Topic: Tax and Budget Policy

Bulgaria Announces 10 Percent Flat Tax

According to Bulgarian news sources, the coalition government in Bulgaria has agreed to implement a low-rate flat tax starting next January. This is good news for Bulgaria, but also good news for the rest of Europe since it means further pressure for tax-rate reductions and tax reforms. The global flat tax revolution is picking up so much steam that the time has come to propose a theme song. I realize I’m showing my age, but Another One Bites the Dust seems appropriate. Perhaps the song could be piped into the European Commission and the Organization for Economic Cooperation and Development, adding to their angst about the market-based reforms sweeping the world?

At an operative cabinet meeting Sunday attended by the top brass from the three parties it was decided to retire the current three-bracket personal income tax rate system and replace it with a flat rate of 10%. …The government also decided on a 10% pension increase from October 2007, enabled by a 20% budget revenue overperformance by end-July, and a 3% cut in the social security burden.

House Farm Bill: “A Major Achievement?”

On Friday, the Democratically controlled U.S. House of Representatives passed a massive new farm bill. In a front page story on Saturday, the Washington Post reported:

The House yesterday passed a far-reaching new farm bill that preserves the existing system of subsidies for commercial farmers and adds billions of dollars for conservation, nutrition and new agricultural sectors.

Passage of the 741-page bill by a vote of 231 to 191, after partisan battling unusual for farm legislation, was a major achievement for the new Democratic leadership.

“A major achievement?” It says a lot about the political culture in our nation’s capital that passing a bill that basically continues more than 80 years of failed farm policy with minimal reforms is considered a major achievement.

In Washington, achievement is measured by how much legislation is passed and how much money is spent, not by whether the nation’s interests are advanced. For reasons we have outlined in great detail at Cato, the policies contained in the House farm bill benefit a small number of farmers at the expense of the vast majority of Americans.

Some achievement.

Parliament of Windbags

Let me add to Sallie’s observations on the House farm bill battle.

I watched the action on CSPAN over the pro-reform Kind/Flake amendment and was really struck by the arrogance of the anti-reform members. They repeatedly said essentially: “How dare members like Flake criticize the hard work of the Agriculture Committee — he’s not on the committee, he’s not a farmer, and so what does he know about farming!”

The anti-reform members also trotted out the ”downtrodden small farmer” rhetoric, despite the frequent reminders from the reformers that the vast share of subsidies go to the largest and wealthiest farms.

And for any voters who still think that the GOP is the party of spending restraint, note that on the vote for the Kind/Flake amendment, 32% of Democrats favored reform while only 23% of Republicans did.

Parliament of Whores, Indeed

Those hoping for reform of the outdated and economically damaging farm bill have cause for disappointment today, after the House defeated, by a margin of three votes to one, an amendment that represented some hope for change. (The roll call can be viewed here). That amendment, whilst by no means close to sufficient reform, included important changes to income eligibility requirements and payment limits for subsidies, and would have closed a loophole allowing producers to manipulate the marketing loan program.

Unscathed passage of the House Agriculture Committee’s bill (see my colleague Dan Griswold’s brief criticism of the House bill here) looked in doubt just a few days ago, but House majority leaders managed to sway Rep. Jim McGovern (D., MA), originally in the reform camp, to vote for the farm bill by promising about $840 million to his pet cause, overseas food aid. The Congressional Black Caucus agreed to support the farm bill after a promise to spend $1.1 million on settling racial discrimination claims from the 1990s.

As if the House proposal for the “new” farm bill wasn’t insult enough for the taxpayer and consumer, the proposal for funding some of the largesse is beyond the pale. The $4 billion increase in food stamps and nutrition programs, which could presumably be paid for by cutting the subsidies to farmers of chosen crops, will instead be financed by taxing “inshoring” companies — U.S.-based subsidiaries of foreign companies who employ American workers.

For a Congress supposedly concerned that international trade is threatening American jobs, taxing employment of American workers seems perverse — not to mention violative of tax treaties. Business groups and Treasury Secretary Henry Paulson have expressed their deep dissatisfaction with the tax increase. Some Republicans, including the ranking member on the House Agriculture Committee Robert Goodlatte (Va.), have indicated they would vote against the farm bill (up for a final vote today) because of the tax increase. I’ll believe that when I see it.

On a more positive note, the proposed tax increase has led the administration to issue a veto threat, albeit of the less-than-clear “his senior advisers will recommend that the president veto this bill” variety.

Trillion Dollar Man

The recent budget update from the Bush administration shows that federal spending will be $2.918 trillion in fiscal 2008. That means that spending increases under Bush will break the $1 trillion mark when the new fiscal year begins in October. Spending was $1.863 trillion when he came to office in fiscal 2001.

Bush’s last budget year will be fiscal 2009, at which time he is projecting to spend $3.016 trillion. Thus in eight short years, with relatively low inflation, this president and spendthrift congresses will have blasted through both the $2 trillion spending mark and the the $3 trillion mark.

