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Posts Tagged ‘Corporate income tax’

With the election less than two months away, there’s a lot of discussion and debate about Trump’s performance.

I put together a report card last year showing that his economic policies have been a mixed bag, with good grades on tax and regulation, but bad grades on trade and spending.

Today, let’s focus specifically on fiscal issues and try to identify the best and worst changes that have occurred during his presidency.

Let’s start with the good news.

For what it’s worth, I’m somewhat conflicted between two different provisions of the 2017 tax reform.

I’m a huge fan of the cap on the state and local tax deduction. For years, I had been arguing that it was very foolish for the federal tax system to subsidize high-tax states.

So I was delighted that the 2017 law restricted this subsidy (and I’m further delighted that we’re already seeing a positive impact with people “voting with their feet” against states such as New York, Illinois, and California).

However, that reform is not permanent. Like many other provisions of that law, it automatically expires at the end of 2025.

Which is why I’m going to choose the lower corporate tax rate as Trump’s best policy. Not only is that reform permanent (at least until/unless Joe Biden takes office), but it was enormously important for American competitiveness since the United States used to have the highest corporate tax rate in the developed world.

And the rate is still too high today, especially if you include the impact of state corporate tax rates, but at least the 2017 reform took a big step in the right direction.

And that big step is good news for jobs, wages, investment, and competitiveness.

Now for the bad news.

I could make the case that Trump’s overall spending increase is the problem.

Indeed, in a column for Reason, Matt Welch points out that Trump has not been a fiscal conservative.

The most traditional way to measure the size of government is to count how much money it spends. In Barack Obama’s last full fiscal year of 2016…, the federal government spent $3.85 trillion… In fiscal year 2020, before the coronavirus pandemic triggered a record amount of spending, the federal government was on course to cough up $4.79 trillion… So under Trump’s signature, before any true crisis hit, the annual price tag of government went up by $937 billion in less than four years—more than the $870 billion price hike Obama produced in an eight-year span… You can argue plausibly that Joe Biden and the Democratic Party will grow the government more. But the fact is, the guy railing against socialism…has grown spending faster than his predecessor and shown considerably less interest in confronting the entitlement bomb.

All of this is true, but I want to focus on specific policies, not just the overall spending performance.

Which is why I would argue that Trump’s worst fiscal policy is captured by this table from the Committee for a Responsible Federal Budget.

It shows what Trump promised compared to what he delivered and I’ve highlighted his awful record on non-defense discretionary spending (which is basically domestic spending other than entitlements). He promised $750 billion of reductions over 10 years and instead he saddled the American economy with $700 billion of additional increases.

P.S. Click here if you want background info on the different types of federal spending. But all you probably need to know is that many parts of the federal government that shouldn’t exist (Department of Education, Department of Agriculture, Department of Housing and Urban Development, Department of Transportation, etc) get much of their funding from the non-defense discretionary budget.

P.P.S. Trump has failed to address entitlements, which is reckless, but that’s a sin of omission. The increase in non-defense discretionary is a sin of commission.

P.P.P.S. I also thought about listing Trump’s failure to follow through on his proposal to get rid of taxpayer subsidies for the Paris-based Organization for Economic Cooperation and Development.

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Assuming the goal is more prosperity, lawmakers who work on tax issues should be guided by the “Holy Trinity” of good policy.

  1. Low marginal tax rates on productive activity such as work and entrepreneurship.
  2. No tax bias (i.e., extra layers of tax) that penalizes saving and investment.
  3. No complicating preferences and loopholes that encourage inefficient economic choices.

Today, with these three principles as our guide, we’re going to discuss a major problem in how dividends are taxed in the United States.

Simply stated, there’s an unfair and counterproductive double tax. All you really need to know is that if a corporation earns a profit, the corporate income tax takes a chunk of the money. But that money then gets taxed again as dividend income when distributed to shareholders (the people who own the company).

So why is this a bad thing?

From an economic perspective, the extra layer of tax means that the actual tax burden on corporate income is not 21 percent (the corporate tax rate) or 23.8 percent (how dividends are taxed on the 1040 form), but a combination of the two rates. And when you include the average additional tax imposed at the state level, the real tax rate on dividends in the United States can be as high as 47.47 percent according to the OECD.

You don’t need to be a wild-eyed supply-sider to think that incentives to build businesses and create jobs are adversely affected when the government grabs nearly half of the additional income generated by corporate investment.

Keep in mind, by the way, that workers ultimately bear most of this tax since lower levels of investment translate to lower wages.

So what’s the solution?

If we want a properly designed system for taxing businesses, we know the answer. Just get rid of the extra layer of tax.

A 2015 report from the Tax Foundation explains how various types of “corporate integration” can achieve this goal.

The United States’ tax code treats corporations and their shareholders as separate taxable entities. The result is two layers of taxation on corporate income: one at the corporate level and a second at the shareholder level. This creates a high tax burden on corporate income, increasing the cost of capital. The double taxation of corporate income reduces investment and distorts business decisions. … Many developed countries have integrated their tax systems in order to mitigate or completely eliminate the double taxation of corporate income. …There are several ways to integrate the corporate tax code. Corporate income can be fully taxed at the entity level (a corporate income tax) and then tax exempt when passed to shareholders as dividend income, or corporations could be given a deduction for dividends passed to their shareholders, who pay tax on the dividend income. Alternatively, shareholders and corporations both pay tax on their income, but shareholders can be given a credit to offset taxes the corporation already paid on their behalf.

For what it’s worth, I think it would be best to get rid of the double tax by eliminating the layer of tax that is imposed on individuals.

In other words, modify the above image in this way.

Though the economic benefit would be the same if the corporate income tax was abolished and the income was taxed one time at the individual level.

I’ll close today’s column with a bit of good news.

A few years ago, the United States had a much higher burden of double taxation because the corporate tax rate was so high. Indeed, the combined tax rate on dividends was the fourth-highest in the developed world.

Today, thanks to the 2017 tax reform, the combined tax rate is “only” the tenth-highest in the developed world.

P.S. The Estonian tax system for businesses is a good role model.

P.P.S. Under Joe Biden’s tax plan, the U.S. would have the world’s-highest combined tax rate on dividends.

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A few years ago, I put together a basic primer on corporate taxation. Everything I wrote is still relevant, but I didn’t include much discussion about international topics.

In part, that’s because those issues are even more wonky and more boring than domestic issues such as depreciation. But that doesn’t mean they’re not important – especially when they involve tax competition. Here are some comments I made in March of last year.

The reason I’m posting this video about 18 months after the presentation is that the issue is heating up.

The tax-loving bureaucrats at the International Monetary Fund have published a report whining about the fact that businesses utilize low-tax jurisdictions when making decisions on where to move money and invest money.

According to official statistics, Luxembourg, a country of 600,000 people, hosts as much foreign direct investment (FDI) as the United States and much more than China. Luxembourg’s $4 trillion in FDI comes out to $6.6 million a person. FDI of this size hardly reflects brick-and-mortar investments in the minuscule Luxembourg economy. …much of it is phantom in nature—investments that pass through empty corporate shells. These shells, also called special purpose entities, have no real business activities. Rather, they carry out holding activities, conduct intrafirm financing, or manage intangible assets—often to minimize multinationals’ global tax bill. …a few well-known tax havens host the vast majority of the world’s phantom FDI. Luxembourg and the Netherlands host nearly half. And when you add Hong Kong SAR, the British Virgin Islands, Bermuda, Singapore, the Cayman Islands, Switzerland, Ireland, and Mauritius to the list, these 10 economies host more than 85 percent of all phantom investments.

That’s a nice list of jurisdictions. My gut instinct, of course, is to say that high-tax nations should copy the pro-growth policies of places such as Bermuda, Singapore, the Cayman Islands, and Switzerland.

The IMF, however, thinks those are bad places and instead argues that harmonization would be a better approach.

…how does this handful of tax havens attract so much phantom FDI? In some cases, it is a deliberate policy strategy to lure as much foreign investment as possible by offering lucrative benefits—such as very low or zero effective corporate tax rates. …This…erodes the tax bases in other economies. The global average corporate tax rate was cut from 40 percent in 1990 to about 25 percent in 2017, indicating a race to the bottom and pointing to a need for international coordination. …the IMF put forward various alternatives for a revised international tax architecture, ranging from minimum taxes to allocation of taxing rights to destination economies. No matter which road policymakers choose, one fact remains clear: international cooperation is the key to dealing with taxation in today’s globalized economic environment.

Here’s a chart that accompanied the IMF report. The bureaucrats view this as proof of something bad

I view it as prudent and responsible corporate behavior.

At the risk of oversimplifying what’s happening in the world of international business taxation, here are four simple points.

  1. It’s better for prosperity if money stays in the private sector, so corporate tax avoidance should be applauded. Simply stated, politicians are likely to waste any funds they seize from businesses. Money in the private economy, by contrast, boosts growth.
  2. Multinational companies will naturally try to “push the envelope” and shift as much income as possible to low-tax jurisdictions. That’s sensible corporate behavior, reflecting obligation to shareholders, and should be applauded.
  3. Nations can address “profit shifting” by using rules on “transfer pricing,” so there’s no need for harmonized rules. If governments think companies are pushing too far, they can effectively disallow tax-motivated shifts of money.
  4. A terrible outcome would be a form of tax harmonization known as “global formula apportionment.” This wouldn’t be harmonizing rates, as the E.U. has always urged, but it would force companies to overstate income in high-tax nations.

Why does all this wonky stuff matter?

As I said in my presentation, we will suffer from “goldfish government” unless tax competition exiss to serve as a constraint on the tendency of politicians to over-tax and over-spend.

P.S. Sadly, America’s Treasury Secretary is sympathetic to global harmonization of business taxation.

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The crown jewel of the 2017 tax plan was the lower corporate tax rate.

I appeared on CNBC yesterday to debate that reform, squaring off against Jason Furman, who served as Chairman of Obama’s Council of Economic Advisers.

Here are a couple of observations on our discussion.

  • Jason Furman thinks it would be crazy to raise the corporate tax rate back to 35 percent. Yes, he wants to rate to be higher, but rational folks on the left know it would be very misguided to fully undo that part of the tax plan. That signifies a permanent victory.
  • Based on his comments about expensing and interest deductibility, he also seems to have a sensible view on properly and neutrally defining corporate income. These are boring and technical issues, but they have very important economic implications.
  • Critics say the lower corporate rate is responsible for big increases in red ink, but it’s noteworthy that the corporate rate was reduced by 40 percent and revenue is down by only 8.7 percent (a possible Laffer-Curve effect?). Here’s the relevant chart from the latest Monthly Budget Report from the Congressional Budget Office.

  • There’s a multi-factor recipe that determines prosperity, so it’s extremely unlikely that any specific reform will have a giant effect on growth, but even a small, sustained uptick in growth can be hugely beneficial for a nation.
  • There’s a big difference between a pro-market Democrat like Bill Clinton and some of the extreme statists currently seeking the Democratic nomination (just like there’s a big difference between Ronald Reagan and some of today’s big-government Republicans).
  • I close the discussion by explaining why “double taxation” is a profound problem with the current tax code. For all intents and purposes, we are punishing the savers and investors who generate future growth.

P.S. This wasn’t addressed in the interview, but I can’t resist pointing out that overall revenues for the current fiscal year have increased 2.2 percent, which is faster than needed to keep pace with inflation. So why has the deficit increased? Because spending has jumped by 5.8 percent. We have a spending problem in America, not a deficit problem. Fortunately, there’s a very practical solution.

P.P.S. It also wasn’t mentioned, but the other crown jewel of tax reform was the restriction on the state and local tax deduction.

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Welcome Instapundit readers! Thanks, Glenn

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The International Monetary Fund is one of my least favorite international bureaucracies because the political types who run the organization routinely support bad policies such as bailouts and tax increases.

But there are professional economists at the IMF who do good work.

While writing about the mess in Argentina yesterday, for instance, I cited some very sensible research from one of the IMF’s economists.

Today, I’m going to cite two other IMF scholars. Serhan Cevik and Fedor Miryugin have produced some new research looking at the relationship between firm survival and business taxation. Here’s the basic methodology of their study.

While creative destruction—through firm entry and exit—is essential for economic progress, establishing a conducive ecosystem for firm survival is also necessary for sustainable private sector development… While corporate income taxes are expected to lower firms’ capital investment and productivity by raising the user cost of capital, distorting factor prices and reducing after-tax return on investment, taxation also provides resources for public infrastructure investments and the proper functioning of government institutions, which are key to a firm’s success. …the overall impact of taxation on firm performance depends on the relative weight of these two opposing effects, which can vary with the composition and efficiency of taxation and government spending. … In this paper, we focus on how taxation affects the survival prospects of nonfinancial firms, using hazard models and a comprehensive dataset covering over 4 million nonfinancial firms from 21 countries with a total of 21.5 million firm-year observations over the period 1995–2015. …we control for a plethora of firm characteristics, such as age, size, profitability, capital intensity, leverage and total factor productivity (TFP), as well as systematic differences across sectors and countries.

By the way, I agree that there are some core public goods that help an economy flourish. That being said, things like courts and national defense can easily be financed without any income tax.

And even with a very broad definition of public goods (i.e., to include infrastructure, education, etc), it’s possible to finance government with very low tax burdens.

But I’m digressing.

Let’s focus on the study. As you can see, the authors grabbed a lot of data from various European nations.

And they specifically measured the impact of the effective marginal tax rate on firm survival.

Unsurprisingly, higher tax burdens have a negative effect.

We find that the tax burden—measured by the firm-specific EMTR—exerts an adverse effect on companies’ survival prospects. In other words, a lower level of EMTR increases the survival probability among firms in our sample. This finding is not only statistically but also economically important and remains robust when we partition the sample into country subgroups. …digging deeper into the tax sensitivity of firm survival, we uncover a nonlinear relationship between the firm-specific EMTR and the probability of corporate failure, which implies that taxation becomes a detriment to firm survival at higher levels. With regards to the impact of other firm characteristics, we obtain results that are in line with previous research and see that survival probability differs depending on firm age and size, with older and larger firms experiencing a lower risk of failure.

For those that like statistics, here are the specific results.

Here are the real-world implications.

Reforms in tax policy and revenue administration should therefore be designed to cut the costs of compliance, facilitate entrepreneurship and innovation, and encourage alternative sources of financing by particularly addressing the corporate debt bias. In this context, the EMTR holds a special key by influencing firms’ investment decisions and the probability of survival over time, especially in capital intensive sectors of the economy. Importantly, the challenge for policymakers is not simply reducing the statutory CIT rate, but to level the playing field for all firms by rationalizing differentiated tax treatments across sectors, capital asset types and sources of financing.

There are some obvious takeaways from this research.

For what it’s worth, this IMF study basically embraces the sensible principles of business taxation that you find in a flat tax.

