In the past year American pre-tax corporate earnings have grown by $1.2trn, or 30%. Companies in the S&P 500 index are handily beating forecasts. Taxes on corporate profits have collapsed (see chart 1).
VAST SPENDING on AI infrastructure has created a profit boom. And yet Uncle Sam is seeing little of the benefit. Government beancounters did expect lower receipts this year, owing to recent changes that let firms write off more investments against their tax bills. But the scale of the drop has surprised even them, as unusually profitable tech giants are writing off unusually high capital spending. The episode hints at how AI may upend tax systems across the world.
Because it taxes labour fairly heavily relative to capital and because wages and salaries form an unusually large share of GDP, america takes a smaller but still significant hit—both. You might think of AI as a godsend for governments, many of which are accumulating vast debts (see chart 2). Higher economic growth could reduce the debt-to-GDP ratio after 30 years by 50% or so of GDP, relative to where it would be otherwise. Across the OECD club of mostly rich countries, personal-income taxes and social-security contributions account for a high and rising share of overall tax revenue (see chart 3). The Budget Lab, part of Yale University, explores a range of scenarios in which AI boosts annual GDP growth to as much as 3.3%. But the majority of governments that rely on labour taxes would be crippled (see chart 4).
“As AI reduces labour’s share of income, the traditional tax base erodes,” argue Anton Korinek of Anthropic and Lee Lockwood of the University of Virginia, in a recent paper. Economists expect AI to boost productivity growth, which should in turn create a bigger economy. In a recent paper Karen Dynan, Douglas Elmendorf and Louise Sheiner, three economists, model the potential effects of AI on America’s debt. Good news? Kind of. America’s debt ratio continues to rise—just less quickly than before. The risk is that tax receipts continue to lag behind spending, sometimes by many trillions of dollars. It is even possible that AI may not reduce budget deficits, but widen them. One problem is that AI may create value in areas which governments tax lightly while destroying value in the more heavily taxed bits. The economy could expand rapidly while leaving the government increasingly starved of funds. At present governments get most of their revenues from workers. In America about three-quarters of all federal tax revenue comes from labour. Taxes on consumption and capital (including corporate profits and capital gains) are smaller. This tax mix may not suit a world in which AI displaces workers or reduces their salaries, even as corporate profits rise. This produces higher tax revenues—but the extent of the boost depends greatly on the distribution of the extra income between capital and labour. To gauge how profound, The Economist has calculated the effects on tax revenue of AI causing labour’s share of national income to decline by ten percentage points. A few countries with relatively high taxes on capital, including Australia and South Korea, emerge relatively unscathed. In Italy, the hardest-hit big country in our model, the budget deficit could more than double as a share of GDP (assuming that spending remains constant relative to GDP). France and Germany are not far behind.
Even in an America where AI turbocharges the economy, by the 2050s the government could be much more indebted than today.
We estimate that American consumers and businesses currently spend about $700bn a year on building and running AI models. This is a tiny tax base relative to the total labour bill ($16trn last year). Total capital investments in AI from big tech firms is expected to plateau from 2028, while technological improvements might mean that businesses’ spending on AI need not rocket. In 1990, 11 rich countries raised money by taxing fortunes, but today only four do.
Such considerations help explain why many countries that had introduced wealth taxes have abandoned them. Yet it might raise surprisingly little revenue. AI spending may balloon from here, but by how much is anyone’s guess. The revenue from such a tax is thus highly uncertain. Yet robust academic evidence shows that the rich respond to wealth taxes by shifting assets offshore, or moving themselves. Privately owned businesses, where many keep their riches, are also notoriously hard to value, making it hard for the taxman to know how much to demand. What was John D. Rockefeller’s stake in Standard Oil, which was not listed, really worth?
