What’s To Lose from a Corporate Tax Hike?

The Potential Cost on Global Competitiveness

Apr 12, 2021
Finance

SMITH BRAIN TRUST – Among the centerpieces of the Biden administration’s proposed $2 trillion infrastructure bill is an increase in the top corporate tax rate, meant to help cover the costs of the expansive spending plan. And it’s a move that some warn would carry a slew of implications.

Maryland Smith’s Michael Faulkender says the impact of the tax increase will be felt in the competition to attract companies to locate and maintain operations in the United States.

The Trump administration’s Tax Cuts and Jobs Act (TCJA), which passed in 2017, was intended to bolster the country’s position in that area by cracking down on the ability of firms to hold money overseas, he says.

“Prior to TCJA, if you operated domestically, you would pay 35% in federal corporate income tax. Whereas if you were able to structure your international operations in a certain way, you could essentially pay zero at the time and it would be deferred until the money was brought back to the United States,” says Faulkender, professor of finance at the University of Maryland’s Robert H. Smith School of Business. “What happened as a result of TCJA is that instead, if you operate here in the U.S., it's 21%; if you operate overseas, the tax rate is roughly 13%, so there wasn't as much disparity in taxes depending upon where you operate.”

Prior to the TCJA, the United States had the highest top corporate tax rate of any country in the Organisation for Economic Co-operation and Development (OECD), a group of the world’s most advanced economies.

The new tax law, which went into effect in 2017, sought to create incentives for investment on the front end, Faulkender says. It reduced corporate tax receipts in order to spur investment, with those funds being made up later on through stronger economic activity. It was a strategy that was beginning to come into its own, Faulkender says, but then the COVID-19 pandemic drastically altered business operations globally.

“It was understood that because of the immediate expensing that there was going to be a reduction in corporate tax receipts within the first one or two years, but that we would see a rebound in corporate tax payments,” says Faulkender. “We began seeing that rebound prior to the onset of the pandemic with an increase of roughly 20% in corporate tax receipts during the first four months of the 2020 fiscal year.”

The TCJA also aimed to discourage U.S. companies from offshoring, or moving their headquarters to countries with lower corporate tax rates, even when most operations take place domestically, Faulkender says, by reducing the potential tax burden facing those firms.

“By raising corporate income tax rates, we risk curtailing private sector economic activity in the years to come.”

GET SMITH BRAIN TRUST DELIVERED
TO YOUR INBOX EVERY WEEK

SUBSCRIBE NOW

About the Expert(s)

Michael Faulkender's research focuses on empirical corporate finance in the areas of capital structure, risk management, corporate liquidity, and executive compensation. His work has been published in the Journal of Finance, Journal of Financial Economics, and Review of Financial Studies and has been cited in the Wall Street Journal, Washington Post, and The New York Times. He was awarded the Barclay's Global Investors/Michael Brennan Best Paper Award in the Review of Financial Studies in 2013, was runner up for that prize in 2006, and won the Jensen Prize for Corporate Finance – Second Prize in the Journal of Financial Economics in 2013.

More In

Finance

Buffett’s Designated Successor: Less Charisma but Extreme Competence

And 23 other takeaways from the Berkshire Hathaway's annual shareholders meeting.

May 06, 2021
The Weird New World of NFTs

For those who have regrets about missing out on the rise of cryptocurrency, the next big thing is here – NFTs, or non-fungible tokens. But instead of trading currency, these tokens come in the form of pictures and video clips. While unconventional, they might just be the next digital gold, says Maryland Smith's David Kass.

Mar 31, 2021
Lessons from Citi’s Revlon Error

A recent $500 million “clerical error” at Citigroup exposes an inherent weakness in big banks that provides lessons to be learned.

Mar 22, 2021
Robert H. Smith School of Business
Map of Robert H. Smith School of Business
University of Maryland
Robert H. Smith School of Business
Van Munching Hall
College Park MD 20742
SmithInfo@umd.edu