Too bad we can’t convince the political types who run the IMF to push the policies supported by IMF economists!

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Like most taxpayer-supported international bureaucracies, the Organization for Economic Cooperation and Development (OECD) has a statist orientation.

The Paris-based OECD is particularly bad on fiscal policy and it is infamous for its efforts to prop up Europe’s welfare states by hindering tax competition.

It even has a relatively new “BEPS” project that is explicitly designed so that politicians can grab more money from corporations.

So it’s safe to say that the OECD is not a hotbed of libertarian thought on tax policy, much less a supporter of pro-growth business taxation.

Which makes it all the more significant that it just announced that supporters of free markets are correct about the Laffer Curve and corporate tax rates.

The OECD doesn’t openly acknowledge that this is the case, of course, but let’s look at key passages from a Tuesday press release.

Taxes paid by companies remain a key source of government revenues, especially in developing countries, despite the worldwide trend of falling corporate tax rates over the past two decades… In 2016, corporate tax revenues accounted for 13.3% of total tax revenues on average across the 88 jurisdictions for which data is available. This figure has increased from 12% in 2000. …OECD analysis shows that a clear trend of falling statutory corporate tax rates – the headline rate faced by companies – over the last two decades. The database shows that the average combined (central and sub-central government) statutory tax rate fell from 28.6% in 2000 to 21.4% in 2018.

So tax rates have dramatically fallen but tax revenue has actually increased. I guess many of the self-styled experts are wrong on the Laffer Curve.

By the way, whoever edits the press releases for the OECD might want to consider changing “despite” to “because of” (writers at the Washington Post, WTNH, Irish-based Independent, and Wall Street Journal need similar lessons in causality).

Let’s take a more detailed look at the data. Here’s a chart from the OECD showing how corporate rates have dropped just since 2000. Pay special attention to the orange line, which shows the rate for developed nations.

I applaud this big drop in tax rates. It’s been good for the world economy and good for workers.

And the chart only tells part of the story. The average corporate rate for OECD nations was 48 percent back in 1980.

In other words, tax rates have fallen by 50 percent in the developed world.

Yet if you look at this chart, which I prepared using the OECD’s own data, it shows that revenues actually have a slight upward trend.

I’ll close with a caveat. The Laffer Curve is very important when looking at corporate taxation, but that doesn’t mean it has an equally powerful impact when looking at other taxes.

It all depends on how sensitive various taxpayers are to changes in tax rates.

Business taxes have a big effect because companies can easily choose where to invest and how much to invest.

The Laffer Curve also is very important when looking at proposals (such as the nutty idea from Alexandria Ocasio-Cortez) to increase tax rates on the rich. That’s because upper-income taxpayers have a lot of control over the timing, level, and composition of business and investment income.

But changes in tax rates on middle-income earners are less likely to have a big effect because most of us get a huge chunk of our compensation from wages and salaries. Similarly, changes in sales taxes and value-added taxes are unlikely to have big effects.

Increasing those taxes is still a bad idea, of course. I’m simply making the point that not all tax increases are equally destructive (and not all tax cuts generate equal amounts of additional growth).

P.S. The International Monetary Fund also accidentally provided evidence about corporate taxes and the Laffer Curve. And there was also a little-noticed OECD study last year making the same point.

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There were several good features of the 2017 tax bill, including limitations on the state and local tax deduction.

But the 21 percent corporate tax rate was the unquestioned crown jewel of the Tax Cut and Jobs Act. The U.S. system had become extremely anti-competitive thanks to a 35 percent rate that was far above the world average, so reform was desperately needed.

That’s the good news.

The bad news is that Democrats in the House of Representatives already are pushing for a big increase in the corporate rate.

Rep. John Yarmuth, the new House Budget chairman, said his chamber’s budget blueprint will aim to claw back lost revenue by boosting the corporate tax rate from its current 21 percent to as high as 28 percent… he anticipates the budget resolution will envision changes to the 2017 GOP tax overhaul, including raising the corporate tax rate above its current 21 percent. “…We’ll see how much revenue we can get out of it.” The rate was 35 percent before it was cut in the GOP tax bill.

Since Republicans control the Senate and Trump is in the White House, there’s probably no short-term risk of a higher corporate tax rate.

But such an initiative could be a major threat after the 2020 election, so let’s augment our collection of evidence showing why a higher rate would be a very bad idea.

We’ll start with some analysis from the number crunchers at the Tax Foundation.

A corporate tax rate that is more in line with our competitors reduces the incentives for firms to realize their profits in lower-tax jurisdictions and encourages companies to invest in the United States. Raising the corporate income tax rate would dismantle the most significant pro-growth provision in the Tax Cuts and Jobs Act, and carry significant economic consequences. …Raising the corporate income tax rate would reduce economic growth, and lead to a smaller capital stock, lower wage growth, and reduced employment. …Raising the rate to 25 percent would reduce GDP by more than $220 billion and result in 175,700 fewer jobs.

Here’s the table showing the negative effect of a 22 percent rate and a 25 percent rate, so a bit of extrapolation will give you an idea of how the economy will suffer with a 28 percent rate.

By the way, since the adverse impact on wages is one of the main reasons to be against a higher corporate tax rate, I’ll also share this helpful flowchart from the article.

Now let’s look at some research from China, which underscores the importance of low rates if we want more innovation.

Here’s the unique set of data that created an opportunity for the research.

In November 2001, China implemented a tax collection reform on all manufacturing firms established on or after January 2002, which switched the collection of corporate income taxes from the local tax bureau to the state tax bureau. After the reform, similar firms established before or after 2002 could pay very different effective tax rates because of the differences in the management and incentives of those two types of tax bureaus…, resulting in a reduction of effective corporate income tax rates by almost 10% among newly established firms. …the policy change created exogenous variations in the effective tax rate among similar firms established before versus after 2002. We can thus apply a regression discontinuity design (RD) and use the generated variation in the effective tax rate to identify the impact of taxes on firm innovation.

And here are the findings.

Our analysis yields several interesting results. First, we show a strong and robust causal relationship between tax rate and firm innovation. Decreasing the effective tax rate by one standard deviation (0.01) increases the average number of patent application by a significant 5.7% (see Figure 2 for the graphical evidence). The reform also stimulated R&D expenditures and increased the skilled-labour ratio by 14%. Second, a lower tax rate also improves the quality of patents. The impact of tax reform on patent applications mainly comes from its effect on invention and utility patents – decreasing the effective tax rate by one standard deviation improves the probability of having an invention patent application by 4.4% and increases the number of utility patent applications by 4.7%.

Don’t forget that high personal tax rates also discourage innovation, so it’s a pick-your-poison menu.

Here’s a chart from the study, showing the difference in patents between higher-taxed firms and lower-taxed firms.

Last but not least, let’s review some of the findings from a study published by the National Bureau of Economic Research.

We present new data on effective corporate income tax rates in 85 countries in 2004. …In a cross-section of countries, our estimates of the effective corporate tax rate have a large adverse impact on aggregate investment, FDI, and entrepreneurial activity. For example, a 10 percent increase in the effective corporate tax rate reduces aggregate investment to GDP ratio by 2 percentage points. Corporate tax rates are also negatively correlated with growth, and positively correlated with the size of the informal economy. The results are robust to the inclusion of controls for other tax rates, quality of tax administration, security of property rights, level of economic development, regulation, inflation, and openness to trade

And here’s one of the many charts and tables in the study.

The bottom line is that a higher corporate tax rate will be bad for workers for the simple reason that less investment means lower productivity and lower productivity means lower wages.

P.S. It’s also likely that House Democrats will try to increase the top personal tax rate, though hopefully they’re not so crazy as to push for Ocasio-Cortez’s 70 percent rate.

P.P.S. it’s quite possible that an increase in the corporate tax rate would reduce revenues, especially in the long run.

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There are three reasons why the right kind of tax reform can help the economy grow faster.

  1. Lower tax rates give people more incentive to earn income.
  2. Less double taxation boosts incentives to save and invest.
  3. Fewer loopholes improves incentives for economic efficiency.

Let’s focus on the third item. I don’t like special preferences in the tax code because it’s bad for growth when the tax code lures people into misallocating their labor and capital. Ethanol, for instance, shows how irrational decisions are subsidized by the IRS.

Moreover, I’d rather have smart and capable people in the private sector focusing how to create wealth instead of spending their time figuring out how to manipulate the internal revenue code.

That’s why, in my semi-dream world, I’d like to see a flat tax.* Not only would there be a low rate and no double taxation, but there also would be no distortions.

But in the real world, I’m happy to make partial progress.

That’s why I was happy that last year’s tax bill produced a $10,000 cap for the state and local tax deduction and reduced the value of other write-offs by increasing the standard deduction. Yes, I’d like to wipe out the deductions for home mortgage interest, charitable giving, and state and local taxes, but a limit is better than nothing.

And I’m also happy that lower tax rates are an indirect way of reducing the value of loopholes and other preferences.

To understand the indirect benefits of low tax rates, consider this new report from the Washington Post. Unsurprisingly, we’re discovering that a less onerous death tax means less demand for clever tax lawyers.

A single aging rich person would often hire more than a dozen people — accountants, estate administrators, insurance agents, bank attorneys, financial planners, stockbrokers — to make sure they paid as little as possible in taxes when they died. But David W. Klasing, an estate tax attorney in Orange County, Calif., said he’s seen a sharp drop in these kinds of cases. The steady erosion of the federal estate tax, shrunk again by the Republican tax law last fall, has dramatically reduced the number of Americans who have to worry about the estate tax — as well as work for those who get paid to worry about it for them, Klasing said. In 2002, about 100,000 Americans filed estate tax returns to the Internal Revenue Service, according to the IRS. In 2018, only 5,000 taxpayers are expected to file these returns… “You had almost every single tax professional trying to grab as much of that pot as they could,” Klasing said. “Now almost everybody has had to find other work.”

Needless to say, I’m delighted that these people are having to “find other work.”

By the way, I’m not against these people. They were working to protect families from an odious form of double taxation, which was a noble endeavor.

I’m simply stating that I’m glad there’s less need for their services.

Charles “Skip” Fox, president of the American College of Trust and Estate Counsel, said he frequently hears of lawyers shifting their focus away from navigating the estate tax, and adds that there has been a downturn in the number of young attorneys going into the estate tax field. Jennifer Bird-Pollan, who teaches the estate tax to law students at the University of Kentucky, said that nearly a decade ago her classes were packed with dozens of students. Now, only a handful of students every so often may be interested in the subject or pursuing it as a career. “There’s about as much interest in [the class] law and literature,” Pollan said. “The very, very wealthy are still hiring estate tax lawyers, but basically people are no longer paying $1,000 an hour for advice about this stuff. They don’t need it.”

Though I am glad one lawyer is losing business.

Stacey Schlitz, a tax attorney in Nashville, said when she got out of law school about a decade ago roughly 80 percent of her clients were seeking help with their estate taxes. Now, less than 1 percent are, she said, adding that Tennessee’s state inheritance tax was eliminated by 2016. “It is disappointing that this area of my business dried up so that such a small segment of society could get even richer,” Schlitz said in an email.

I hope every rich person in Nashville sees this story and steers clear of Ms. Schlitz, who apparently wants her clients to be victimized by government.

Now let’s shift to the business side of the tax code and consider another example showing why lower tax rates produce more sensible behavior.

Now that the corporate tax rate has been reduced, American companies no longer have as much desire to invest in Ireland.

US investment in Ireland declined by €45bn ($51bn) in 2017, in another sign that sweeping tax reforms introduced by US president Donald Trump have impacted the decisions of American multinational companies. …Economists have been warning that…Trump’s overhaul of the US tax code, which aimed to reduce the use of foreign low-tax jurisdictions by US companies, would dent inward investment in Ireland. …In November 2017, Trump went so far as to single out Ireland, saying it was one of several countries that corporations used to offshore profits. “For too long our tax code has incentivised companies to leave our country in search of lower tax rates. It happens—many, many companies. They’re going to Ireland. They’re going all over,” he said.

Incidentally, I’m a qualified fan of Ireland’s low corporate rate. Indeed, I hope Irish lawmakers lower the rate in response to the change in American law.

And I’d like to see the US rate fall even further since it’s still too high compared to other nations.

Heck, it would be wonderful to see tax competition produce a virtuous cycle of rate reductions all over the world.

But that’s a topic I’ve addressed before.

Today’s lesson is simply that lower tax rates reduce incentives to engage in tax planning. I’ll close with simple thought experiment showing the difference between a punitive tax system and reasonable tax system.

  • 60 percent tax rate – If you do nothing, you only get to keep 40 cents of every additional dollar you earn. But if you find some sort of deduction, exemption, or exclusion, you increase your take-home pay by an additional 60 cents. That’s a good deal even if the tax preference loses 30 cents of economic value.
  • 20 percent tax rate – If you do nothing, you get to keep 80 cents of every dollar you earn. With that reasonable rate, you may not even care about seeking out deductions, exemptions, and exclusions. And if you do look for a tax preference, you certainly won’t pick one where you lose anything close to 20 cents of economic value.

The bottom line is that lower tax rates are a “two-fer.” They directly help economic growth by increasing incentives to earn income and they indirectly help economic growth by reducing incentives to engage in inefficient tax planning.

*My semi-dream world is a flat tax. My dream world is when the federal government is so small (as America’s Founders envisioned) that there’s no need for any broad-based tax.

P.S. It’s not the focus of today’s column, but since I talked about loopholes, it’s worth pointing out that they should be properly defined. Sadly, that simple task is too challenging for the Joint Committee on Taxation, the Government Accountability Office, and the Congressional Budget Office (or even the Republican party).

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As illustrated by this video tutorial, I’m a big advocate of the Laffer Curve.

I very much want to help policy makers understand (especially at the Joint Committee on Taxation) that there’s not a linear relationship between tax rates and tax revenue. In other words, you don’t double tax revenue by doubling tax rates.

Having worked on this issue for decades, I can state with great confidence that there are two groups that make my job difficult.

  • The folks who don’t like pro-growth tax policy and thus claim that changes in tax policy have no impact on the economy.
  • The folks who do like pro-growth tax policy and thus claim that every tax cut will “pay for itself” because of faster growth.

Which was my message in this clip from a recent interview.

For all intents and purposes, I’m Goldilocks in the debate over the Laffer Curve. Except instead of stating that the porridge is too hot or too cold, my message is that it is that changes in tax policy generally lead to more taxable income, but the growth in income is usually not enough to offset the impact of lower tax rates.

In other words, some revenue feedback but not 100 percent revenue feedback.

Yes, some tax cuts do pay for themselves. But they tend to be tax cuts on people (such as investors and entrepreneurs) who have a lot of control over the timing, level, and composition of their income.

And, as I said in the interview, I think the lower corporate tax rate will have substantial supply-side effects (see here and here for evidence). This is because a business can make big changes in response to a new tax law, whereas people like you and me don’t have the same flexibility.

