Kevin Hassett Updates Adam Smith

The chair of the White House Council of Economic Advisors, Kevin Hassett, visited Cato last week to talk about tax reform. Under Kevin’s leadership, the CEA has produced two reports discussing how corporate tax cuts can boost wages and growth.

The CEA explains the basic mechanism:

reductions in the corporate tax rate incentivize corporations to pursue additional capital investments as their cost declines. Complementarities between labor and capital then imply that the demand for labor rises under capital deepening and labor becomes more productive. Standard economic theory implies that the result of more productive and more sought-after labor is an increase in the price of labor, or worker wages.

And discusses how lower taxes attract investment from abroad:

One component of investment is foreign direct investment (FDI), and numerous empirical studies … have observed that FDI is highly responsive to cross-border differences in tax rates.

And describes how high corporate taxes hurt workers in the global economy:

The fact that capital can move relatively easily across borders while labor cannot serves to intensify the burden of the corporate tax on workers.

Essentially, the CEA studies update Adam Smith with new empirical data. Writing in his Wealth of Nations, Smith described how heavy taxes on mobile “stock,” or capital, in a world with open borders would cause losses to workers and the broader economy:

Secondly, land is a subject which cannot be removed, whereas stock easily may. The proprietor of land is necessarily a citizen of the particular country in which his estate lies. The proprietor of stock is properly a citizen of the world, and is not necessarily attached to any particular country. He would be apt to abandon the country in which he was exposed to a vexatious inquisition, in order to be assessed to a burdensome tax, and would remove his stock to some other country where he could either carry on his business, or enjoy his fortune more at his ease. By removing his stock he would put an end to all the industry which it had maintained in the country which he left. Stock cultivates land; stock employs labour. A tax which tended to drive away stock from any particular country, would so far tend to dry up every source of revenue, both to the sovereign and to the society. Not only the profits of stock, but the rent of land and the wages of labour, would necessarily be more or less diminished by its removal.

Today, people have much greater ability than in Smith’s time to move their capital across borders, and so taxes on capital are more damaging than ever.

Veronique de Rugy and I discussed these issues in a 2002 paper on international tax competition. Fifteen years later, it is gratifying that Congress may finally make reforms to attract capital rather than repel it.