Do Tax Cuts Lead to Economic Growth?

[Franknburger]

It is not only about how much, but also what is being taxed. After the Reagan tax cuts, several German corporations found out that their US subsidiaries' effective tax burden had increased! Why? Because the tax cuts were accompanied with "simplification" that essentially did away with various accelerated depreciations, limited the scope of deferring profits / losses, etc.

Now, there are certain types of major investments (like, e.g., a German firm setting up a plant in the US) which take several years before generating a positive cash flow, and even longer to break even. These investments were discouraged and even penalised by the Reagan tax cuts. I saw a similar effect in Lithuania - they had massively reduced their corporate tax rate, but at the same time done away with various possibilities for tax deduction, including on certain marketing expenses (e.g. trade fair samples), insurance, warranty reserves, R&D investment etc. The effect: Enterprises get risk-adverse and adopt a rent-seeking behaviour.

To put it differently: Management is much more likely to venture into new technology when government takes over 50% of the investment cost & risk (which is the case at 50% corporate tax, combined with liberal depreciation / tax deduction rules and the possibility to defer losses over several years), than at 25% corporate tax with restrictive tax deductibility. At the same time, a higher corporate (& individual) tax makes shareholders more likely to focus on increasing the company value, while low taxes promote a tendency to distribute earnings as dividends instead of reinvesting them.

In short: Moderate taxes (I am not talking about confiscatory taxes above 50-55%) promote investment and risk-taking, which (if done properly) should increase economic growth.

[Franknburger]

Your hypo   Franknburger does not entail the government taking half the risk because if there are losses and no future profits, you/the corporation eat all the losses - unless you can sell the tax loss carryforwards to a third party for cash one way or the other. The US tax code and ancillary regulations has about 100 pages dealing with this issue, mostly in the context of mergers.

Your point is valid for a complete start-up, but not for a going concern that is already profitable (and be it only due to importing into the US, with the intention to shift some of the production there as well).

[Franknburger]

OK. You have profits from something else. I am not sure this is good policy by the way (the government, albeit even handedly - for once, subsidizing risk taking). I would be interested in a "dense" academic article on that point with real data, not just chat, if such a paper exists. Plus it creates an incentive for companies to become inefficient conglomerates - solely for tax reasons.

In fact, government would not be subsidising risk taking. It is just that government, by claiming a higher (nominal) share on profits, also takes a higher share of the risk that is associated with  profit generation.
To be clear: I am no friend of 'big government', but there are a number of (pretty costly) functions that government needs to assume (education, infrastructure, guaranteeing rule of law, etc.). If all that can be financed with 20% corporate tax - fine. But I don't know any country in the world that is able to maintain decent standards of public service provision at such a taxation level. So, tax decreases are typically financed by closing 'loopholes', which results in  effective tax rates that may be substantially higher than the nominal tax rate, thereby often penalising risk taking (which is never "business as usual", and as such typically not addressed properly by a "simplified" tax code).

I haven't seen (nor looked for) any academic article on that point, but I have myself done a few studies for organisations like the Asian Development Bank on individual countries' tax systems and their impact on business (especially small and medium enterprises).So, what I can offer you is a practioner's experience, and a plausible (though not empirically proven) explanation why tax reductions do not necessarily stimulate growth, and may on the long run even be counter-productive.

Otherwise: Your point on conglomerates is a good one. Haven't yet thought of it (I am more in the SME field). I may come back on it later, after giving it some more thought.

[Franknburger]

If taxable profits are calculated in a way that reflects really economic profits, then win or lose, it's tax neutral. If you artificially reduce taxable profits through accounting gimmicks (like accelerated depreciation), that loads the dice from an investment perspective. At the margin, it is a subsidy for investment. So, I'm hostile out of the gate, absent empirical data and more theory, that I don't possess at the moment.

Have you ever done a return-on-investment calculation? In  the "profitable going concern" case, higher taxes mean lower cash-out during the investment phase, and lower cash surplus after break-even.  As the surpluses occur later in time, they are discounted stronger, so higher taxes tend to result in a higher internal rate of return. The effect depends of course on the specific payment and revenue streams, the extent to which investment costs are tax-deductible, and the discount rate applied. The longer the investment period, and the higher the discount rate applied, the stronger it will be.
In practical terms, this means that especially R&D and software  investments, which are typically 
not depreciated but directly written to expense accounts, and may require some time before generating earning / cost savings, become less profitable when taxes decrease. Large capital investment, e.g. construction of a new plant, may also be positively affected by high taxes.

IIRC, one of the points criticised in the 1980s by German corporations  in relation to the Reagan tax cuts was the exclusion of loss referral (to they extent it was ever allowed in the US, which is beyond my knowledge). German tax laws at that time allowed to refer losses back for up to two years. These corporations compared their past and projected tax debt under the German (56% corporate tax, but possibility of loss referral) and new US tax legislation (33% corporate tax), and concluded that German regulation resulted in lower average tax payment.