Question

(Related to the Chapter Opener on page 600 ) In 2017 , the Trump administration proposed changes to the federal tax code, including reducing the top corporate income tax rate from 35 percent to 15 percent. An article in the Wall Street Journal noted, "A tax overhaul could give companies more incentive to invest." a. What type of investments is the article referring to? Why would cutting the corporate income tax rate lead companies to engage in more investment? b. Some policymakers and economists are critical of cuts in the corporate income tax rate because they argue that such cuts increase income inequality. Does the incidence of the corporate income tax matter in evaluating this argument? Briefly explain.

Short answer

The article refers to capital investments - new equipment, buildings, machinery, research and development or other productive assets. Reduced corporate income tax rates lead to more investment by increasing the post-tax return on investments, thereby making more projects economically viable. Whether cuts in the corporate income tax rate increase income inequality depends on the incidence of the tax. If the burden of the tax falls predominantly on wealthier shareholders, a tax cut could increase income inequality, as these individuals retain a larger share of the profits.

Step-by-step solution

Understanding Investments and Tax Influence

The major types of investments companies typically participate in are capital investments. These typically include new equipment, buildings, machinery, research and development or other operating inputs necessary to increase productivity. When the corporate income tax rate is reduced, companies retain more of their earnings. They can utilize these additional funds in a way that brings about a higher return than the cost of capital, such as stimulating growth through capital investments.

Discuss Tax Incidence and Income Inequality

The incidence of a tax refers to who ultimately bears the burden of the tax. While companies are directly responsible to pay the corporate income tax, the incidence of the tax can fall on various stakeholders such as the company, its employees, its customers, or even its shareholders. If the tax incidence falls predominantly on the shareholders (who are typically wealthier individuals), a reduction in such tax rates might allow these individuals to retain a larger share of profits, thereby potentially exacerbating income inequality.

Key concepts

Capital Investments

When we talk about capital investments, we're referring to the significant amounts of money that companies put into long-term assets. These might include purchasing new machinery, building new facilities, upgrading technology, or investing in research and development. Capital investments are crucial for businesses because they enable growth and expansion, eventually leading to increased productivity and efficiency.

The corporate income tax rate can influence capital investments directly. If the tax rate is lowered, companies are left with more after-tax income. With additional funds available, businesses often choose to invest in capital assets. These investments improve their operational capabilities, potentially leading to higher profits in the long run. Lower taxes increase the return on investment (ROI), making such capital ventures more attractive to companies.

Tax Incidence

Tax incidence deals with understanding who bears the real burden of a tax. It's a frequent point of discussion in economic policies. While corporations might seem like the direct payers of corporate income tax, the true impact spreads across various groups.

Here's how it works:

• Shareholders: If companies pay less tax, shareholders might enjoy higher dividends or increased stock value.
• Employees: More available capital might also mean higher wages or better facilities for workers.
• Customers: Sometimes companies pass tax savings onto consumers through lower prices.

Understanding who truly shoulders the tax helps evaluate any economic policy's broader impact on society.

Income Inequality

Income inequality is the disparity in income distribution among people in a society. It's a hot topic because it affects economic stability and social fairness. When corporate taxes are cut, it might seem like a positive development for companies, but its influence on income inequality can be significant.

If the primary beneficiaries of tax cuts are the wealthier shareholders, the disparity between high and low-income individuals may increase. This is because wealthier individuals gain more from returns on investments or as part of corporate earnings, while lower-income groups do not experience the same benefit.

The distribution of income is a key consideration for any policy involving tax rates. Evaluating the implications on inequality helps in designing fairer tax systems.

Corporate Tax Rate

The corporate tax rate is the percentage that corporations pay on their profits. It's an essential part of any country's tax policy because it affects business profitability, investment decisions, and economic growth.

By reducing corporate tax rates, governments aim to stimulate investment by leaving more money in the hands of businesses. This can lead to increased hiring, better wages, or expansion projects, potentially boosting the overall economy.

However, policymakers must balance these rates to ensure the government still collects sufficient revenue for public services. It's a delicate play between encouraging business growth and meeting public financial needs.

Economic Incentives

Economic incentives are tools used to motivate and encourage individuals and businesses to pursue certain economic activities. They can be in the form of tax breaks, subsidies, or grants. In the context of tax policy, lowering the corporate tax rate acts as an incentive.

This incentive can lead companies to increase investments, boost productivity, and expand their workforce. By knowing they will pay less tax, companies might find new projects more feasible, which they previously couldn't afford.

The ultimate goal of offering economic incentives is to foster an environment where businesses can flourish, leading to a healthier national economy. This growth results from strategic policy-making aiming to align corporate interests with broader economic goals.