More Evidence for a Corporate Rate Cut

Glenn Hubbard, the former chairman of the Council of Economic Advisers, comments in a Wall Street Journal column ($) that the corporate income tax hurts workers. He cites recent research showing that a lower corporate tax rate would have a substantial Laffer Curve effect.

As explained in a recent Tax & Budget Bulletin, the rest of the world is moving toward lower tax rates. The longer U.S. policy makers wait to implement similar reforms, the larger the losses for American workers:

[T]he tax may be borne not entirely (or even principally) by owners of capital, but by workers. Globalization plays a role. In an open economy, with mobile capital, a source-based tax like the corporate tax will lead to a capital outflow, reducing investment and productivity and wages.

…In other research assuming that the world-wide capital stock is fixed, William Randolph of the Congressional Budget Office finds that labor bears about 70% of the corporate tax. …A recent paper by Kevin Hassett and Aparna Mathur of the American Enterprise Institute analyzes data across countries and over time, concluding that for countries that are part of the Organization for Economic Cooperation and Development (OECD), a 1% increase in corporate tax rates results in a 0.8% decrease in manufacturing wage rates.  …A recent survey and study by KPMG shows, for example, that competition for investment continues to drive down tax rates around the globe, with further cuts in the pipeline from China, Germany, Singapore and Britain, among others. The desire for these cuts comes in part from the significant responsiveness both of real investment and taxable income to corporate tax rates. …Recent research by Michael Devereux of the University of Warwick suggests, though, that the revenue-maximizing corporate tax rate in OECD countries is likely less than 30%. That is, higher corporate investment (and subsequent corporate profits and corporate tax revenue) and shifts in taxable income by multinational firms will substantially reduce the revenue “cost” of a corporate rate cut from the present 35% to, say, 30%.

Cutting the corporate tax rate would be positive for investment, productivity and economic growth. It would also reduce a tax burden now borne in large part (or even entirely) by labor, bolstering wages. And business responses to the tax cut will offset much of the “static” revenue cost.

Urgency on Corporate Tax Reform

The U.S. Treasury held a conference today regarding the growing uncompetitiveness of the U.S. corporate tax system.

Scholars and heads of large corporations have been pointing out the serious problems with the corporate tax for more than 15 years. There is now a growing consensus that the complex and high-rate corporate tax needs to be overhauled.

Here are some of the themes discussed today:

  • Europe is on a corporate tax-cutting binge. Today, the U.S. federal plus average state corporate tax rate stands at 40 percent, which is much higher than the average rate of 24 percent in the European Union. It appears that foreign rates will keep on falling for some time, putting an ever greater squeeze on U.S. competitiveness.
  • Intel Corporation stressed that tax costs are an important consideration when they locate new semiconductor plants. Over a 10-year time frame, Intel figures that it costs $1 billion more to build and run a plant in the United States over competing countries such as Ireland and Malaysia. About 70 percent of the U.S. cost disadvantage stems from taxes.
  • General Electric noted that taxes are not the key issue in determining where it builds new plants. Instead, in GE’s case, tax rules on foreign income determine whether, say, a U.S. or German company ends up owning a new facility in other countries such as Brazil. From a tax perspective, the United States is a bad place to locate the headquarters of a multinational corporation. Most economists believe that damages the U.S. economy.
  • There is a trend toward “territorial” corporate tax systems, with about two-thirds of countries having such systems today. A U.S.-style “worldwide” system is less and less popular because it puts home-country corporations at a disadvantage in global markets.
  • Several speakers stressed that a greater share of corporate value is in the form of intangible property such as patents. Intangible property is more mobile than tangible property, and thus easier to relocate to low-tax jurisdictions.
  • Peter Merrill of PricewaterhouseCoopers noted that because of higher capital mobility, a greater share of the U.S. corporate tax burden is falling on U.S. workers. Kevin Hassett of the American Enterprise Institute has shown statistically that higher corporate tax rates mean lower worker wages.
  • Supply-side economists have long pushed for tax breaks on new capital investments. But there was widespread agreement at the Treasury roundtable that getting the corporate tax rate down is more important than incentives such as investment tax credits. A lower corporate rate reduces all the distortions in the corporate tax code and directly responds to the challenges of growing global capital mobility.

The only red herring I noticed was a repeated suggestion that we should “broaden the base” of the corporate tax to pay for a corporate rate cut. But there is very little broadening that we could do that wouldn’t be economically damaging. There are not a great number of obvious loopholes in the corporate income tax. (There is lots of tax avoidance, but that is a different issue.) The Treasury listed some targeted loopholes in a recent report, but I bet most people at the conference today would object to repealing most of those, such as “deferral of income from controlled foreign corporations.”  

Anyway, kudos to Treasury Secretary Henry Paulson for the important conference and beginning some momentum for corporate tax reform. 

See here for more background on international tax competition and corporate tax reform.