Topic: Tax and Budget Policy

Corporate Tax Rates and Revenues in Britain

If Republicans succeed in slashing the federal corporate tax rate from 35 percent to 20 percent or less, the tax base will expand as investment increases and tax avoidance falls. There is no need for a legislated expansion in the tax base, as the GOP is proposing with its “border adjustment” scheme. The tax base will broaden automatically over time to offset the government’s revenue loss from the rate cut.

New evidence comes from Britain, which has enacted a series of corporate tax rate cuts. A study by the Centre for Policy Studies includes this chart. It shows the tax rate falling from 35 percent to 20 percent since the late 1980s and corporate tax revenues as a percentage of gross domestic product (GDP) trending upwards. As the rate has fallen, the tax base has grown more than enough to keep money pouring into the Treasury.

Does legislated base broadening explain the increase in U.K. tax revenues? Not for the most recent round of rate cuts. In 2010-11, the government collected £36.2 billion from a 28 percent corporate tax. The government expected its corporate tax package—including a rate cut to 20 percent—to lose £7.9 billion a year by 2015-16 on a static basis. That large expected loss indicated that the package had little legislated base broadening. Study author Daniel Mahoney sent me a table confirming that the package included only modest base-broadening measures that were mainly offset by base-narrowing measures.

The government’s dynamic analysis of the corporate tax package projected a revenue loss of about half of the static amount over the long run. But that analysis was apparently too pessimistic: actual revenues in 2015-16 had risen to £43.9 billion. So in five years, the statutory tax rate fell 29 percent (28 percent to 20 percent) but revenues increased 21 percent (£36.2 billion to £43.9 billion). That is dynamic!

Looking at the longer term, the CPS study says, “In 1982-83 when the rate was 52%, corporation tax receipts yielded revenues equivalent to 2% of GDP. Corporation tax now raises over 2.3% of GDP when the headline rate is at just 20%.” The Brits have scheduled a further rate cut to 17 percent.

Canada’s experience also shows that when you slash the corporate tax rate, substantially more profits appear on corporate returns over time. Canada cut its federal corporate tax rate from 28 percent and higher in the 1980s to just 15 percent today, but it collects about the same amount of corporate tax revenues as a share of GDP now as then.

The British and Canadian experiences show that large corporate tax rate cuts lose governments little if any money. There is no need for risky changes to the corporate tax base, as House Republicans are proposing with border adjustments. That approach would disrupt the economy and invite retaliation from our trading partners for no economic gain.

The CPS study suggests that British industry has responded strongly to tax rate cuts, with rising investment and higher wages for workers. That’s what we want here. So Republicans should put aside their complex base-broadening plan, and just slash the corporate tax rate to the British-Canadian range of 15 to 20 percent.

The CPS study is here.

Kenneth Boulding on the Serious Distortion of Economic Ethics

From Kenneth Boulding, A Reconstruction of Economics (NY, Science Editions 1962) pp. 481-82:

“Economic ethics has been seriously distorted by static and short-run criteria of value. ‘Justice’ has been thought of too much in terms of division of a fixed pie than in terms of encouraging the baking of more pies… .The importance of this problem rests on a matter of simple arithmetic: that if redistribution toward any group causes a fall in the rate of growth of national income, no matter how slight, there will be some date beyond which the absolute income of the favored group will be less than it would have been if the redistribution had not taken place.”

Misconceptions in Raj Chetty’s “Fading American Dream”

Raj Chetty, the head of Stanford’s “Equality of Opportunity” project, recently released a paper called “The Fading American Dream” co-authored with another economist, a sociologist, and three grad students. It claims that “rates of absolute mobility have fallen from approximately 90% for children born in 1940 to 50% for children born in the 1980s.” [Though the study ends with 2014, when most of those “born in the 1980s” were not yet 30.]

The title alone was sure to attract media excitement, particularly because the new study thanks New York Times columnist David Leonhardt “for posing the question that led to this research.” 

Leonhardt, in turn, gushed that Chetty’s research “is among the most eye-opening economics work in recent years.”  He explained that he asked Chetty to “create an index of the American dream” which “shows the percentage of children who earn more money… than their parent earned at the same age.”  The result, he concludes, is “very alarming. It’s a portrait of an economy that disappoints a huge number of people who have heard that they live in a country where life gets better, only to experience something quite different.”

“Another Chetty-bomb just exploded in the mobility debate,” declared a Brookings Institution memo: “Only half of Americans born in 1980 are economically better off than their parents. This compares to 90 percent of those born in 1940.”

At Vox.com,  Jim Tankersley proclaimed “The  American Dream [is] collapsing for young adults.”

“Sons born in 1984 are only 41 percent likely to earn more than their fathers, compared to 95 percent of sons born in 1940,” wrote USA Today reporter Nathan Bomey.  “If the American dream is defined as earning more money than your parents,” said Bomey, “today’s young adults are just as likely to have a nightmare as they are to achieve the dream.”

The Chetty study proved to be a politically irresistible story, since it appears to confirm a popular nostalgia for the good old days and belief that it has become more and more difficult to get ahead. But that is not what the study really shows.  What it really shows is:

First: Incomes were extremely low in 1940, so it was quite easy to do better 30 years later.

Second: Doing better than your parents is not defined by your income at age 30, but by income and wealth accumulated over a lifetime (including retirement).

Third: A rising percentage of young people remain in grad school at age 30, so their current income is lower than that of their parents at that age but their future income is likely to be much higher.

