Tag: Tax Reform

A Fiscal Royal Wedding

The British royal wedding was splendid, and the bride and groom were a great match. As a fiscal wonk, my idea of a royal match-up would be marrying corporate tax cuts and business subsidy cuts. The Obama administration is talking about corporate tax cuts and Republicans are talking about cuts to farm subsidies. Might they get together over a cup of tea and work out nuptials?

The global average corporate tax rate has fallen over the last decade from 32 to 25 percent (KPMG, page 79). We have been stuck with a highly damaging 40% federal-state rate. Canada is chopping its combined federal-provincial rate to 25 percent. The Conservative government just won a parliamentary majority, which promises even more pro-investment changes for our largest trading partner.

Consider a Japanese car company deciding where to build its next North American plant. Should it choose a place with a 25 percent tax and stable government finances, or a place with a 40 percent tax and soaring government debt threatening major tax hikes?

The American economy is sputtering, and today we learned that the unemployment rate is back up to 9 percent. If the Obama administration wants to get the economy booming before next year’s election, it should push for a cut in the federal corporate tax rate from 35 percent to 20 percent or lower. And it should put aside all this stuff about “closing corporate loopholes.” A lot of supposed corporate loopholes aren’t loopholes to begin with, and as soon as you start trying to cut the real loopholes, half the business community lines up against reform and nothing gets done. Furthermore, if we chopped the corporate rate, the economic distortions caused by loopholes would decline.

Anyway, the largest corporate “loopholes” are probably “homemade loopholes,” which start disappearing automatically if we cut the tax rate. With a high tax rate, corporations have fashioned all kinds of financial structures to avoid taxes. Corporate tax experts agree that the mobility of the corporate tax base is high and rising. If we sharply cut our corporate rate, reported income would increase substantially as multinationals shift their profits into the United States. (For more on this, see my book).

A corporate tax cut would spur capital investment and economic growth. In 2005, the Joint Committee on Taxation used two macro models to look at the effects of various fiscal reform packages. By far, the largest positive impacts on GDP came from matching a corporate tax rate cut with federal spending cuts. (See charts 1c and 1d). The JCT found that:

A decrease in the corporate income tax rate primarily affects the economy through increasing the after-tax rate of return on corporate capital, which provides incentives for increased investment in corporate capital. Over time, this increased investment results in more goods and services and higher total output. It also results in higher labor productivity, leading to increased wages and employment.

So, let’s get cracking on a corporate tax rate cut. Forget about the corporate loopholes, and instead match a rate cut with cuts to business subsidies, such as farm handouts.

Let’s also put aside the idea of tying corporate tax reform to individual tax reform, as Ways and Means chairman David Camp has suggested. That’s just a recipe for gridlock. Obama is offering up corporate tax reform — for the sake of jobs and the economy, Republicans should jump on that opportunity right away.

The IRS: Even Worse Than You Think

Since it is tax-filing season and we all want to honor our wonderful tax system, let’s go into the archives and show this video from last year about the onerous compliance costs of the internal revenue code.

Narrated by Hiwa Alaghebandian of the American Enterprise Institute, the mini-documentary explains how needless complexity creates an added burden - sort of like a hidden tax that we pay for the supposed privilege of paying taxes.

Two things from the video are worth highlighting.

First, we should make sure to put most of the blame on Congress. As Ms. Alaghebandian notes, the IRS is in the unenviable position of trying to enforce Byzantine tax laws. Yes, there are examples of grotesque IRS abuse, but even the most angelic group of bureaucrats would have a hard time overseeing 70,000-plus pages of laws and regulations (by contrast, the Hong Kong flat tax, which has been in place for more than 60 years, requires less than 200 pages).

Second, we should remember that compliance costs are just the tip of the iceberg. The video also briefly mentions three other costs.

  1. The money we send to Washington, which is a direct cost to our pocketbooks and also an indirect cost since the money often is used to finance counterproductive programs that further damage the economy.
  2. The budgetary burden of the IRS, which is a staggering $12.5 billion. This is the money we spend to employ an army of tax bureaucrats that is larger than the CIA and FBI combined.
  3. The economic burden of the tax system, which measures the lost economic output from a tax system that penalizes productive behavior.
  4. The way to fix this mess, needless to say, is to junk the entire tax code and start all over.

    I’ve been a big proponent of the flat tax, which would mean one low tax rate, no double taxation of savings, and no corrupt loopholes. But I’m also a big fan of national sales tax proposals such as the Fair Tax, assuming we can amend the Constitution so that greedy politicians don’t pull a bait and switch and impose both an income tax and a sales tax.

    But the most important thing we need to understand is that bloated government is our main problem. If we had a limited federal government, as our Founding Fathers envisioned, it would be almost impossible to have a bad tax system. But if we continue to move in the direction of becoming a European-style welfare state, it will be impossible to have a good tax system.

