Personal income tax rates that rise to the level of 77 per cent obviously discourage incentives, investment, and production. But no politician raises the point for fear he will be accused of defending the rich.
What is probably an even greater discouragement to new investment and increased production is the present income tax rate of 52.8 per cent on corporations. Yet this gets even less criticism than high personal income taxes. Nobody wants to defend the corporations. They are everybody’s whipping boy. And yet they are the key productive element on which the nation’s income, wealth, and economic growth depend.
There was at least some awareness of this until recent years. When the tax on corporation income was first imposed in 1913 it was at the very cautious rate of 1 per cent. It never got above 15 per cent until 1937. In the midst of World War II it was still only 40 per cent. It did not get to 52 per cent until 1952.
Today such a rate is taken for granted. Yet most of those who approve of it, and even suggest it could be a little higher, are the very people who have been complaining most loudly in recent years about the country’s disappointing rate of economic growth.
The present average tax on all corporations is about 45 per cent. On successful corporations of any size, however, the average rate is close to 52 per cent. Broadly speaking, therefore, when anybody contemplates a new corporate investment, he will not make it unless the investment promises to yield before taxes at least twice as much as the return he would consider worthwhile. If, for example, a man would not consider a new investment worthwhile unless it promised a 10 per cent average annual return on his capital outlay, it would have to promise a return of 20 per cent on that outlay before taxes.
What is at least as important as reducing the incentive to investment is that the present corporate income tax reduces the funds available for investment. In the second quarter of 1968, according to estimates of the Department of Commerce, U.S. corporations were earning total profits before taxes at an annual rate of $92 billion. Out of this their corporate tax liability was $41 billion. This reduced their profits after taxes to $50.7 billion. Out of this sum, in turn, $24.4 billion was paid out in dividends while $26.3 billion was retained in undistributed profits.
This last figure represents the corporations’ own reinvestment in working capital, inventories, improvement, new plant, and equipment. If there had been no corporate tax whatever, and there had been the same proportionate distribution of profits between dividends and reinvestment, the amount of money reinvested would have been $47 billion instead of $26 billion—about $21 billion, or 80 per cent, more a year.
By discouraging and retarding investment in new machinery and plant, the 52.8 per cent marginal corporation income tax shields existing obsolescent capacity from the competition of the new, modern and efficient plant and equipment that would otherwise come into existence, or come into existence much sooner.
It is obvious that a corporation income tax in the neighborhood of 50 per cent must drastically reduce both the incentive and the funds for new investment, and therefore for the consequent increase in jobs, productivity, real wages, and economic growth that the politicians are always calling for. By striking so directly against new investment, in fact, the present high corporate income tax slows down economic growth more effectively than almost any other type of tax.
Copyright 1968, Los Angeles Times. Reprinted by permission.
Henry Hazlitt
Henry Hazlitt (1894-1993) was the great economic journalist of the 20th century. He is the author of Economics in One Lesson among 20 other books. See his complete bibliography. He was chief editorial writer for the New York Times, and wrote weekly for Newsweek. He served in an editorial capacity at The Freeman and was a board member of the Foundation for Economic Education.