State Department Spending Triples

President Trump is reportedly planning to cut the Department of State’s budget by 37 percent. I’m not an expert on the department’s activities, but it would seem ripe for cuts given the large run-up in spending in recent years.

The chart shows Department of State outlays since 1970 in constant 2016 dollars. Real spending has more than tripled the past 16 years—from $9.5 billion in 2000 to $30.9 billion in 2016. The data comes from President Obama’s last budget. You can chart spending on federal departments and agencies here at DownsizingGovernment.org.

The Trump administration apparently wants to make budget room for Department of Defense spending increases, but the Pentagon is also bloated with inefficiency, as discussed here, here, and here.

Trump’s Budget Situation

President Donald Trump will lay out some of his budget priorities in an address to Congress tonight. He wants to increase spending on defense, a border wall, and perhaps infrastructure. He also wants to cut taxes and balance the budget, yet does not favor reductions to Medicare or Social Security. His budget chief, Mick Mulvaney, faces a challenge in meshing all those priorities.

The chart shows federal spending in four categories as a percent of gross domestic product (GDP). No doubt, Mulvaney is pondering the CBO baseline projections to the right of the vertical line for 2018-2027. As a share of GDP, entitlement and interest spending are expected to soar, while defense and nondefense discretionary spending are expected to fall. Below the chart, I discuss the ups and downs of the four categories since 1970.

Here are some of the causes of the fluctuations seen in the chart:

1970s: Defense spending plunges as the Vietnam War subsides in the early 1970s. But the cost of new Lyndon Johnson/Richard Nixon entitlement and discretionary programs skyrockets.

1980s: Ronald Reagan boosts defense spending, and interest costs soar due to the rising debt. But Reagan cuts numerous discretionary and entitlement programs. For example, “income security” programs fall from 1.6 percent of GDP in 1981 to 1.1 percent by 1989.

1990s: The end of the Cold War prompts large defense cuts. But the recession and spendthrift approach of George H.W. Bush causes other spending to rise early in the decade. Bill Clinton lucks out as Social Security spending falls from 4.4 percent in 1992 to 4.0 percent by the end of the decade, while spending on Medicare and Medicaid remains fairly flat.

2000s: Medicare spending soars under George W. Bush, partly due to his Part D drug plan. Bush also pushes up spending on defense, homeland security, food stamps, education subsidies, and other programs. However, Bush benefits from the Fed’s policy of low interest rates, which moderates federal interest costs.

2010s: The recession of 2007 to 2009 causes spending on entitlements—such as unemployment insurance and food stamps—to soar. The Obama stimulus package includes big increases for many discretionary and entitlement programs in 2009 and subsequent years. The early Obama years also include high levels of Iraq and Afghanistan war spending. However, Obama also benefits from the Fed’s interest rate policies.

2018-2027: CBO projections show entitlement and interest costs rising rapidly, and deficits topping $1 trillion by 2023. To sustain economic growth and avert a fiscal disaster, Trump should push to terminate and privatize programs in every federal department. He talks a good game, but we will see whether he is interested in actual budget reforms in coming weeks as he rolls out specific proposals.


Notes: CBO data is here. I adjusted the entitlement line to take out TARP from 2009-2011 because it ended up costing taxpayers little or nothing.

For ways to cut federal spending, see this essay at DownsizingGovernment.org.

Court: IRS, Unlike Caligula, May Punish Only Under Well-Proclaimed Law

Judge Jeffrey Sutton, writing for a Sixth Circuit panel, has reversed a Tax Court ruling in an opinion [Summa Holdings v. Commissioner of Internal Revenue] beginning thus:

Caligula posted the tax laws in such fine print and so high that his subjects could not read them. Suetonius, The Twelve Caesars, bk. 4, para. 41 (Robert Graves, trans., 1957). That’s not a good idea, we can all agree. How can citizens comply with what they can’t see? And how can anyone assess the tax collector’s exercise of power in that setting? The Internal Revenue Code improves matters in one sense, as it is accessible to everyone with the time and patience to pore over its provisions.

In today’s case, however, the Commissioner of the Internal Revenue Service denied relief to a set of taxpayers who complied in full with the printed and accessible words of the tax laws. The Benenson family, to its good fortune, had the time and patience (and money) to understand how a complex set of tax provisions could lower its taxes.

And taking issue with the IRS Commissioner’s decision to disallow the combined use of two Congressionally approved devices, the Roth IRA and DISC (domestic international sales corporation), in a way said to trigger the so-called substance-over-form doctrine:

Each word of the “substance-over-form doctrine,” at least as the Commissioner has used it here, should give pause. If the government can undo transactions that the terms of the Code expressly authorize, it’s fair to ask what the point of making these terms accessible to the taxpayer and binding on the tax collector is. “Form” is “substance” when it comes to law. The words of law (its form) determine content (its substance). How odd, then, to permit the tax collector to reverse the sequence—to allow him to determine the substance of a law and to make it govern “over” the written form of the law—and to call it a “doctrine” no less.

[cross-posted from Overlawyered]

New Study on Low-Income Housing Subsidies

A new study at Downsizing Government looks at low-income housing aid. Howard Husock of the Manhattan Institute examines the history of federal aid and discusses problems with current policies, particularly rental subsidies and public housing.

One problem is that housing aid is costly to taxpayers. The federal government spent $30 billion on rental subsidies (Section 8 vouchers) and almost $6 billion on public housing in 2016.

Another problem is that housing aid and related rules are costly to urban communities. Howard argues that federal interventions undermine neighborhoods, encourage dependency, and create disincentives for long-term maintenance and improvements in housing.