But I don’t want this column to be nothing but theory, so here’s a news report from Estonia on the Laffer Curve in action.

After Estonia raised its alcohol excise tax rates considerably in 2017, Estonian daily Postimees has estimated that the target of the money the alcohol excise tax would bring into state coffers could have been missed by at least EUR 40 million. …Initially, in the state budget of 2017, the ministry had been planned that proceeds from the alcohol excise tax would bring EUR 276.4 million, but last summer, it cut the forecast to EUR 237.5 million.

I guess I’ll make this story Part VII in my collection of examples designed to educate my friends on the left (here’s Part I, Part II, Part III, Part IV, Part V, and Part VI).

But there’s a much more important point I want to make.

The fact that most tax increases produce more revenue is definitely not an argument in favor of higher tax rates.

That argument is wrong in part because government already is far too large. But it’s also wrong because we should consider the health and vitality of the private sector. Here’s some of what I wrote about some academic research in 2012.

…this study implies that the government would reduce private-sector taxable income by about $20 for every $1 of new tax revenue. Does that seem like good public policy? Ask yourself what sort of politicians are willing to destroy so much private sector output to get their greedy paws on a bit more revenue. What about capital taxation? According to the second chart, the government could increase the tax rate from about 40 percent to 70 percent before getting to the revenue-maximizing point. But that 75 percent increase in the tax rate wouldn’t generate much tax revenue, not even a 10 percent increase. So the question then becomes whether it’s good public policy to destroy a large amount of private output in exchange for a small increase in tax revenue. Once again, the loss of taxable income to the private sector would dwarf the new revenue for the political class.

The bottom line is that I don’t think it’s a good trade to reduce the private sector by any amount simply to generate more money for politicians.

P.S. I’m also Goldilocks when considering the Rahn Curve.

P.P.S. For what it’s worth, Paul Krugman (sort of) agrees with me about the Laffer Curve.

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Last month, I revealed that even Paul Krugman agreed with the core principle of the Laffer Curve.

Today, we have another unlikely ally. Regular readers know that I’m not a big fan of the Organization for Economic Cooperation and Development. The Paris-based international bureaucracy routinely urges higher tax burdens, both in the United States and elsewhere in the world.

But the professional economists who work for the OECD are much better than the political appointees who push a statist agenda.

So when I saw that three of them (Oguzhan Akgun, David Bartolini, and Boris Cournède) produced a study estimating the relationship between tax rates and tax revenues, I was very curious to see the results.

They start by openly acknowledging that high tax rates can backfire.

This paper investigates the capacity of governments to raise revenue by assessing the ways in which tax receipts respond to rates… Revenue returns from tax increases can be expected to decrease with the level of tax rates, because higher rates exacerbate disincentives to produce and raise incentives to avoid taxation. These two main channels can therefore imply that tax receipts rise less than proportionately with rates and may peak at a given point.

Given the OECD’s love affair with higher tax burdens, this is a remarkable admission about an important limit on the ability of governments to grab revenue.

Their estimate of the actual revenue-maximizing burden is almost secondary. But nonetheless still noteworthy.

According to the estimated coefficients in model 5 of Table 3, an EMTR of 25% maximises CIT revenue.

Not that different from the estimates produced at the Tax Foundation and American Enterprise Institute.

Here’s a chart showing the revenue-maximizing level of tax, which varies depending on the degree to which a country has close economic ties with the rest of the world.

Interestingly, the study openly admits that tax competition plays a big role.

Trade openness is found to reduce CIT revenue. The latter is consistent with…international tax competition, which is likely to increase the effects of tax rates on the location of firms or more broadly of their profit-generating activities.

Sadly, the political types at the OECD have a “BEPS” scheme that is designed to curtail tax competition.

Which is a very good argument for why tax competition should be allowed to flourish.

But let’s not digress. Here’s another remarkable admission in the study. The OECD economists point out that it is not a good idea for governments to try to maximize revenue.

Estimates of revenue-maximising rates should not be seen as policy objectives or recommendations, as they imply high levels of economic distortions or tax avoidance.

Amen. I cited a study in 2012 showing that a revenue-maximizing tax rate might destroy as much as $20 of private sector output for every $1 collected by government. Only Bernie Sanders would think that’s a good deal.

Last but not least, the study even points out a class-warfare approach is misguided when looking at personal income taxes.

More progressive broadly defined personal income taxes generally yield more revenue, but very strong progressivity is associated with lower revenue.

Another wise observation.

The bottom line is that high tax rates of any kind are not a good idea.

P.S. The International Monetary Fund inadvertently provided very strong evidence about the Laffer Curve and corporate taxes.

P.P.S. An occasional good study doesn’t change my belief that the OECD no longer should be subsidized by American taxpayers.

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When I write about the economics of fiscal policy and need to give people an easy-to-understand explanation on how government spending affects growth, I share my four-part video series.

But. other than a much-too-short primer on growth and taxation from 2016, I don’t have something similar for tax policy. So I have to direct people to various columns about marginal tax rates, double taxation, tax favoritism, tax reform, corporate taxation, and tax competition.

Today’s column isn’t going to be a comprehensive analysis of taxes and growth, but it is going to augment the 2016 primer by taking a close look at how some taxes are more destructive than others.

And what makes today’s column noteworthy is that I’ll be citing the work of left-leaning international bureaucracies.

Let’s look at a study from the OECD.

…taxes…affect the decisions of households to save, supply labour and invest in human capital, the decisions of firms to produce, create jobs, invest and innovate, as well as the choice of savings channels and assets by investors. What matters for these decisions is not only the level of taxes but also the way in which different tax instruments are designed and combined to generate revenues…investigating how tax structures could best be designed to promote economic growth is a key issue for tax policy making. … this study looks at consequences of taxes for both GDP per capita levels and their transitional growth rates.

For all intents and purposes, the economists at the OECD wanted to learn more about how taxes distort the quantity and quality of labor and capital, as illustrated by this flowchart from the report.

Here are the main findings (some of which I cited, in an incidental fashion, back in 2014).

The reviewed evidence and the empirical work suggests a “tax and growth ranking” with recurrent taxes on immovable property being the least distortive tax instrument in terms of reducing long-run GDP per capita, followed by consumption taxes (and other property taxes), personal income taxes and corporate income taxes. …relying less on corporate income relative to personal income taxes could increase efficiency. …Focusing on personal income taxation, there is also evidence that flattening the tax schedule could be beneficial for GDP per capita, notably by favouring entrepreneurship. …Estimates in this study point to adverse effects of highly progressive income tax schedules on GDP per capita through both lower labour utilisation and lower productivity… a reduction in the top marginal tax rate is found to raise productivity in industries with potentially high rates of enterprise creation. …Corporate income taxes appear to have a particularly negative impact on GDP per capita.”

Here’s how the study presented the findings. I might quibble with some of the conclusions, but it’s worth noting all the minuses in the columns for marginal tax, progressivity, top rates, dividends, capital gains, and corporate tax.

This is all based on data from relatively prosperous countries.

A new study from the International Monetary Fund, which looks at low-income nations rather than high-income nations, reaches the same conclusion.

The average tax to GDP ratio in low-income countries is 15% compared to that of 30% in advanced economies. Meanwhile, these countries are also those that are in most need of fiscal space for sustainable and inclusive growth. In the past two decades, low-income countries have made substantial efforts in strengthening revenue mobilization. …what is the most desirable tax instrument for fiscal consolidation that balances the efficiency and equity concerns. In this paper, we study quantitatively the macroeconomic and distributional impacts of different tax instruments for low-income countries.

It’s galling that the IMF report implies that there’s a “need for fiscal space” and refers to higher tax burdens as “strengthening revenue mobilization.”

But I assume some of that rhetoric was added at the direction of the political types.

The economists who crunched the numbers produced results that confirm some of the essential principles of supply-side economics.

…we conduct steady state comparison across revenue mobilization schemes where an additional tax revenues equal to 2% GDP in the benchmark economy are raised by VAT, PIT, and CIT respectively. Our quantitative results show that across the three taxes, VAT leads to the least output and consumption losses of respectively 1.8% and 4% due to its non-distorting feature… Overall, we find that among the three taxes, VAT incurs the lowest efficiency costs in terms of aggregate output and consumption, but it could be very regressive… CIT, on the other hand, though causes larger efficiency costs, but has considerable better inequality implications. PIT, however, deteriorates both the economic efficiency and equity, thus is the most detrimental instrument.

Here’s the most important chart from the study. It shows that all taxes undermine prosperity, but that personal income taxes (grey bar) and corporate income tax (white bar) do the most damage.

I’ll close with two observations.

First, these two studies are further confirmation of my observation that many – perhaps most – economists at international bureaucracies generate sensible analysis. They must be very frustrated that their advice is so frequently ignored by the political appointees who push for statist policies.

Second, some well-meaning people look at this type of research and conclude that it would be okay if politicians in America imposed a value-added tax. They overlook that a VAT is bad for growth and are naive if they think a VAT somehow will lead to lower income tax burdens.

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Two months ago, I shared some data on private gun ownership in the United States and declared that those numbers generated “The Most Enjoyable Graph of 2018.”

Now I have something even better because it confirms my hypothesis about tax competition being the most effective way of constraining greedy politicians.

To set the stage, check out these excerpts from a heartwarming story in the Wall Street Journal.

Last year’s corporate tax cut is reducing U.S. tax collections, as expected. But that change is likely to ripple far beyond the country’s borders in the years ahead, shrinking other countries’ tax revenue… The U.S. tax law will reduce what other countries collect from multinational corporations by 1.6% to 13.5%… Companies will be more likely to put profits and real investment in the U.S. than they were before the U.S. lowered its corporate tax rate from 35% to 21%, according to the paper. That will leave fewer corporate profits for other countries to tax. And as that happens, other countries are likely to chase the U.S. by lowering their corporate tax rates, too, creating the potential for what critics have called a race to the bottom. …Mexico, Japan and the U.K. rank near the top of the paper’s list of countries likely to lose revenue… Corporate tax rates steadily declined over the past few decades as countries competed to attract investment.

Amen. This was one of my main arguments last year for the Trump tax plan. Lower tax rates in America will lead to lower taxes elsewhere.

For instance, look at what’s now happening in Germany.

Ever since Donald Trump last year unveiled deep tax cuts for companies in America, German industry has been wracked with fears over the economic fallout. …“In the long term, Germany cannot afford to have a higher tax burden than other countries,” warned Monika Wünnemann, a tax specialist at German business federation BDI. …the BDI urges Berlin to cut the overall tax burden, including corporate and trade levies, to a maximum 25 percent, compared to 26 percent in the US. …tax competition has clearly heated up within the European Union: France plans to reduce its top corporate rate to 25 percent by 2022 from 34 percent. The UK wants to cut its rate to 17 percent by 2021 from 20 percent today. If it fails to take action, Germany will be stuck with the heaviest corporate tax burden among industrialized countries.

Now let’s peruse a recent study from the International Monetary Fund.

Tax competition and declining corporate income tax (CIT) rates are not new phenomena. However, over the past 30 years, the United States has been an outlier in not reducing tax rates Combined with the worldwide system of taxation, this is widely regarded as having served as an anchor to world CIT rates. Now the United States has cut its rate by 14 percentage points to 26 percent (21 percent excluding state taxes), which is close to the OECD member average of 24 percent (Figure 1). Combined with the (partial) shift toward territoriality, this may intensify tax competition. …Given the combination of highly mobile capital and source-based corporate income taxation, pressures on tax systems are not surprising. …The most clear-cut, and possibly largest, spillovers are still likely to be caused by the cut in the tax rate. …Depending on parameter assumptions, we find that reform will lead to average revenue losses of between 1.5 and 13.5 percent of the MNE tax base. …The paper has also discussed the likely policy reactions of other countries. …tax rates elsewhere also fall (by on average around 4 percentage points based on tentative estimates).

And here’s the chart from the IMF report that sends a thrill up my leg.

As you can see, corporate tax rates have plunged by half since 1980.

And the reason this fills me with joy is two-fold. First, we get more growth, more jobs, and higher wages when corporate rates fall.

Second, I’m delighted because I know politicians hate to lower tax rates. Indeed, they’ve tasked the OECD with trying to block corporate tax competition (fortunately the bureaucrats haven’t been very successful).

And I could add a third reason. The IMF confesses that we have even more evidence of the Laffer Curve.

So far, despite falling tax rates, CIT revenues have held up relatively well.

Game, set, match.

I’m very irked by what Trump is doing on trade, government spending, and cronyism, but I give credit where credit is due. I suspect none of the other Republicans who ran in 2016 would have brought the federal corporate tax rate all the way down to 21 percent. And I’m immensely enjoying how politicians in other nations feel pressure to do likewise.

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I generally don’t chortle with joy when I read the Washington Post. This is the newspaper, after all, that often slants the news in ways that irk me.

Though maybe, in one or two instances, I should accuse the paper of sloppiness rather than dishonesty. Regardless, I still shake my head with disdain.

But not today. A recent story about corporate taxation brought a big smile to my face. Here are some passages that warmed my heart.

Taxes on corporations are plummeting across the globe… The average corporate tax rate globally has fallen by more than half over the past three decades, from 49 percent in 1985 to 24 percent in 2018, the study found. …The international decline in corporate taxes threatens to drain governments of a source of funding for health care and other social welfare programs.

And here are some examples.

Republicans in Congress slashed the U.S. federal corporate tax rate from 35 percent to 21 percent. …the United States was joining a crowded party. In Japan and China, corporate tax rates have fallen by about a quarter since 2003. Rates are down about 30 percent over the same period across all of Europe, by 36 percent in Israel and by 27 percent in Canada. …Hungary…has lowered its corporate tax rate from 18 percent to 9 percent.

But I’m not happy simply because corporate tax rates are being reduced.

And I’m not smiling just because tax competition is pressuring politicians to do the right thing (though that does send a tingle up my leg).

I’m also overcome with schadenfreude because advocates of bad policy are chagrined by these developments.

“Corporate taxes are going to die in 10 to 20 years at this rate,” Ludvig Wier, an economist at the University of Copenhagen and a co-author of the study, said in an interview. “Without drastic collective action, you can see we’re nearing the end of it.” …academics say the falling tax rates…reflect a race to the bottom… The falling corporate tax rate represents a “collective action problem,” Wier argued, as each country has a strong incentive to lower its own tax rate, although when that is done the globe suffers.

I guess we know Mr. Wier’s perspective. There’s a “collective action problem” and “the globe suffers” because corporate tax rates are falling.

Perhaps he hasn’t read the substantial academic literature showing that lower rates are good for growth?

Fortunately, some academics are focused on measuring the real-world impact of policy changes. Professor Juan Carlos Suárez Serrato of Duke University crunched some numbers for the National Bureau of Economic Research and found that jobs and investment both decline when companies can’t protect their income from government.

