While state government needs to levy taxes to fund its operations, Minnesotans deserve a serious, reasoned debate on the effects of taxes on the economy. Today, we’ll look at the corporate income tax.

The top federal tax bracket for business is 35%, and Minnesota’s rate is 9.8% (PDF), which trails only Pennsylvania (9.99%) and Iowa (with a top rate of 12%).  If Minnesota’s political leaders reduce the state’s corporate tax rate, what will be the economic effects? Some people say that cutting income taxes on business encourages business owners to invest more in their companies, which in turn will in turn create more jobs and higher incomes. By contrast, Senate Majority Leader Larry Pogemiller argues that cutting tax rates is a “failed strategy” for economic growth.

So which is it? An article in July, 2010 issue of American Economic Journal: Macroeconomics offers some clues. It’s called “The Effect of Corporate Taxes on Investment and Entrepreneurship.” (Here’s a link to the article, which requires a subscription, but you can also read an earlier, free version in PDF.)

The subject of corporate income taxes is confusing and complicated in its own right, and journal articles, including those in economics, can be difficult reading. Fortunately for us, the authors, who are economists at Harvard University and the World Bank, put their findings in plain English. They also give us a few graphs that summarize their main points.

Here’s the abstract of the article, which was written by Simeon Djankov, Tim Ganser, Caralee McLiesh, Rita Ramalho, and Andrei Shleiffer:

We present new data on effective corporate income tax rates in 85 countries in 2004. The data come from a survey, conducted jointly with PricewaterhouseCoopers, of all taxes imposed on “the same” standardized mid-size domestic firm. In a cross-section of countries, our estimates of the effective corporate tax rate have a large adverse impact on aggregate investment, FDI [Foreign Direct Investment], and entrepreneurial activity. Corporate tax rates are correlated with investment in manufacturing but not services, as well as with the size of the informal economy. The results are robust to the inclusion of many controls.

The first two graphs show the negative effects of marginal corporate income tax rates. The first one looks at investment in general. The second looks at Foreign Direct Investment (FDI), or money that comes from outside the country (or by analogy, outside the state.) While both investments are reduced by higher tax rates, the amount of FDI responds more (negatively and positively) to marginal corporate income tax rates than all sources of investment.

Wouldn’t you like to have more job-creating investments coming to Minnesota?

In the next installment of this series,  we will have more to say about the effects of marginal corporate income taxes rates on Foreign Direct Investment (FDI).