then built its own model based on the empirical data out there to predict fiscal multipliers in a unified framework.

Note that the fiscal multiplier describes how much economic output changes for every dollar of tax paid. If the fiscal multiplier is greater than 1.0, then cutting taxes leads to so much additional growth that the additional tax revenues will more than offset the lost revenue from the lower tax rate.

This is the foundation of the Laffer Curve and the ‘trickle-down economist’, which famously has been tried in the US many times over the last forty years without any success. Every time the US government cut taxes, the result was faster growth, but not enough and an increase in the budget deficit. This is what happens when the fiscal multiplier is less than 1.0, as it is in the case of the US. And if, again, all evidence shows a country keeps cutting taxes even though its fiscal multiplier is less than one, you end up being worse than Italy in terms of deficit and debt.

But, and this is an important insight from the study of global fiscal multipliers, the economy’s reaction to changes in corporate tax rates varies widely. Just because something does or doesn’t work in one country does not mean it does or doesn’t work in another.

The chart below shows the estimated fiscal multipliers of a range of countries from a total of more than 200 countries estimated in the paper (so go look up the countries you are interested in there). I use the 5-parameter estimate, but they also provide simpler 3- and 4-parameter model estimates in the paper.

Estimated fiscal multipliers for corporate tax rate changes

Note that for the US, just like France, Italy, and Spain, the estimated fiscal multiplier is below one. That means that cutting taxes leads to a little bit more growth but not enough to compensate for the losses of tax revenues. Hence, cutting taxes in these countries increases the deficit, while hiking taxes reduces the deficit and makes government debt more sustainable.

But look at the UK, where the fiscal multiplier is close to 1.0. That means that hiking corporate taxes reduces growth so much that the government will end up with about the same amount of tax revenues afterwards. Thus, hiking corporate tax rates in the UK is not going to reduce the deficit, and cutting corporate taxes is not going to widen the deficit.

But in Canada, trickle-down economics could work since the fiscal multiplier is much larger than 1.0. Thus, in Canada, the government could reduce corporate tax rates and still generate more tax revenues and reduce the deficit.

Yet, I must end on a warning. This is an estimate for the fiscal multiplier of corporate tax rate changes, and across the globe the median is clearly below 1.0. Hence, cutting corporate tax rates in general does not work to reduce the deficit. Trickle-down economics does not work in general. Plus, the fiscal multipliers for personal income tax changes are likely to be very different in each country, so please don’t extrapolate these results to changes in income taxes.