…eliminating firms’ access to tax havens has unintended consequences for economic growth. We analyze a policy change that limited profit shifting for US multinationals, and show that the reform raised the effective cost of investing in the US. Exposed firms respond by reducing global investment and shifting investment abroad – which lowered their domestic investment by 38% – and by reducing domestic employment by 1.0 million jobs. We then show that the costs of eliminating tax havens are persistent and geographically concentrated, as more exposed local labor markets experience declines in employment and income growth for over 15 years.

The moral of the story is that workers and investors benefit when money stays in the private sector.

This means pushing corporate tax rates as low as possible, while also allowing companies to utilize low-tax jurisdictions for their cross-border transactions.

That’s a win-win for the economy, and the angst on the left is a fringe benefit.

I’ll close with this chart I put together showing how the average corporate rate has decline in developed nations.

P.S. Individual rates also have declined since 1980, thanks if large part by the virtuous cycle of tax competition unleashed by Reagan and Thatcher. Sadly, the left has been somewhat successful in curtailing tax havens, and this has given politicians leeway to push tax rates higher in recent years.

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Since it’s the last day of the year, let’s look back on 2017 and highlight the biggest victories and losses for liberty.

For last year’s column, we had an impressive list of overseas victories in 2016, including the United Kingdom’s Brexit from the European Union, the vote against basic income in Switzerland, the adoption of constitutional spending caps in Brazil, and even the abolition of the income tax in Antigua and Barbuda.

The only good policies I could find in the United States, by contrast, were food stamp reforms in Maine, Wisconsin, and Kansas.

This year has a depressingly small list of victories. Indeed, the only good thing I had on my initial list was the tax bill. So to make 2017 appear better, I’m turning that victory into three victories.

  • A lower corporate tax rate – Dropping the federal corporate tax rate from 35 percent to 21 percent will boost investment, wages, and competitiveness, while also pressuring other nations to drop their corporate rates in a virtuous cycle of tax competition. An unambiguous victory.
  • Limits on the deductibility of state and local taxes – It would have been preferable to totally abolish the deduction for state and local taxes, but a $10,000 cap will substantially curtail the federal tax subsidy for higher taxes by state and local government. The provision is only temporary, so it’s not an unambiguous win, but the whining and complaining from class-warfare politicians in New York and California is music to my ears.
  • No border-adjustment tax – Early in 2017, I was worried that tax reform was going to be tax deform. House Republicans may have had good intentions, but their proposed border-adjustment tax would have set the stage for a value-added tax. I like to think I played at least a small role in killing this bad idea.
  • Regulatory Rollback – The other bit of (modest) good news is that the Trump Administration has taken some steps to curtail and limit red tape. A journey of a thousand miles begins with a first step.

Now let’s look elsewhere in the world for a victory. Once again, there’s not much.

  • Macron’s election in France – As I scoured my archives for some good foreign news, the only thing I could find was that a socialist beat a socialist in the French presidential election. But since I have some vague hope that Emanuel Macron will cut red tape and reduce the fiscal burden in France, I’m going to list this as good news. Yes, I’m grading on a curve.

Now let’s look at the bad news.

Last year, my list included growing GOP support for a VAT, eroding support for open trade, and the leftward shift of the Democratic Party.

Here are five examples of policy defeats in 2017.

  • Illinois tax increase – If there was a contest for bad state fiscal policy, Illinois would be a strong contender. That was true even before 2017. And now that the state legislature rammed through a big tax increase, Illinois is trying even harder to be the nation’s most uncompetitive state.
  • Kansas tax clawback – The big-government wing of the Kansas Republican Party joined forces with Democrats to undo a significant portion of the Brownback tax cuts. Since this was really a fight over whether there would be spending restraint or business-as-usual in Kansas, this was a double defeat.
  • Botched Obamacare repeal – After winning numerous elections by promising to repeal Obamacare, Republicans finally got total control of Washington and then proceeded to produce a bill that repealed only portions. And even that effort flopped. This was a very sad confirmation of my Second Theorem of Government.
  • Failure to control spending – I pointed out early in the year that it would be easy to cut taxes, control spending, and balance the budget. And I did the same thing late in the year. Unfortunately, there is no desire in Washington to restrain the growth of Leviathan. Sooner or later, this is going to generate very bad economic and political developments.
  • Venezuela’s tyrannical regime is still standing – Since I had hoped the awful socialist government would collapse, the fact that nothing has changed in Venezuela counts as bad news. Actually, some things have changed. The economy is getting worse and worse.
  • The Export-Import Bank is still alive – With total GOP control of Washington, one would hope this egregious dispenser of corporate welfare would be gone. Sadly, the swamp is winning this battle.

Tomorrow, I’ll do a new version of my annual hopes-and-fears column.

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In early November, I reviewed the House’s tax plan and the Senate’s tax plan.

I was grading on a curve. I wasn’t expecting or hoping for something really bold like a flat tax.

Instead, I simply put forward a wish list of  a few incremental reforms that would make an awful tax system somewhat less punitive.

A few things to make April 15 more bearable.

Some changes that would give the economy a chance to grow faster and create more jobs so that living standards could improve. Is that asking too much?

It wasn’t even a long list. Just two primary goals.

And two secondary goals.

Based on those items, I think House and Senate GOPers did a reasonably good job (at least compared to my low expectations earlier in the year).

Now let’s look at the agreement in principle (AiP) that was just announced by House and Senate negotiators and assign grades to the key provisions. And we’ll start by looking at the items on my wish list.

Is there a big reduction in the corporate tax rate?

Yes. The deal would slash the current 35 percent rate to 21 percent. That’s not as good as 20 percent, but it’s nonetheless a huge improvement that will result in more investment, higher wages, and enhanced competitiveness. And since other nations will face pressure to further reduce their rates, there will be global economic benefits. Final grade: A-

Is the deduction for state and local taxes abolished?

Not completely. The agreement does impose a $10,000 cap on the amount of that can be deducted. Combined with a doubling of the standard deduction, this will significantly reduce the number of people who “itemize.” As such, there will be more resistance to bad tax policy by state and local governments. Final grade: B+

Is the death tax repealed?

Not fully. The deal doubles the exempt amount to more than $10 million, which will protect many more families from this pernicious form of double taxation (and the ones who will still be impacted are the ones with greater ability to protect themselves, albeit at the cost of allocating their capital less efficiently).  Final grade: B

Are special tax preferences for green energy wiped out?

No. This is a very disappointing feature of the agreement. I’m tempted to assign a failing grade, but that low mark should be reserved for provisions that actually are worse than current law. All that’s happening in the deal is that bad policy is being left in place. Final grade: C

A grade for everything else?

There are other provisions in the final deal that are worthy of attention. In most cases, lawmakers did move in the right direction when looking at the key principles of good tax reform (reducing tax rates, reducing double taxation, and reducing distortionary preferences). Final grade B

Here’s a partial list of the other provisions.

  • There is a modest reduction in personal tax rates, including a reduction in the top rate on households from 39.6 percent to 37 percent. It’s always good to lower marginal tax rates, especially for high earners.
  • The tax rate on pass-through businesses (i.e., smaller businesses that file personal tax returns rather than corporate returns) is indirectly reduced. This is good news, though it may lead to more complexity.
  • Full expensing of business investment for next five years. This would be a very good reform if it was permanent, though even temporary expensing is positive
  • The tax preference for housing is curtailed by allowing the write-off of interest only on mortgages up to $750,000. This is an improvement over current law, especially when combined with the higher standard deduction.
  • The corporate alternative minimum tax is abolished. This is good news.
  • The Obamacare individual mandate is repealed. This is good news, though it doesn’t solve the underlying problems with that law.
  • The individual alternative minimum tax is curtailed. Repeal would have been better, but this is an improvement over current law.

I’ll close with a caveat. An AiP is not the same as final legislative language. It’s not the same as votes for final passage in the House. Or the Senate. And it’s not the same as a presidential signature on a bill.

Aficianados of “public choice” are painfully aware that politicians and interest groups are depressingly clever about preserving their goodies. So while it seems like tax reform is going to happen, it’s not a done deal. When dealing with Washington, it’s wise to assume the worst.

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When Ronald Reagan slashed tax rates in America in the 1980s, the obvious direct effect was more prosperity in America.

But the under-appreciated indirect effect of Reaganomics was that it helped generate more prosperity elsewhere in the world.

Not because Americans had higher income and could buy more products from home and abroad (though that is a nice fringe benefit), but rather because the Reagan tax cuts triggered a virtuous cycle of tax competition. Politicians in other countries had to lower their tax rates because of concerns that jobs and investment were migrating to America (Margaret Thatcher also deserves some credit since she also dramatically reduced tax rates and put even more competitive pressure on other nations to do the same thing).

If you look at the data for developed nations, the average top income tax rate in 1980 was more than 67 percent. It’s now closer to 40 percent.

And because even countries like Germany and France enacted supply-side reforms, the global economy enjoyed a 25-year renaissance of growth and prosperity.

Unfortunately, there’s been some slippage in the wrong direction in recent years, probably caused in part be the erosion of tax competition (politicians are more likely to grab additional money if they think targeted victims don’t have escape options).

But we may be poised for a new virtuous cycle of tax competition, at least with regards to business taxation. A big drop in the U.S. corporate tax rate will pressure other nations to lower their taxes as well. And if new developments from China and Europe are accurate, I’ve been underestimating the potential positive impact.

Let’s start with news from China, where some officials are acting as if dropping the U.S. corporate tax rate to 20 percent is akin to economic warfare.

U.S. tax cuts—the biggest passed since those during the presidency of Ronald Reagan three decades ago—have Beijing in a bind. Prominent in the new tax policy are generous reductions in the corporate tax and a rationalization of the global tax scheme. Both are expected to draw capital and skilled labor back to the United States. …In April, Chinese state-controlled media slammed the tax cuts, accusing the U.S. leadership of risking a “tax war”… On April 27, state-run newspaper People’s Daily quoted a Chinese financial official as saying, “We’ve made our stance clear: We oppose tax competition.” …Beijing has good reason to be afraid. …“Due to the tax cut, the capital—mostly from the manufacturing industry—will flow back to the U.S.,” Chen said.

While Chinese officials are worried about tax competition, they have a very effective response. They can cut tax rates as well.

…the Communist Party had promised to implement financial policy that would be more beneficial for the general public, but has not put this into practice. Instead, Beijing has kept and expanded a regime whereby heavy taxes do not benefit the people…, but are used to prop up inefficient state-owned enterprises… Chinese officials and scholars are considering the necessity of implementing their own tax reforms to keep up with the Trump administration. …Zhu Guangyao, a deputy minister of finance, said in a meeting that it was “indeed impossible” to “ignore the international effects” of the American tax cut, and that “proactive measures” needed to be taken to adjust accordingly. …a Chinese state-run overseas publication called “Xiakedao” came out with a report saying that while Trump’s tax cuts put pressure on China, the pressure “can all the same be transformed into an opportunity for reform.” It remains to be seen whether communist authorities are willing to accept a hit to their tax revenue to balance the economy and let capital flow into the hands of the private sector.

The Wall Street Journal also has a story on how China’s government might react to U.S. tax reform.

…economic mandarins in Beijing are focusing on a potentially… immediate threat from Washington— Donald Trump’s tax overhaul. In the Beijing leadership compound of Zhongnanhai, officials are putting in place a contingency plan to combat consequences for China of U.S. tax changes… What they fear is…sapping money out of China by making the U.S. a more attractive place to invest.

Pardon me for digressing, but isn’t it remarkable that nominally communist officials in China clearly understand that lower tax rates will boost investment while some left-leaning fiscal “experts” in America still want us to believe that lower tax won’t help growth.

But let’s get back to the main point.

An official involved in Beijing’s deliberations called Washington’s tax plan a “gray rhino,” an obvious danger in China’s economy that shouldn’t be ignored. …While the tax overhaul isn’t directly aimed at Beijing, …China will be squeezed. Under the tax plan now going through the U.S. legislative process, America’s corporate levy could drop to about 20% from 35%. Over the next few years, economists say, that could spur manufacturers—whether American or Chinese—to opt to set up plants in the U.S. rather than China.

It’s an open question, though, whether China will respond with bad policy or good policy.

Imposing capital controls to limit the flow of money to the United States would be an unfortunate reaction. Using American reform as an impetus for Chinese reform, by contrast, would be serendipitous.

The sweeping overhaul of the U.S. tax code, estimated to result in $1.4 trillion in U.S. cuts over a decade, is also serving as a wake-up call for Beijing, which for years has dragged its feet on revamping China’s own rigid tax system. Chinese businesses have long complained about high taxes, and the government has pledged to reduce the levies on them. …Chinese companies face a welter of other taxes and fees their U.S. counterparts don’t, including a 17% value-added tax. …Chinese employers pay far-higher payroll taxes. Welfare and social insurance taxes cost between 40% and 100% of a paycheck in China. World Bank figures for 2016 show that total tax burden on Chinese businesses are among the highest of major economies: 68% of profits, compared with 44% in the U.S. and 40.6% on average world-wide. The figures include national and local income taxes, value-added or sales taxes and any mandatory employer contributions for welfare and social security.

I very much hope Chinese officials respond to American tax cuts with their own supply-side reforms. I’ve applauded the Chinese government in the past for partial economic liberalization. Those policies have dramatically reduced poverty and been very beneficial for the country.

Lower tax rates could be the next step to boost living standards in China.

By the way, the Chinese aren’t the only ones paying attention to fiscal developments in the United States. The GOP tax plan also is causing headaches in Europe, as reported by CNN.

Germany, France, Britain, Spain and Italy have written to Treasury Sec. Steven Mnuchin… The letter argues that proposed changes to the U.S. tax code could give American companies an advantage over foreign rivals. …They said the provision could also tax the profits of foreign businesses that do not have a permanent base in the U.S. …The finance ministers said they opposed another measure in the Senate bill that could benefit American companies.

I have two responses. First, I actually agree with some of the complaints in the letter about selected provisions in the tax bill (see, for instance, Veronique de Rugy’s analysis in National Review about the danger of the BAT-like excise tax). We should be welcoming investment from foreign companies, not treating them like potential cash cows for Uncle Sam.

That being said, European officials are throwing stones in a glass house. They are the ones pushing the OECD’s initiative on “base erosion and profit shifting,” which is basically a scheme to extract more money from American multinational firms. And let’s also remember that the European Commission is also going after American companies using the novel argument that low taxes are a form of “state aid.”

Second, I think the Europeans are mostly worried about the lower corporate rate. German officials, for instance, have already been cited for their fear of a “ruinous era of tax competition.” And politicians at the European Parliament have been whining about a “race to the bottom.”

So I’ll give them the same advice I offered to China. Respond to Americans tax cuts by doing the right thing for your citizens. Boost growth and wages with lower tax rates.