Friday Links

Tuesday Links

  • A bombing campaign by either Israel or the United States would rally the Iranian people to support an otherwise unpopular and incompetent regime.
  • What else will it take to rally the so-called fiscal hawks to the cause of reducing spending, balancing the budget, and averting national bankruptcy?
  • Senator Franken’s Pay for War Resolution is a superficially a step in the right direction; but when it comes to war, the Senate could probably easily rally a 60-vote supermajority to override any offset requirements.
  • It should be easy to rally around Paul Ryan’s Medicare choice plan, since seniors will lose benefits in the long run anyway.
  • Tax reform proposals are rallying back on both sides of the aisle–will any of them stick?


Congressman Ryan’s Budget Is a Big Step in the Right Direction

The chairman of the House Budget Committee, Rep. Paul Ryan of Wisconsin, will unveil his FY2012 budget tomorrow. Not all the details are public yet, but what we do know is very encouraging.

Ryan’s plan is a broad reform package, including limits on so-called discretionary spending, limits on excessive pay for federal bureaucrats, and steep reductions in corporate welfare.

But the two most exciting parts are entitlement reform and tax reform. Ryan’s proposals would simultaneously address the long-run threat of bloated government and put in place tax policies that will boost growth and improve competitiveness.

  1. The long-run fiscal threat to America is entitlement spending. Ryan’s plan will address this crisis by block-granting Medicaid to the states (repeating the success of the welfare reform legislation of the 1990s) and transforming Medicare for future retirees into a “premium-support” plan (similar to what was proposed as part of the bipartisan Domenici-Rivlin Debt Reduction Task Force).
  2. America’s tax system is a complicated disgrace that manages to both undermine growth and promote corruption. The answer is a simple and fair flat tax, and Ryan’s plan will take an important step in that direction with lower tax rates, less double taxation of saving and investment, and fewer distorting loopholes.

One potential criticism is that the plan reportedly will not balance the budget within 10 years, at least based on the antiquated and inaccurate scoring systems used by the Congressional Budget Office and Joint Committee on Taxation. While I would prefer more spending reductions, I’m not overly fixated on getting to balance with 10 years.

What matters most is “bending the cost curve” of government. Obama’s budget leaves government on auto-pilot and leaves America on a path to becoming a decrepit European-style welfare state. Ryan’s budget, by contrast, would shrink the burden of federal spending relative to the productive sector of the economy.

Along with other Cato colleagues, I’ll have more analysis of the plan when it is officially released.

Time to Get Rid of the Corporate Income Tax?

Here’s a video arguing for the abolition of the corporate income tax. The visuals are good and it touches on key issues such as competitiveness.

 

I do have one complaint about the video, though it is merely a sin of omission. There is not enough attention paid to the issue of double taxation. Yes, America’s corporate tax rate is very high, but that is just one of the layers of taxation imposed by the internal revenue code. Both the capital gains tax and the tax on dividends result in corporate income being taxed at least two times.

These are points I made in my very first video, which is a good companion to the other video.

There is a good argument, by the way, for keeping the corporate tax and instead getting rid of the extra layers of tax on dividends and capital gains. Either approach would get rid of double taxation, so the economic benefits would be identical. But the compliance costs of taxing income at the corporate level (requiring a relatively small number of tax returns) are much lower than the compliance costs of taxing income at the individual level (requiring the IRS to track down tens of millions of shareholders).

Indeed, this desire for administrative simplicity is why the flat tax adopts the latter approach (this choice does not exist with a national sales tax since the government collects money when income is spent rather than when it is earned).

But that’s a secondary issue. If there’s a chance to get rid of the corporate income tax, lawmakers should jump at the opportunity.

U.S. Corporate Tax Rate the Highest

Japan has announced that it will cut its corporate tax rate by five percentage points. Japan and the United States had been the global laggards on corporate tax reform, so this leaves America with the highest corporate rate among the 34 wealthy nations of the Organization for Economic Cooperation and Development.

That is not a good position for us to be in. Most of the competition faced by U.S. businesses comes from businesses headquartered in other OECD countries. America also competes with other OECD nations as a location for investment. Our high corporate tax rate scares away investment in new factories, makes it difficult for U.S. companies to compete in foreign markets, and provides strong incentives for corporations to avoid and evade taxes.

The chart shows KPMG data on statutory corporate tax rates in the OECD for 2010, but I’ve also put in the new lower rate for Japan. With the Japanese reform, the average rate in the OECD will be 25.6 percent. That means that the 40 percent U.S. rate is 56 percent higher than the wealthy-nation average.

Most fiscal experts agree that cutting the U.S. corporate tax rate is a high priority, and President Obama’s fiscal commission endorsed the idea. If the president wants to get the economy firing on all cylinders–and generate a new pragmatic and centrist image for himself–he should lead the charge to drop the corporate rate to at least 20 percent.

With state-level taxes on top, a federal corporate rate of 20 percent would put America at about the OECD average, and give all those corporations sitting on piles of cash a great reason to start investing again.

Dan Mitchell’s comments are here.

Buy Global Tax Revolution here.