The Enterprise Blog

Two big problems with Obama’s corporate tax proposal

2012-02-22T21:59:25Z

The Obama administration’s plan to cut the corporate rate to 28 percent goes some ways toward improving the competitiveness of the U.S. economy as a destination for investment flows, relative to the other OECD countries. However, the plan also calls for removing loopholes and deductions and doing away with tax credits, etc. While having a simpler, uniform code is certainly desirable from the point of view of economic efficiency, we need to be sure that the base broadening does not raise effective rates for corporations. In other words, the base broadening may more than offset the benefits arising from a reduction in the top rate. As a result, effective tax rates may be higher than what firms face today. In that case, the investment effects would still be negative and there is little chance that the proposal would be a revenue raiser. Even today, effective tax rates in the U.S. are much higher than for the average OECD country, and yet we raise some of the lowest revenues in the OECD from corporate taxes.

The second issue I have is with the imposition of a minimum foreign tax on multinationals. Our current system of international taxation allows firms to be competitive in the global economy by enabling them to defer taxation on foreign profits, until those profits are repatriated to the U.S. parent. As a result, firms can pay taxes at the same rate as other firms operating in that country. With the imposition of the minimum foreign tax, we will end up imposing higher tax rates on U.S. multinationals operating abroad relative to their foreign counterparts, and make them less competitive. This would negatively impact their profitability.

New Romney tax plan goes the full Reagan

2012-02-22T20:08:38Z

Back in January 1983, the Wall Street Journal published an editorial with the headline ”Finally, a Tax Cut,” referring to how the bulk of President Ronald Reagan’s tax reductions didn’t kick in until that year. It was as much an expression of relief as satisfaction.

Well, “finally a tax cut” plan from Mitt Romney. Oh, sure, Romney’s original plan did call for cutting corporate tax rates and capital gains tax rates for middle-incomers. It also called for abolishing the death tax. A nice start, but not nearly bold enough for a nation facing the sorts of economic challenges that America does.

Romney 2.0 goes the full Reagan. The plan’s centerpiece: An across-the-board tax-rate cut of 20 percent, returning the top rate to 28 percent, where it was when Reagan left office in January 1989. In addition, the tax rate for people in the lowest income bracket would drop to 8 percent from 10 percent, and to 20 percent from 25 percent for those Americans in the middle, according to the Wall Street Journal.

And how would Romney pay for the tax cuts? Well, the revenue would come through a combination of faster economic growth and new limits placed on deductions, exemptions, and credits—particularly on higher-income Americans. Indeed, if you are going to cut the corporate rate to 25 percent, as Romney proposes, then you really need to get top marginal rates in that ballpark, too, to avoid avoid creating distortions leading to tax shelter mania. (The Obama White House ignores this in its new corporate tax plan. Team Obama would lower the corporate rate to 28 percent, leaving a huge gap with the 40 percent top marginal individual income tax rate it also wants.)

Is the Romney plan as bold and aggressive as those proposed by Rick Santorum (two individual rates, 28 percent and 10 percent, along with a 17.5 percent corporate rate) and Newt Gingrich (a 15 percent flat income tax, 12.5 percent corporate tax, zero investment taxes)? Certainly not, though it remains to be seen how Romney would alter the vast tangle of tax preferences cluttering up the code. But Romney’s plan would have a much better chance of actually being enacted by the next Congress if he becomes the 45th president of the United States. So Romney should get points for realism.

But part of me wishes Romney would have listened a bit more to economic adviser Glenn Hubbard. In a recent Financial Times op-ed, Hubbard proposed a progressive consumption tax which would “drastically” lower tax rates on dividends and capital gains, along with equalizing the tax treatment of debt and equity. Instead, Romney would leave investment taxes at 15 percent for upper-income taxpayers, while eliminating them for families with an annual income below $200,000. Increasing the child-care tax credit would have been another intriguing option.

(Interestingly, Romney might pay more taxes under his own plan. Hubbard told the WSJ that Romney would direct his Treasury secretary—which might be Hubbard himself—to determine if some part of “carried interest” income from investment funds like Bain Capital should be taxed at regular income tax rates rather than at lower capital gains rates.)