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As part of yesterday’s column about the comparatively tiny – and temporary – tax cut in the Republican tax reform plan, I quoted a leftist columnist for US News & World Report, who argued that there should be a big tax increase (including a big tax hike on middle-income taxpayers) and that such a tax hike would not hurt the economy.

Today, I want to address the latter argument about taxes and economic growth. When this topic arises, I normally cite both public-finance theory and empirical research to make the case that taxes do impact economic performance, and I try to always stress that not all taxes are created equal.

And if the focus is corporate taxation, I usually share my primer on the issue, and then link to research from Australia, Canada, Germany, and the United Kingdom.

But maybe it will be more persuasive to look at some new academic evidence from a study on U.S. corporate taxes by Professor Eric Ohrn (forthcoming in the American Economic Journal).

If you don’t want to dwell on the details, the paper’s abstract tells you the highlights. Simply stated, a lower corporate rate translates into more investment and less debt.

I exploit quasi-experimental variation created by the Domestic Production Activities Deduction, a corporate tax expenditure created in 2005. A one percentage point reduction in tax rates increases investment by 4.7 percent of installed capital, increases payouts by 0.3 percent of sales, and decreases debt by 5.3 percent of total assets. These estimates suggest that lower corporate tax rates and faster accelerated depreciation each stimulate a similar increase in investment, per dollar in lost revenue.

But hopefully there will be interest in some of the details from the study.

Here’s the problem Professor Ohrn identified.

…relatively little empirical work has been able to directly estimate the effects of a reduction in the corporate income tax rate on business activity. This study provides new evidence on these effects.

His evidence is based on the fact lawmakers created a lower tax rate for America-based manufacturing (a.k.a., the domestic production activities deduction, or DPAD).

In 2005, when the DPAD was implemented, firms could deduct 3 percent of manufacturing income. This rate was scaled to 6 percent in 2007 and 9 percent in 2010, where it remains today. As a result of the policy, after 2010, firms that derive all of their income from domestic manufacturing activities and face the top statutory corporate income tax rate have a 3.15 (= 0.09 × 35 percent) percentage point lower effective tax rate than firms with no domestic manufacturing activities. …I use data provided by the IRS Statistics of Income (SOI) Division. The SOI publishes the aggregate annual dollar values of the DPAD and Net Taxable Income for corporations in 75 unique industries and all businesses in 12 asset-classes (firm size bins).

And what did he find as he looked at the difference between firms with lower tax rates and higher tax rates?

It turns out that even modest differences in tax rates can have a big impact.

I find that the DPAD has a large effect on corporate behavior. A one percentage point reduction in the effective corporate income tax rate via the DPAD increases investment by 4.7 percent of installed capital, increases payouts by 0.3 percent of revenues, and decreases debt usage by 5.3 percent of total assets. …corporations respond strongly to the DPAD, and corporate income tax rate cuts more generally, by increasing investment and payouts and decreasing debt usage. The average firm does not report more taxable income per dollar of asset, suggesting that any increases in revenue generated by corporate tax rate reductions are the product of real effects such as investment but not decreased avoidance activity.

Here are a couple of charts from the study. The dark blue line represents companies with lower tax rates and the dashed line represents the ones with higher tax rates.

And since it’s good to have more investment and good to have less debt, both these findings re very positive.

Interestingly, the benefits of fixing depreciation laws (by moving in the direction of expensing) are quite similar to the benefits of lowering the corporate tax rates.

…a dollar spent by the government stimulates virtually the same amount of investment whether it is used to reduce corporate tax rates or accelerate depreciation expenses.

I hate to digress, but I can’t resist pointing out that I’m irked by the language about “a dollar spent by the government.” Professor Ohrn certainly seems to be a rigorous and capable economist, but he has a bit of a moral blind spot. If the federal government adopts a policy that allows a business to keep more of the money it earns, that is not “a dollar spent” by government.

Unless you have the bizarre mindset of some statists who think all output belongs to the state.

Anyhow, back to regularly scheduled programming.

We’re now at a critical point in the battle for tax reform. The House passed its version and now the Senate has passed its version. The good news is that there’s strong agreement on Capitol Hill to slash the corporate tax rate.

This latest study underscores why that reform will boost investment. And remember, when investment increases, that translates into higher wages for workers.

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House Republicans have unveiled their much-anticipated tax plan.

Is this something to celebrate? Well, that depends on whether you’re grading on a curve. Compared to a pure, simple, and fair flat tax, it’s timid and disappointing.

But compared to today’s wretched and unfair tax code, there are some very positive changes.

At the end of 2015, I reviewed the major tax plans put forth by the various presidential candidates, grading them on issues such as tax rates, double taxation, and simplicity.

Trump’s plan got the lowest score, though “B-” nonetheless represented a non-trivial improvement over the status quo.

And since he wound up in the White House, nobody should be surprised to see that many of his priorities are reflected in the House plan.

So let’s grade the major provisions of this new proposal (with the caveat that grades may change as more details emerge).

Lower corporate rate: A

America’s high corporate tax rate is probably the most self-destructive feature of the current system. If the rate is permanently reduced from 35 percent to 20 percent, that will be a huge boost to competitiveness.

Lower individual rates: C+

The proposal is relatively timid on rate reductions for households. This is disappointing, but not unexpected since lower individual tax rates mean considerable revenue loss.

Ending deduction for state and local income taxes: A-

Next to the lower corporate tax rate, this is the most encouraging part of the proposal. It generates revenue to use for pro-growth provisions while also eliminating a subsidy for bad policy on the part of state and local governments.

Curtailing mortgage interest deduction: B-

Instead of allowing mortgage interest deduction on homes up to $1 million, the cap is reduced to $500,000. A modest but positive improvement that will reduce the distortion that creates a bias for residential real estate compared to business investment.

Death tax repeal: A-

Don’t die for six years, because that’s how long it will take before the death tax is repealed. But if we actually get to that point, this will represent a very positive change to the tax system.

Change to consumer price index: C

It is quite likely that the consumer price index overstates inflation because it doesn’t properly capture increases in the quality of goods and service. Shifting to a different price index will lead to higher revenues because tax brackets and other provisions of the tax code won’t adjust at the same rate. That’s fine, but I’m dissatisfied with this provision since it should apply to spending programs as well as the tax code.

Reduced business interest deduction: C+

The business interest deduction is partially undone, which is a step toward equal treatment of debt and equity. It’s not the right way of achieving that goal, but it does generate revenue to finance other pro-growth changes in the legislation.

Here’s a useful summary from the Wall Street Journal of changes to business taxation.

Now let’s zoom out and grade the overall plan in terms of major fiscal and economic goals.

Restraining the growth of government: F

In my fantasy world, I want a return to the very small federal government created and envisioned by the Founding Fathers. In the real world, I simply hope for a modest bit of spending restraint. This legislation doesn’t even pretend to curtail the growth of government, which is unfortunate since some fiscal prudence (federal budget growing about 2 percent per year) would have allowed a very large tax cut while also balancing the budget within 10 years.

Collecting revenue in a less-destructive manner: B

This is a positive proposal. It will mean more jobs, increased competitiveness, and higher incomes. The wonks in Washington doubtlessly will debate whether these positive effects are small or large, but I’m not overly fixated on that issue. Yes, I think the growth effects will be significant, but I also realize that many other policies also determine economic performance. The most important thing to understand, thought is that even small increases in growth make a big difference over time.

The bottom line is that half a loaf (or, in this case, a fourth of a loaf) is better than nothing. House Republicans have a good plan. Now the question is whether the Senate makes it better or worse (hint: don’t be optimistic).

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I’ve been arguing all year that a substantially lower corporate tax rate is the most vital goal of tax reform for reasons of competitiveness.

And I continued to beat that drum in an interview last week with Fox Business.

The Wall Street Journal agrees that the time has come for a lower corporate rate. Unless, of course, one would prefer the United States to fall even further behind other countries.

President Emmanuel Macron last week pushed a budget featuring substantial tax relief through the National Assembly. The top rate on corporate profits will fall to 28% by 2020 from 33.33% today, and Mr. Macron has promised 25% by 2022. …Critics branded Mr. Macron “the President for the rich” for these overhauls, but the main effect will be to stimulate investment and job creation… The Netherlands also is jumping on the bandwagon. Prime Minister Mark Rutte promises to cut the top corporate rate to 21% from 25% by 2021… Do American politicians really want to have to explain to voters why they let the U.S. trail even France?

For the most part, opponents of tax reform in the United States understand that they have lost the competitiveness argument. So they will pay lip service to the notion that a lower corporate rate is desirable (heck, even Obama notionally agreed), but they will fret about the loss of tax revenue and a supposed windfall for the “rich.”

I agree that tax revenues will decrease, at least in the short run. But there’s some very good research showing the long-run revenue-maximizing corporate rate is somewhere between 15 percent and 25 percent.

And Chris Edwards of the Cato Institute reviewed fifty years of data for industrialized nations and ascertained that lower tax rates are associated with rising revenue.

There’s also good evidence from Canada and the United Kingdom if you want country-specific examples of the relationship between corporate tax rates and corporate tax revenue.

By the way, even left-leaning multilateral bureaucracies such as the International Monetary Fund and the Organization for Economic Cooperation and Development have published research showing the same thing.

And what about the debate over whether the “rich” benefit?

That issue is a red herring. Yes, shareholders of companies, on average, have higher incomes, and they will benefit if the rate is reduced, but I’ve never been motivated by animosity against those with more money (assuming they earned their money rather than mooching off the government).

What does get my juices flowing, however, is growth. And if we can get more dynamism in the economy, that translates into more jobs and higher income.

A new report from the Council of Economic Advisers estimates the potential benefit for ordinary people.

Reducing the statutory federal corporate tax rate from 35 to 20 percent would, the analysis below suggests, increase average household income in the United States by, very conservatively, $4,000 annually. …Moreover, the broad range of results in the literature suggest that over a decade, this effect could be much larger.

There’s some good cross-country data showing nations with lower corporate tax rates do better.

Between 2012 and 2016, the 10 lowest corporate tax countries of the OECD had corporate tax rates 13.9 percentage points lower than the 10 highest corporate tax countries, about the same scale as the reduction currently under consideration in the U.S. The average wage growth in the low tax countries has been dramatically higher.

Here’s the accompanying chart.

As you can see, there’s a clear divergence between higher-tax and lower-tax nations. Though, given the limited time period in the chart and the fact that many other factors can impact wage growth, I’m actually more persuaded by some of the other empirical research cited in the CEA report.

Arulpalapam et al (2012) find that workers pay nearly 50 percent of the tax, while Desai et al (2007) estimate a worker share of 45 to 75 percent. Gravelle and Smetters (2006) generate a rate of 21 percent when the rate of capital mobility across countries is moderate and 73 percent when capital can flow freely, evidence that the labor incidence is likely both dynamic and positively correlated with the rate of international capital transfers. A Congressional Budget Office (CBO) study (Randolph, 2006) finds that workers bear 70 percent of the corporate income tax burden in the baseline and 59 to 91 percent in alternative specifications. In a summary study, Jensen and Mathur (2011) argue for an assumption of greater than 50 percent. …A cross-country study by Hassett and Mathur (2006) based on 65 countries and 25 years of data finds that the elasticity of worker wages in manufacturing after five years with respect to the highest marginal tax rate in a country is as low as -1.0 in some specifications, although other sets of control variables increase the elasticity to -0.3. Expanded analysis by Felix (2007) follows the Hassett and Mathur strategy, but incorporates additional control variables, including worker education levels. Felix settles on an elasticity of worker wages with respect to corporate income taxes of -0.4, at the high end of the Hassett and Mathur range. …Felix (2009) estimates an elasticity of worker wages with respect to corporate income tax rates based on variation in the marginal tax rate across U.S. states. In this case, the elasticity is substantially lower; a 1 percentage point increase in the top marginal state corporate rate reduces gross wages by 0.14 to 0.36 percent over the entire period (1977-2005) and by up to 0.45 percent for the most recent period in her data (2000-2005). …Desai et al (2007)…measure both the changes in worker wages and changes in capital income associated with corporate income tax changes. The estimated labor burden of the corporate tax rate varies from 45 to 75 percent under various specifications in the paper.

That’s a lot of jargon, so I suspect that many readers will find data from Germany and Australia to be more useful when considering how workers benefit from lower corporate rates.

P.S. While I think a lower corporate tax rate may result in more revenue over time, that’s definitely not my goal.

P.P.S. The biggest obstacle to good tax policy is the unwillingness of Republicans to impose even a modest amount of spending restraint.

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In my ideal world, we’re having a substantive debate about corporate tax policy, double taxation, marginal tax rates, and fundamental tax reform (plus spending restraint so big tax cuts are feasible).

Sadly, we don’t live in my ideal world (other than my Georgia Bulldogs being undefeated). So instead of a serious discussion about things that matter, there’s a big fight in Washington about the meaning of Donald Trump’s words.

Politico has a report on this silly controversy. Here are some of highlights.

“We are the highest taxed nation in the world,” President Donald Trump has repeated over and over again. …He said it at a White House event last Friday. He’s tweeted it, repeated it in television interviews and declared it at countless rallies. It is his go-to talking point, his favorite line… It is also false — something fact checkers have been pointing out since 2015.

This fight revolves around the fact that Trump is referring to corporate taxes, but generally does not make that explicit. So you have exchanges like this.

White House press secretary Sarah Huckabee Sanders sought for the second time in less than a week to defend the comment… “We are the highest taxed corporate tax [sic] in the developed economy. That’s a fact,” Sanders said when pressed on the comment during a briefing. “But that’s not what the president said,” a reporter retorted. “That’s what he’s talking about,” Sanders responded. “We are the highest taxed corporate nation.” “But that’s not what he said. He said we’re the highest taxed nation in the world,” said the reporter, Trey Yingst.

Sigh. What a silly exchange. It reminds me of the absurd debate about “what the definition of is is” during the Clinton years.

I start with the assumption that all politicians aggressively manipulate words, either deliberately or instinctively. Or maybe just out of sloppiness.

So let’s look at three bits of data, starting with the numbers that are least favorable to Trump. Here’s a chart from the Organization for Economic Cooperation and Development. It’s definitely not my favorite international bureaucracy, but it has good apples-to-apples figures for developed nations. And you can see that the United States (highlighted in red) definitely does not have the highest overall tax burden.

For what it’s worth, we should be happy about these numbers. Indeed, I think they help to explain why Americans are much more prosperous than our European friends. And it’s also worth noting that Trump – at best – is being sloppy when he asserts that America is the “highest taxed nation.”

The President’s defenders can argue, with some legitimacy, that he often makes that claim while talking about business taxation. In those cases, it’s presumably obvious that “highest taxed” is a reference to corporate rates.

And if that’s the case, looking at a second set of numbers, the President is spot on. The United States unambiguously has the highest corporate tax rate among developed nations. And the U.S. may even have the highest corporate rate in the entire world depending on how certain severance taxes in developing nations are categorized.

