Macroeconomic analysis of a revenue-neutral reduction in the corporate income tax rate financed by an across-the-board limitation on corporate interest expenses
by EY’s Quantitative Economics and Statistics (QUEST) group
Commissioned by the BUILD Coalition, July 2013.
In the midst of increased momentum surrounding tax reform, new research from EY shows that limiting interest deductibility to finance a lower corporate tax rate reduces long-run economic growth. The report, which specifically examines the impact of limiting the deductibility of corporate interest to its noninflationary component to finance a revenue neutral 1.5 percent reduction in the corporate income tax rate, finds:
- GDP falls by an estimated 0.2% in the long-run* or $33.6 billion in today’s economy;
- Investment falls by an estimated 0.3%, or $6 billion in today’s economy; and,
- Economic welfare, measured by the value of household’s consumption and leisure, falls by an estimated 0.4%.
This study shows that by reducing long-run economic growth, policies designed to limit interest deductibility are in direct opposition to the stated goals of tax reform, boosting economic growth.
*Two-thirds to three-fourths of long-run impact are felt in the first 10 years
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EY estimates the impact of a 25% across-the-board limitation on corporate interest expenses and the approximately 1.5 percentage-point reduction in the CIT rate it could finance. The driver behind these outcomes is an increase in the cost of capital for businesses due to the limitation on interest deductibility. In total, the report finds that the marginal effective tax rate on new investment increases by 9.6 percent in the corporate sector. This higher cost of capital is estimated to reduce investment, job creation, and economic growth.
“Limiting interest deductibility would fundamentally change the business model that has made our economy successful and hurt small businesses especially hard. Given continued high unemployment rates, this would be the opposite policy outcome we need.”
– Beth Solomon, President & CEO of the National Association of Development Companies
The report also shows that all industry and states suffer from financing lower rates through limiting interest. Services, retail and wholesale trade, manufacturing, and construction take the strongest hits. California, Texas, and New York seeing the largest drops in the aggregate and Alaska, Delaware, Wyoming, and Connecticut see the largest drops in GDP on a per capita basis.
Read the full report below or download the pdf (right click, save as).
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