Moreover, the United States has a very onerous system of worldwide taxation, accompanied by rules that rank very near the bottom.

In other words, Trump has a very strong case, but he undermines his argument when he doesn’t explicitly state that he’s talking about corporate taxation.

There’s even a third set of numbers that Trump could cite when discussing the “highest taxed nation.” As I’ve noted before, the United States actually has the most “progressive” tax system in the developed world.

But the President shouldn’t cite me when he can easily use quotes and data from the Washington Post on September 19, 2012.

The United States has by far the most progressive income, payroll, wealth and property taxes of any developed country.

Or the same newspaper on April 4, 2013.

…the American system remains the most progressive tax system in the developed world.

Or the Washington Post on April 5, 2013.

A few readers were surprised by my mention Thursday that the U.S. tax code…is actually the most progressive in the developed world. But it’s true! …Our top 10 percent…pays a much higher share of the tax burden than the upper classes in other countries do.

Here’s the most relevant chart.

These numbers may not be terribly relevant for the current controversy since Trump’s tax plan is focused more on business taxpayers rather than individual taxpayers.

But our friends on the left are very anxious to impose more class-warfare taxation, so we should file this data for future reference.

P.S. The April 4, 2013, story in the Washington Post includes this very important passage.

…social democracies like France, Germany and Sweden have actively regressive systems heavily reliant on value-added taxes.

This reinforces what I’ve repeatedly noted, which is that Europe’s costly welfare states are financed by lower-income and middle-class taxpayers (in large part because of punitive value-added taxes). The bottom line is that we should listen to Bernie Sanders and become more like Europe. But only if we want ordinary citizens to pay much higher taxes and to accept much lower living standards.

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The Republican tax plan is based on some very attractive principles.

Unfortunately, the GOP isn’t planning to completely fix these policies, largely because there’s no commitment to control government spending. But any shift toward better tax policy will be good for the nation.

Another goal to add to the above list is that Republicans want to create a level playing field for American-based firms by replacing “worldwide taxation” of business income with “territorial taxation” of business income.

For those who have wisely avoided the topic of international business taxation, here’s all you need to know: Worldwide taxation means a company that earns income in another country is taxed both by the government where the income is earned and by the government back home. Territorial taxation, by contrast, is simply the common-sense notion that income is taxed only by the government where the income is earned.

In a column for the Wall Street Journal, two authors explain how America’s anti-competitive system of worldwide taxation undermines U.S.-domiciled companies.

…earlier this month Iconix , the U.S.-based company that owns the rights to Charles Schulz’s comic characters, announced it will sell them to Canada’s DHX Media. That makes Charlie Brown America’s latest expatriate. It’s a clear signal that U.S. corporate taxes are nudging business elsewhere. …why? In part because the U.S. corporate tax system hampers U.S.-based businesses by subjecting them to world-wide taxation. Canada’s aggregate corporate taxes are about 10 percentage points lower. …America’s high corporate tax rate and its practice of taxing international income is out of step with the rest of the world. The solution is so clear even a cartoon character should grasp it: Cut tax rates and adopt a system for taxing international income that more closely resembles those used by the country’s international competitors.

Indeed, it’s worth noting that the entire “inversion” controversy only exists because of America’s worldwide tax regime.

Simply stated, American-domiciled multinationals have a big competitive disadvantage compared to their foreign rivals. So it’s understandable that many of them try to protect shareholders, workers, and consumers by arranging (usually through a merger) to become foreign companies.

That’s the bad news.

The good news is that the Republican tax reform plan ostensibly will shift America to a territorial tax system. As explained above, this is the sensible notion of letting other nations tax income earned inside their borders while the IRS would tax the income earned by companies in the United States.

This would be good for competitiveness, particularly since the United States is one of only a handful of nations that impose a worldwide tax burden on domestic firms.

But not everybody likes the idea of territorial taxation.

One reason for opposition is that some people see corporations primarily as sources of tax revenue. So when there are discussions of international tax, their mindset is nations should compete on grabbing the most money. I’m not joking.

European Union regulators’ tax crackdown on Amazon.com Inc. — like the EU’s case against Apple Inc. — should spur U.S. policy makers to address companies’ aggressive offshore tax-avoidance strategies before it’s too late, experts said. …“Really, what we are seeing is a race by the different taxing jurisdictions to claim a share of the tax prize represented by the largely untaxed streams of income that U.S. multinationals have engineered for themselves,’’ said Ed Kleinbard, a professor at the University of Southern California and the former chief of staff for Congress’s Joint Committee on Taxation. “If the United States doesn’t join the race, it will just lose tax revenue to more aggressive host countries around the world.’’ The EU rulings “do make it clear that if we are not interested in protecting our corporate tax base, other countries will be more than happy to tax the income,’’ said Kimberly Clausing, a professor of economics at Reed College in Portland, Oregon.

Call me crazy, but I think American policymakers should be in a race to create jobs, boost investment, and increase wages. And that means doing the opposite of what these supposed experts want.

Unsurprisingly, left-wing groups also are opposed to territorial taxation. Here are some passages from a report published by the Hill.

One hundred organizations, including a number of progressive groups and labor unions, are urging Congress to reject a major international tax change proposed in Republicans’ framework for a tax overhaul. In a letter dated Monday, the groups speak out against the framework’s move toward a “territorial” tax system that would largely exempt American companies’ foreign profits from U.S. tax. …”Ending taxation of offshore profits would give multinational corporations an incentive to send jobs offshore, thereby lowering U.S. wages,” they wrote.

Both assertions in that excerpt are wrong and/or misleading.

First, territorial taxation doesn’t mean that profits are exempt from tax. It simply means that the IRS doesn’t impose an additional layer of tax on income that already has been subject to the tax system of another country.

And other countries impose plenty of tax on American firms operating overseas.

Second, the incentive to shift job overseas is caused by America’s high corporate tax rate. That’s what makes it attractive for firms to operate in other nations.

Worldwide taxation is not the way to fix that bias since foreign-domiciled companies wouldn’t be impacted and they easily can sell into the American market.

By the way, the Republican tax plan doesn’t even create a real territorial tax system. Returning to the Bloomberg story cited above, the GOP proposal basically copies a very bad idea that was being pushed a few years ago by the Obama Administration.

…the GOP tax framework contemplates a so-called “minimum foreign tax’’ on multinationals’ future earnings that would apply in cases where a company’s effective tax rate fell below a pre-determined threshold.

To be fair, the Republican approach is less punitive that what Obama wanted.

Nonetheless, I worry that if Republicans adopt some sort of global minimum tax, it will just be a matter of time before that rate increases. In which case a shift toward territoriality actually plants a seed for a more onerous worldwide system!

Without knowing what will happen in the future, there’s no right or wrong answer, but I’m wondering whether the smart approach is to simply leave the current system in place. Yet, it’s based on worldwide taxation, but at least companies have deferral, which creates de facto territoriality for firms that manage their affairs astutely.

Such a shame that the GOP isn’t capable of simply doing the right thing.

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For months, I’ve been arguing that the big reduction in the corporate tax rate is the most important part of Trump’s tax agenda.

But not because of politics or anything like that. Instead, my goal is to enable additional growth by shifting to a system that doesn’t do as much damage to investment and job creation. A lower rate is consistent with good theory, and there’s also recent research from Australia and Germany to support my position.

Especially since the United States is falling behind the rest of the world. America now has the highest corporate tax rate in the developed world and arguably may have the highest rate in the entire world.

Needless to say, this is a self-inflicted wound on U.S. competitiveness.

But since the numbers I’ve been sharing are now a few year’s old, let’s now update some of this data.

Check out these four charts from a new OECD annual report on tax policy changes (the some one that I cited a few days ago when explaining that European-sized government means a suffocating tax burden on the poor and middle class).

Here’s the grim data on the corporate income tax rate (the vertical blue bars). As you can see, the United wins the booby prize for having the highest rate.

But here’s some “good news.” When you add in the second layer of tax on corporate income, the United States is “only” in third place, about where we were back in 2011.

France imposes the highest combined rate on corporate and dividend income (no surprise since the nation’s national sport is taxation), while Ireland is in second place (the corporate rate is very low, but personal rates are high and dividends receive no protection from double taxation).

For what it’s worth, I think it’s incredibly bad policy when governments are skimming 30 percent, 40 percent, 50 percent, and even 60 percent of the income being generated by business investment.

Particularly since high rates don’t translate into high revenue. Check out this third chart. You’ll notice that revenues are relatively low in the United States even though (or perhaps because) the tax rate is very high.

But our final chart provides the strongest evidence. Just like the IMF, the OECD is admitting that tax revenues have remained constant over time, even though (or because) corporate tax rates have plunged.

In other words, the Laffer Curve is alive and well.

Incidentally, the global shift to lower tax rates hasn’t stopped. I wrote back in May about plans for lower corporate tax burdens in Hungary and the United Kingdom and I noted last November that Croatia was lowering its corporate rate.

And, thanks to liberalizing effect of tax competition, more and more nations are hopping on the tax cut bandwagon.

Consider what’s happening in Sweden.

Sweden’s center-left minority government is proposing a corporate tax cut to 20 percent from 22 percent, Finance Minister Magdalena Andersson and Financial Markets Minister Per Bolund said on Monday… “With the proposals we want to strengthen competitiveness and create a more dynamic business climate,” they said… The proposed corporate tax cut would be…implemented on July 1, 2018.

Or what’s taking place in Belgium.

…government ministers finally reached agreement on a number of reforms to the Belgian tax and employment systems. …Belgium is to slash corporation tax from 34% to 29% next year. By 2020 corporation tax will have been cut to 25%. …Capital gains tax on the first 627 euros of dividends from shares disappears, a measure intended to encourage share ownership.

Or what’s looming in Germany.

Germany will likely need to make changes to its corporation tax system in coming years in response to growing tax competition from other countries, Finance Minister Wolfgang Schaeuble said on Wednesday… “I expect there will be a need to take action on corporation tax in coming years because in some countries, from the U.S. to Britain, but also on other continents, there are many considerations where we can’t simply say we’ll ignore them,” Schaeuble told a real estate conference.

This bring a smile to my face. Greedy politicians are being pressured to cut tax rates, even though they would prefer to do the opposite. Let’s hope the United States joins this “race to the bottom” before it’s too late.

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The most common arguments for reducing the 35 percent federal tax on corporate income usually revolve around the fact that having the developed world’s highest tax rate on business undermines competitiveness and reduces investment in America.

And all of that is true. But we should never lose sight of the fact that the corporate income tax is merely a collection device. Businesses may pay the tax, but the real burden is borne by people.

  • Shareholders (investors) receive lower dividends.
  • Consumers pay more for goods and services.
  • Workers receive lower levels of compensation.

Politicians don’t really care about investors since some shareholders are rich, but they definitely pay lip service to the notion that they are on the side of consumers and workers.

So I think this new study from German scholars is worth sharing because it measures the effect of corporate taxation on wages. Here are some of the highlights.

In this paper, we revisit the question of the incidence of corporate taxes on wages both theoretically and empirically. …we exploit the specific institutional setting of the German local business tax (LBT) to identify the corporate tax incidence on wages. …we test the theoretical predictions using administrative panel data on German municipalities from 1993 to 2012. Germany is well suited to test our theoretical model for several reasons. First, we have substantial tax variation at the local level. From 1993 to 2012, on average 12.4% of municipalities adjusted their LBT rates per year. Eventually, we exploit 17,999 tax changes in 10,001 municipalities between 1993 to 2012 for identification. …Moreover, the municipal autonomy in setting tax rates allows us to treat municipalities as many small open economies within the highly integrated German national economy – with substantial mobility of capital, labor and goods across municipal borders.

And here are the key results. There’s a good bit of economic jargon, so the main takeaway is that 43 percent of the corporate tax is borne by workers.

For our baseline estimate, we focus on firms that are liable to the LBT. Figure 2 depicts the results. Pre-reform trends are flat and not statistically different from zero. After a change in the municipal business tax rate in period 0 (indicated by the vertical red line), real wages start to decline and are 0.047 log points below the pre-reform year five years after the reform. The coefficient corresponds to a wage elasticity with respect to the LBT rate of 0.14. …this central estimate implies that a 1-euro increase in the tax bill leads to a 0.56-euro decrease in the wage bill. …we have to rely on estimates from the literature to quantify the total incidence on labor. If we assume a marginal deadweight loss of corporate taxation of 29% as suggested by Devereux et al. (2014), 43% of the total tax burden is borne by workers. This finding is comparable to other studies analyzing the corporate tax incidence on wages (Arulampalam et al., 2012; Liu and Altshuler, 2013; Su´arez Serrato and Zidar, 2014). …We find that part of the tax burden is borne by low-skilled workers. …the view that the corporate income tax primarily falls on firm owners is rejected by our analysis.

For what it’s worth, I use a different approach when trying to explain the impact of the corporate income tax.

I state that shareholders pay 100 percent of the corporate income tax when looking at the direct (or first-order) effect.

However, since shareholders respond to this tax by investing less money in businesses, that means productivity won’t grow as fast, and this translates into lower wages for workers (compared to how fast they would have grown if the tax was lower or didn’t exist). This is the indirect (or second-order) effect of corporate taxation, and it’s akin to the “deadweight loss” discussed in the aforementioned study.

And this is also the approach that can be used to calculate the damage to consumers.

For today, though, the moral of the story is very simple. A high corporate tax rate is bad for growth and competitiveness, but one of the main effects is that workers wind up earning less income. So when the class-warfare crowd takes aim at “rich corporations,” there’s a lot of collateral damage on ordinary people.

P.S. For more information, here’s a video from the Center for Freedom and Prosperity that describes some of the warts associated with the corporate income tax.

P.P.S. There’s lots of evidence – including some from leftist international bureaucracies – that a lower corporate tax rate won’t mean less tax revenue.

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While I realize there’s zero hope of ripping up America’s awful tax code and getting a simple and fair flat tax, I’m nonetheless hopeful that there will be some meaningful incremental changes as part of the current effort to achieve some sort of tax reform.

A package that lowers the corporate rate, replaces depreciation with expensing, and ends the death tax would be very good for growth, and those good reforms could be at least partially financed by eliminating the state and local tax deduction and curtailing business interest deductions so that debt and equity are on a level playing field.

All that sounds good, and a package like this should be feasible since Republicans control both Congress and the White House (especially now that the BAT is off the table), but I warn in this interview that there are lots of big obstacles that could cause tax reform to become a disaster akin to the Obamacare repeal effort.

Here’s my list of conflicts that need to be solved in order to get some sort of plan through Congress and on to the President’s desk.

  • Carried interest – Trump wants to impose a higher capital gains tax on a specific type of investment, but this irks many congressional GOPers who have long understood that any capital gains tax is a form of double taxation and should be abolished. The issue apparently has some symbolic importance to the President and it could become a major stumbling block if he digs in his heels.
  • Tax cut or revenue neutrality – Budget rules basically require that tax cuts expire after 10 years. To avoid this outcome (which would undermine the pro-growth impact of any reforms), many lawmakers want a revenue-neutral package that could be permanent. But that means coming up with tax increases to offset tax cuts. That’s okay if undesirable tax preferences are being eliminated to produce more revenue, but defenders of those loopholes will then lobby against the plan.
  • Big business vs small business – Everyone agrees that America’s high corporate tax rate is bad news for competitiveness and should be reduced. The vast majority of small businesses, however, pay taxes through “Schedule C” of the individual income tax, so they want lower personal rates to match lower corporate rates. That’s a good idea, of course, but would have major revenue implications and complicate the effort to achieve revenue neutrality.
  • Budget balance – Republicans have long claimed that a major goal is balancing the budget within 10 years. That’s certainly achievable with a modest amount of spending restraint. And it’s even relatively simple to have a big tax cut and still achieve balance in 10 years with a bit of extra spending discipline. That’s the good news. The bad news is that there’s very little appetite for spending restraint in the White House or Capitol Hill, and this may hinder passage of a tax plan.
  • Middle class tax relief – The main focus of the tax plan is boosting growth and competitiveness by reducing the burden on businesses and investment. That’s laudable, but critics will say “the rich” will get most of the tax relief. And even though the rich already pay most of the taxes and even though the rest of us will benefit from faster growth, Republicans are sensitive to that line of attack. So they will want to include some sort of provision designed for the middle class, but that will have major revenue implications and complicate the effort to achieve revenue neutrality.

There’s another complicating factor. At the risk of understatement, President Trump generates controversy. And this means he doesn’t have much power to use the bully pulpit.

Though I point out in this interview that this doesn’t necessarily cripple tax reform since the President’s most important role is to simply sign the legislation.

Before the 2016 election, I was somewhat optimistic about tax reform.

A few months ago, I was very pessimistic.

I now think something will happen, if for no other reason than Republicans desperately want to achieve something after botching Obamacare repeal.

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As a general rule, the International Monetary Fund is a statist organization. Which shouldn’t be too surprising since its key “shareholders” are the world’s major governments.

And when you realize who controls the purse strings, it’s no surprise to learn that the bureaucracy is a persistent advocate of higher tax burdens and bigger government. Especially when the IMF’s politicized and leftist (and tax-free) leadership dictates the organization’s agenda.

Which explains why I’ve referred to that bureaucracy as a “dumpster fire of the global economy” and the “Dr. Kevorkian of global economic policy.”

I always make sure to point out, however, that there are some decent economists who work for the IMF and that they occasionally are allowed to produce good research. I’ve favorably cited the bureaucracy’s work on spending caps, for instance.

But what amuses me is when the IMF tries to promote bad policy and accidentally gives me powerful evidence for good policy. That happened in 2012, for example, when it produced some very persuasive data showing that value-added taxes are money machines to finance a bigger burden of government.

Well, it’s happened again, though this time the bureaucrats inadvertently just issued some research that makes the case for the Laffer Curve and lower corporate tax rates.

Though I can assure you that wasn’t the intention. Indeed, the article was written as part of the IMF’s battle against tax competition. As you can see from these excerpts, the authors clearly seem to favor higher tax burdens on business and want to cartelize the global economy for the benefit of the political class.

…what’s the problem when it comes to governments competing to attract investors through the tax treatment they provide? The trouble is…competing with one another and eroding each other’s revenues…countries end up having to…reduce much-needed public spending… All this has serious implications for developing countries because they are especially reliant on the corporate income tax for revenues. The risk that tax competition will pressure them into tax policies that endanger this key revenue source is therefore particularly worrisome. …international mobility means that activities are much more responsive to taxation from a national perspective… This is especially true of the activities and incomes of multinationals. Multinationals can manipulate transfer prices and use other avoidance devices to shift their profits from high tax countries to low, and they can choose in which country to invest. But they can’t shift their profits, or their real investments, to another planet. When countries compete for corporate tax base and/or real investments they do so at the expense of others—who are doing the same.

Here’s the data that most concerns the bureaucrats, though they presumably meant to point out that corporate tax rates have fallen by 20 percentage points, not by 20 percent.

Headline corporate income tax rates have plummeted since 1980, by an average of almost 20 percent. …it is a telling sign of international tax competition at work, which closer empirical work tends to confirm.

But here’s the accidental admission that immediately caught my eye. The authors admit that lower corporate tax rates have not resulted in lower revenue.

…revenues have remained steady so far in developing countries and increased in advanced economies.

And this wasn’t a typo or sloppy writing. Here are two charts that were included with the article. The first one shows that revenues (the red line) have climbed in the industrialized world as the average corporate tax rate (the blue line) has plummeted.

This may not be as dramatic as what happened when Reagan reduced tax rates on investors, entrepreneurs, and other upper-income taxpayers in the 1980, but it’s still a very dramatic and powerful example of the Laffer Curve in action.

And even in the developing world, we see that revenues (red line) have stayed stable in spite of – or perhaps because of – huge reductions in average corporate tax rates (blue line).

These findings are not very surprising for those of us who have been arguing in favor of lower corporate tax rates.

But it’s astounding that the IMF published this data, especially as part of an article that is trying to promote higher tax burdens.

It’s as if a prosecutor in a major trial says a defendant is guilty and then spends most of the trial producing exculpatory evidence.

I have no idea how this managed to make its way through the editing process at the IMF. Wasn’t there an intern involved in the proofreading process, someone who could have warned, “Umm, guys, you’re actually giving Dan Mitchell some powerful data in favor of lower tax burdens”?

In any event, I look forward to repeatedly writing “even the IMF agrees” when pontificating in the future about the Laffer Curve and the benefits of lower corporate tax rates.

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What’s the best argument for reducing the onerous 35 percent corporate tax rate in the United States?

These are all good reasons to dramatically lower the corporate tax rate, hopefully down to the 15-percent rate in Trump’s plan, but the House proposal for a 20-percent rate wouldn’t be a bad final outcome.

But there’s a 9th reason that is very emotionally appealing to me.

  • 9. Should the rate be lowered to trigger a new round of tax competition, even though that will make politicians unhappy? Actually, the fact that politicians will be unhappy is a feature rather than a bug.

I’ve shared lots of examples showing how jurisdictional competition leads to better tax policy.

Simply stated, politicians are less greedy when they have to worry that the geese with the golden eggs can fly away.

And the mere prospect that the United States will improve its tax system is already reverberating around the world.

The German media is reporting, for instance, that the government is concerned that a lower corporate rate in America will force similar changes elsewhere.

The German government is worried the world is slipping into a ruinous era of tax competition in which countries lure companies with ever-more generous tax rules to the detriment of public budgets. …Mr. Trump’s “America First” policy has committed his administration to slashing the US’s effective corporate tax rate to 22 from 37 percent. In Europe, the UK, Ireland, and Hungary have announced new or rejigged initiatives to lower corporate tax payments. Germany doesn’t want to lower its corporate-tax rate (from an effective 28.2 percent)… Germany’s finance minister, Wolfgang Schäuble, …left the recent meeting of G7 finance ministers worried by new signs of growing beggar-thy-neighbor rivalry among governments.

A “ruinous era of tax competition” and a “beggar-thy-neighbor rivalry among governments”?

That’s music to my ears!

I”d much rather have “competition” and “rivalry” instead of an “OPEC for politicians,” which is what occurs when governments impose “harmonization” policies.

The Germans aren’t the only ones to be worried. The Wall Street Journal observes that China’s government is also nervous about the prospect of a big reduction in America’s corporate tax burden.

China’s leaders fear the plan will lure manufacturing to the U.S. Forget a trade war, Beijing says a cut in the U.S. corporate rate to 15% from 35% would mean “tax war.” The People’s Daily warned Friday in a commentary that if Mr. Trump succeeds, “some powerful countries may join the game to launch competitive tax cuts,” citing similar proposals in the U.K. and France. …Beijing knows from experience how important tax rates are to economic competitiveness. …China’s double-digit growth streak began in the mid-1990s after government revenue as a share of GDP declined to 11% in 1995 from 31% in 1978—effectively a supply-side tax cut. But then taxes began to rise again…and the tax man’s take now stands at 22%. …Chinese companies have started to complain that the high burden is killing profits. …President Xi Jinping began to address the problem about 18 months ago when he launched “supply-side reforms” to cut corporate taxes and regulation. …the program’s stated goal of restoring lost competitiveness shows that Beijing understands the importance of corporate tax rates to growth and prefers not to have to compete in a “tax war.”

Amen.

Let’s have a “tax war.” Folks on the left fret that this creates a “race to the bottom,” but that’s because they favor big government and think our incomes belong to the state.

As far as I’m concerned a “tax war” is desirable because that means politicians are fighting each other and every bullet they fire (i.e., every tax they cut) is good news for the global economy.

Now that I’ve shared some good news, I’ll close with potential bad news. I’m worried that the overall tax reform agenda faces a grim future, mostly because Trump won’t address old-age entitlements and also because House GOPers have embraced a misguided border-adjustment tax.

Which is why, when the dust settles, I’ll be happy if all we get a big reduction in the corporate rate.

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I like the main components of the Trump tax plan, particularly the sweeping reduction in the corporate tax rate.

But, as I say at the beginning of this Fox Business interview, there’s a big difference between proposing a good idea and actually getting legislation approved.

But just because I’m pessimistic, that doesn’t change the fact that a lower tax burden would be good for the country.

Toward the end of the interview, I explained that the most important reason for better tax policy is not necessarily to lower taxes for families, but rather to get more prosperity.

If we can restore the kind of growth we achieved when we had more market-friendly policy in the 1980s and 1990s, that would be hugely beneficial for ordinary people.

That’s the main economic argument for Trump’s plan.

But now I’ve come across what I’ll call the emotionally gratifying argument for Trump’s tax cuts. The Bureau of National Affairs is reporting that European socialists are whining that a lower corporate tax rate in the United States will cause “a race to the bottom.”

U.S. President Donald Trump’s plans to slash corporate taxes by more than half will accelerate a “race to the bottom” and undermine global efforts to combat corporate tax evasion by multinationals, according to a second political group in the European Parliament. The Socialists and Democrats, made up of 190 European Parliament lawmakers, insisted the Trump tax reform, announced April 26, threatens the current work in the Organization for Economic Cooperation and Development and the Group of Twenty to establish a fair and efficient tax system.

As you might expect, the socialists make some nonsensical arguments.

Paul Tang—who heads the Group of the Progressive Alliance of Socialists and Democrats and leads the European Parliament negotiations on the pending EU Common Corporate Tax Base (CCTB) proposal—accused the Trump administration of pursuing a “beggar-they-neighbor policy similar to those in the 1930s.”

Huh?!? Does Mr. Tang think there were tax cuts in the 1930s?

That was a decade of tax increases, at least in the United States!

Or is he somehow trying to equate tax cuts with protectionism? But that makes zero sense. Yes, protectionism was rampant that decade, but higher tariffs mean higher taxes on trade. That’s the opposite of tax cuts.

Mr Tang is either economically illiterate or historically illiterate. Heck, he’s a socialist, so probably both.

Meanwhile, another European parliamentarian complained that the U.S. would become more of a tax haven if Trump’s tax cut was enacted.

Sven Giegold, a European Green Party member and leading tax expert in the European Parliament, told Bloomberg BNA in a April 27 telephone interview that the Trump tax plan further cemented the U.S. as a tax haven. He added the German government must put the issue on the agenda during its current term as holder of the G-20 presidency. …The European Green Party insists the U.S. has become an international tax haven because, among other things, it has not committed to implement the OECD Common Reporting Standard and various U.S. states, including Delaware, Nevada and South Dakota, have laws that allow companies to hide beneficial owners.

He’s right and wrong.

Yes, the United States is a tax haven, but only for foreigners who passively invest in the American economy (we generally don’t tax interest and capital gains received by foreigners, and we also generally don’t share information about the indirect investments of foreigners with their home governments).

Corporate income, however, is the result of direct investment, and that income is subject to tax by the IRS.

But I suppose it’s asking too much to expect politicians to understand such nuances.

For what it’s worth, I assume Mr. Giegold is simply unhappy that a lower corporate tax rate would make America more attractive for jobs and investment.

Moreover, he presumably understands adoption of Trump’s plan would put pressure on European nations to lower their corporate tax rates. Which is exactly what happened after the U.S. dropped its corporate tax rate back in the 1980s.

Which is yet another example of why tax competition is something that should be celebrated rather than persecuted. It forces politicians to adopt better policy even when they don’t want to.

That is what gets them angry. And I find their angst very gratifying.

P.S. You may have noticed at the very end of the interview that I couldn’t resist interjecting a plea to reduce the burden of government spending. That’s not merely a throwaway line. When the Congressional Budget Office released its fiscal forecast earlier this year, I crunched the numbers and showed that we could balance the budget within 10 years and lower the tax burden by $3 trillion (on a static basis!) if politicians simply restrained spending so that it grew 1.96 percent per year.

P.P.S. It’s worth remembering that the “race to the bottom” is actually a race to better policy and more growth. And politicians should be comforted by the fact that this doesn’t necessarily mean less revenue.

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My crusade against the border-adjustable tax (BAT) continues.

In a column co-authored with Veronique de Rugy of Mercatus, I explain in today’s Wall Street Journal why Republicans should drop this prospective source of new tax revenue.

…this should be an opportune time for major tax cuts to boost American growth and competitiveness. But much of the reform energy is being dissipated in a counterproductive fight over the “border adjustment” tax proposed by House Republicans. …Republican tax plans normally receive overwhelming support from the business community. But the border-adjustment tax has created deep divisions. Proponents claim border adjustability is not protectionist because it would automatically push up the value of the dollar, neutralizing the effect on trade. Importers don’t have much faith in this theory and oppose the GOP plan.

Much of the column is designed to debunk the absurd notion that a BAT is needed to offset some mythical advantage that other nations supposedly enjoy because of their value-added taxes.

Here’s what supporters claim.

Proponents of the border-adjustment tax also are using a dodgy sales pitch, saying that their plan will get rid of a “Made in America Tax.” The claim is that VATs give foreign companies an advantage. Say a German company exports a product to the U.S. It doesn’t pay the American corporate income tax, and it receives a rebate on its German VAT payments. But an American company exporting to Germany has to pay both—it’s subject to the U.S. corporate income tax and then pays the German VAT on the product when it is sold.

Sounds persuasive, at least until you look at both sides of the equation.

When the German company sells to customers in the U.S., it is subject to the German corporate income tax. The competing American firm selling domestically pays the U.S. corporate income tax. Neither is hit with a VAT. In other words, a level playing field.

Here’s a visual depiction of how the current system works. I include the possibility that that German products sold in America may also get hit by the US corporate income tax (if the German company have a US subsidiary, for instance). What’s most important, though, is that neither American-produced goods and services nor German-produced goods and services are hit by a VAT.

Now let’s consider the flip side.

What if an American company sells to a customer in Germany? The U.S. government imposes the corporate income tax and the German government imposes a VAT. But guess what? The German competitor selling domestically is hit by the German corporate income tax and the German VAT. That’s another level playing field. This explains why economists, on the right and left, repeatedly have debunked the idea that countries use VATs to boost their exports.

Here’s the German version of the map. Once again, I note that it’s possible – depending on the structure of the US company – for American products to get hit by the German corporate income tax. But the key point of the map is to show that American-produced goods and services and German-produced goods and services are subject to the VAT.

By the way, it’s entirely possible that an American company in Germany or a German company in America may pay higher or lower taxes depending on whether there are special penalties or preferences. Those companies may also pay more or less depending on the cleverness of their tax lawyers and tax accountants.

But one thing can be said with total certainty: The absence of an American VAT does not result in a “Made-in-America” tax on American companies. Even Paul Krugman agrees that VATs don’t distort trade.

Moreover, Veronique and I point out that the lack of a VAT creates a big advantage for the United States.

One big plus for Americans is that Washington does not impose a VAT, which would enable government to grow. This is a major reason that the U.S. economy is more vibrant than Europe’s. In Germany, the VAT raises so much tax revenue that the government consumes 44% of gross domestic product—compared with 38% in America.

And to the extent that there is a disadvantage, it’s not because of some sneaky maneuver by foreign governments. It’s because of a self-inflicted wound.

America’s top corporate income tax of 35% is the highest in the developed world. If state corporate income taxes are added, the figure hits nearly 40%, according to the Congressional Budget Office. That compares very unfavorably with other nations. Europe’s average top corporate rate is less than 19%, and the global average is less than 23%… That’s the real “Made in America Tax,” and it’s our own fault.

The column does acknowledge that BAT supporters have their hearts in the right place. They are proposing that new source of revenue to help finance a lower corporate tax rate, as well as expensing.

But there’s a much better way to enable those pro-growth reforms.

If Congress simply limits the growth of outlays to about 2% a year, that would create enough fiscal space to balance the budget over 10 years and adopt a $3 trillion tax cut. If Republicans want a win-win, dropping the border-adjustment tax is the way to get one.

And what if Republicans aren’t willing to restrain spending? Then maybe the sensible approach is to simply cut the corporate tax rate and declare victory.

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The good news is that the House put together an Obamacare-repeal bill that reduced the fiscal burden of government. The bad news is that the legislation didn’t address the regulations and interventions that produce rising costs and sectoral inefficiency because of the third-party payer problem.

Whether the bill was a net plus is now moot since it didn’t have enough votes for approval. And the withdrawal of the legislation has generated a bunch of stories on whether Trump and congressional Republicans are incapable of governing.

In particular since it appears that GOPers also seem incapable of coming to agreement on how to reduce the tax burden. I commented on the dysfunctional state of affairs in this interview with Neil Cavuto.

The bottom line is that there are big divisions. There is (thankfully) a lot of opposition to the border-adjustable tax, and there’s also no agreement on whether the tax plan should be a pure tax cut or whether it should be a revenue-neutral package that finances lower tax rates by eliminating or curtailing undesirable preferences.

Jason Furman, who was the Chairman of Obama’s Council of Economic Advisers, suggest that Republican divisions won’t matter if tax reform becomes a bipartisan issue. But I’m not overly impressed by the five conditions he outlines in a column in today’s Wall Street Journal.

  • “Commit to revenue neutrality and distributional neutrality, as in the 1986 tax reform” – This is a poison pill, mostly because “distributional neutrality” means lawmakers would be constrained by class warfare concerns instead of focusing on how to produce growth. Indeed, this is why the plan put forth by the previous Chairman of the Ways & Means Committee was such a dud.
  • “Focus on business taxes only” – As I mentioned in the interview, I actually think this suggestion makes sense.
  • “For overseas business income, adopt something like a ‘minimum tax.'” – This is another poison pill. It’s designed to preserve worldwide taxation. Moreover, I explained last year that such schemes discriminate against nations with better tax policy.
  • “For domestic business income, adopt something along the lines of the House Republican proposal” – There’s not a lot of detail in the WSJ column, so it’s unclear if Furman is endorsing the notorious BAT from the House plan. He does explicitly endorse expensing over depreciation and he wants to put debt and equity on a level playing field. If that’s all he means, I agree with him.
  • “Incorporate into the bill a real plan for public infrastructure spending” – Since the federal government should not have any role in transportation, I’m obviously not enthusiastic about this proposal. Though if a bit of pork was the price to get an otherwise good bill through the process, I wouldn’t object too strenuously.

It’s unclear if Furman considers the five conditions a package deal. If so, there is zero chance of bipartisanship because Republicans presumably will not agree if they are bound by distributional neutrality.

But if a “business taxes only” agenda can get some Democrats on board, then there may be hope. Especially since that may make a virtue out of necessity, as I suggested in the interview.

And for those who question whether lowering the corporate tax rate is important, here’s an argument-ending chart from a recent Tax Foundation publication. Keep in mind that the U.S. corporate rate (including state levies) is 39 percent.

It’s particularly noteworthy that average corporate tax rates in Europe and Asia are about 20 percent, far lower than the tax burden imposed on companies in the United States.

No wonder many American companies have redomiciled to other nations.

The ultimate answer is to junk the entire tax code and adopt a simple and fair flat tax. The best-possible answer we may get out of dysfunctional Washington is probably a lower corporate rate.

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There are many powerful arguments for junking the internal revenue code and replacing it with a simple and fair flat tax.

  1. It is good to have lower tax rates in order to encourage more productive behavior.
  2. It is good to get rid of double taxation in order to enable saving and investment.
  3. It is good the end distorting preferences in order to reduce economically irrational decisions.

Today, let’s review a feature of good tax reform that involves the second and third bullet points.

Under current law, there is double taxation of corporate income. This means that companies must pay a tax on income, but that the income is then taxed a second time when distributed to the owners of the company (i.e., shareholders).

This means that the effective tax rate is a combination of the corporate income tax rate and the tax rate imposed on dividends. And this higher tax rate is an example of why double taxation discourages capital formation and thus leads to lower wages.

But this double taxation of dividends also creates a distortion because there isn’t double taxation of corporate income that is distributed to bondholders. This means companies have a significant tax-driven incentive to rely on debt, which is risky for them and the overall economy.

Curtis Dubay has a very straightforward explanation of the problem.

In debt financing, a business raises money by issuing debt, usually by selling a bond. In equity financing, a business raises funds by selling a share in the business through the sale of stock. The tax system provides a relative advantage to financing capital expenditures through debt because under current tax law, businesses can deduct their interest payments on the debt instruments, but dividend payments to shareholders are not deductible. Thus, equity is disadvantaged because it is double taxed while debt correctly faces only a single layer of taxation.

By the way, when public finance people write that something is “not deductible” or non-deductible, that simply means it subject to the tax (much as the non-deductibility of imports under the BAT is simply another way of saying there will be a tax levied on all imports).

But I’m digressing. Let’s get back to the analysis. Curtis then explains why it doesn’t make sense to create an incentive for debt.

The double tax on equity makes debt a relatively more attractive way for businesses to finance themselves, all else equal. As a result, businesses will take on more debt than they otherwise might. …This is a serious problem because carrying significant amounts of debt can make businesses less stable during periods when profitability declines. Interest payments on debt are a fixed cost that businesses must pay regardless of their performance. This can be onerous and endanger a business’s solvency when profits fall.

He points out that the sensible way of putting debt and equity on a level playing field is by getting rid of the double tax on dividends, not by imposing a second layer of tax on interest.

…it does not make sense to equalize their tax treatment by eliminating interest deductibility for businesses. Doing so would further suppress economic growth, job creation, and wage increases. Instead, Congress should end the double taxation of income earned through equity financing in tax reform by eliminating taxes on saving and investment, including capital gains and dividends.

Incidentally, what Curtis wrote isn’t some sort of controversial right-wing theory. It’s well understood by every public finance economist.

The International Monetary Fund, for instance, is generally on the left on fiscal issues (and that’s an understatement). Yet in a study published by the IMF, Ruud A. de Mooij outlines the dangers of tax-induced debt.

Most tax systems today contain a “debt bias,” offering a tax advantage for corporations to finance their investments by debt. …One cannot compellingly argue for giving tax preferences to debt based on legal, administrative, or economic considerations. The evidence shows, rather, that debt bias creates significant inequities, complexities, and economic distortions. For instance, it has led to inefficiently high debt-to-equity ratios in corporations. It discriminates against innovative growth firms, impeding stronger economic growth. … recent developments suggest that its costs to public welfare are larger—possibly much larger—than previously thought. …The economic crisis has also made clear the harmful economic effects of excessive levels of debt… These insights make it more urgent to tackle debt bias by means of tax policy reform.

What’s the solution?

Well, just as Curtis Dubay explained, there are two options.

What can be done to mitigate debt bias in the tax code? In a nutshell, it will require either reducing the tax deductibility of interest or introducing similar deductions for equity returns.

And the author of the IMF study agree with Curtis that the way to create neutrality between equity and debt is by using the latter approach.

Abolishing interest deductibility would indeed eliminate debt bias, but it would also introduce new distortions into investment, and implementing it would be very difficult. …The second option, introducing a deduction for corporate equity, has better prospects. …such an allowance would bring other important economic benefits, such as increased investment, higher wages, and higher economic growth.

And Mooij even acknowledges that there’s a Laffer Curve argument for getting rid of the double tax on dividends.

The main obstacle is probably its cost to public revenues, estimated at around 0.5 percent of GDP for an average developed country. …In the long term, the budgetary cost is expected to be significantly smaller, since the favorable economic effects of the policy change would broaden the overall tax base. And in fact, a number of countries have successfully introduced variants of the allowance for corporate equity, suggesting that it is not only conceptually desirable but also practically feasible.

Another study from the International Monetary Fund, authored by Mooij and  Shafik Hebous, highlights the damage caused by luring companies into taking on excessive debt.

Excessive corporate debt levels are a serious macroeconomic stability concern. For instance, high debt can increase the probability of a firm’s bankruptcy in case of an adverse shock… Given this concern about excessive corporate debt, it is hard to understand why almost all tax systems around the world encourage the use of corporate debt over equity. Indeed, most corporate income tax (CIT) systems allow interest expenses, but not returns to equity, to be deducted in calculating corporate tax liability. This asymmetry stimulates corporations to use debt over equity to finance investment.

We get the same explanation of how to address the inequity in the tax treatment of debt and equity.

Effectively, there are two ways in which debt bias can be neutralized: either by treating equity more similar as debt by adding an allowance for corporate equity (ACE); or by treating debt more similar for taxation as equity by denying interest deductibility for corporations.

And we get the same solution. Stop double taxing dividends.

ACE systems have been quite widely advocated by economists and implemented in some countries, such as Belgium, Cyprus, Italy, Switzerland, and Turkey. Evaluations generally suggest that these systems have been effective in reducing debt bias… Yet, many countries are still reluctant to introduce an ACE due to the expected revenue loss.

By the way, the distortionary damage becomes greater when tax rates are onerous.

A recent academic study addresses the added damage of extra debt that occurs when tax rates are high.

For a country like the United States with a relatively high corporate income tax rate (a statutory federal rate of 35%), theory argues that firms in this country should have significant leverage. …The objective of our study is to estimate how much such variation in tax structure arising from global operations explains the variation in capital structure that we observe among US publicly traded multinational firms. …We employ the BEA’s multinational firm data and augment it with international tax data… Using our calculated weighted average tax rate, we include otherwise identified explanatory variables for capital structure and estimate in a multivariate regression setting how much our blended tax rate measure improves our understanding of why capital structure varies across firms and, to a lesser extent, across time. …Economically, this coefficient corresponds to a 7.1% higher book leverage ratio for a firm with a 35% average tax rate over the sample period compared to an otherwise identical firm with a 25% average tax rate. These results demonstrate that, contrary to some of the earlier literature finding that tax effects were negligible, firms that persistently confront high tax rates have significantly more debt, both economically and statistically, than otherwise equivalent firms who persistently face lower corporate income tax rates. …Irrespective of whether we examine leverage ratios based on book values or market values, whether we include cash or not, or if we alternatively examine interest coverage, we find that multinational firms confronting lower tax rates use less debt. The results are not only statistically significant, but the coefficient magnitudes suggest that these effects are first order

There’s some academic jargon in the above excerpt, so I’ll also include this summary of the paper from the Tax Foundation.

A new paper published in the Journal of Financial Economics finds that countries with high tax rates on corporate income also have higher corporate leverage ratios. …Using survey data of multinational corporations from the Bureau of Economic Analysis (BEA), the authors…find that businesses that report their income in high tax jurisdictions have corporate leverage ratios that are substantially higher than those in low tax jurisdictions. More precisely, they find that a business facing an average tax rate of 35% has a leverage ratio that is 7.1% higher than a similar firm facing an average tax rate of 25%.

By the way, here are the results from another IMF study by Mooij about how the debt bias is connected to high tax rates.

We find that, typically, a one percentage point higher tax rate increases the debt-asset ratio by between 0.17 and 0.28. Responses are increasing over time, which suggests that debt bias distortions have become more important.

The bottom line is that the U.S. corporate tax rate is far too high. And when you combine that punitive rate with a distortionary preference for debt over equity, the net result is that we have companies burdened by too much debt, which puts them (and the overall economy) in danger when there’s a downturn.

So the obvious solution (beyond simply lowering the corporate rate, which should be a given) is to get rid of the double tax on dividends.

The good news is that Republicans want to move in that direction.

The not-so-good news is that they are not using the ideal approach. As I noted last year, the “Better Way Plan” proposed by House Republicans is sub-optimal on this issue.

Under current law, companies can deduct the interest they pay and recipients of interest income must pay tax on those funds. This actually is correct treatment, particularly when compared to dividends, which are not deductible to companies (meaning they pay tax on those funds) while also being taxable for recipients. The House GOP plan gets rid of the deduction for interest paid. Combined with the 50 percent exclusion for individual capital income, that basically means the income is getting taxed 1-1/2 times. But that rule would apply equally for shareholders and bondholders, so that pro-debt bias in the tax code would be eliminated.

For what it’s worth, I suggest this approach was acceptable, not only because the debt bias was eliminated, but also because of the other reforms in the plan.

…the revenue generated by disallowing any deduction for interest would be used for pro-growth reforms such as a lower corporate tax rate.

Though I can’t say the same thing about the border-adjustability provision, which is a poison pill for tax reform.

P.S. While the preference for debt is quite harmful, I nonetheless still think the worst distortion in the tax code is the healthcare exclusion.

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