Yet take a step back and consider the following: Romney wants to a) slash income tax rates by 20 percent, b) lower corporate tax rates by 30 percent while slashing corporate welfare, c) reform Social Security by gradually raising the retirement age and indexing benefit growth for higher-income retirees to inflation instead of wages, d) create a premium-support Medicare system for younger workers, and e) cut government spending by $500 billion during his first term. If Romney does become the Republican nominee, he would certainly be running on the boldest GOP agenda since Reagan ’80, maybe ever.

Here’s the new and improved Romney tax cut plan

2012-02-22T18:04:52Z

Here are the details of Mitt Romney’s new tax cut plan. My analysis is coming up:

– Make Permanent, Across-The-Board 20 Percent Cut In Marginal Rates. This bold stroke reduces the tax on the next dollar of income earned for all taxpayers. The new top rate of 28 percent returns to the top rate signed by President Reagan in 1986.

– Promote Savings And Investment For The American People. Mitt Romney will maintain the current 15 percent rate on income from qualified dividends and capital gains. He will cut taxes further on lower- and middle-income Americans by ensuring that families with an annual income below $200,000 will pay no taxes on income from capital gains, interest, and qualified dividends. These low tax rates will create powerful incentives for Americans to save and invest, while spurring business investment and economic growth.

– Abolish The Death Tax. Eliminating the death tax will allow families to pass assets between generations without complicated tax avoidance schemes and without breaking up family businesses.

– Repeal The Alternative Minimum Tax (AMT). The AMT was originally implemented in the 1970s with the purpose of ensuring that the wealthiest of Americans could not artificially reduce their tax burden. But if Congress fails to pass the annual AMT patch, many middle-income Americans will become ensnared in the AMT trap. It should be repealed immediately to eliminate harmful distortions in the tax code, and replaced with a simpler tax system that reduces tax avoidance schemes.

– Cut The Corporate Rate To 25 Percent. It is vital that the U.S. move to quickly reduce the corporate tax rate and put American companies on a level playing field. The high U.S. corporate tax rate handicaps the nation’s overall economy in competition with the rest of the world.

– Strengthen And Make Permanent The R&D Tax Credit. This credit promotes innovation in both manufacturing and non-manufacturing industries, and helps businesses plan their innovation spending. With a strong, permanent credit, companies will now be able to invest for the future with confidence.

– Switch To A Territorial Tax System. The United States taxes income on a worldwide basis, regardless of where it is earned. This worldwide system of taxation sets the U.S. apart from most other OECD countries, which have converted to territorial systems of taxation. Japan and the United Kingdom are two countries that recently traded their worldwide tax systems for territorial systems. This switch will promote U.S. interests in two key ways:

– Repeal The Corporate Alternative Minimum Tax (AMT). One major drawback of the Corporate AMT is its effect of penalizing companies that invest in capital equipment. A growing economy depends on robust capital investment. Unfortunately, corporations that are subject to the Corporate AMT are unfairly hit by strict depreciation rules. Due to this chilling effect on capital investment, the corporate AMT must be fully repealed. Investment will no longer be penalized, spurring labor productivity, an increase in American incomes, and greater economic prosperity.

Sorry, Kevin Drum, even the effective U.S. corporate tax rate is sky high

2012-02-22T19:12:47Z

Over at Mother Jones, the always readable Kevin Drum takes issue with my criticism of President Obama’s new corporate tax plan, which lowers rates but raises corporate taxes by $250 billion:

In this entire thousand-word blast Pethokoukis apparently doesn’t have room to explain the distinction between statutory tax rates and effective rates. But it only takes a sentence or two, so here it is. The statutory rate is the top rate in the tax table. Right now it’s 35% for corporations. The effective rate is what corporations actually pay after their accountants are done combing the tax code for deductions and loopholes. The former is one of the highest in the world. That latter has been falling for years and is now one of the lowest. That’s right! The actual federal income tax paid by corporations is one of the lowest in the world. Even if you think statutory rates are more important, surely this is germane to the conversation?

Thanks, Kevin, for pointing that out! But guess what, the effective average tax rate American corporations pay is also really high, as this 2011 study notes:

We use publicly available financial statement information for 11,602 public corporations from 82 countries from 1988 to 2009 to estimate country-level effective tax rates (ETRs). We find that the location of a multinational and its subsidiaries substantially affects its worldwide ETR. Japanese firms always faced the highest ETRs. U.S. multinationals are among the highest taxed. Multinationals based in tax havens face the lowest taxes. … The findings in this study may hasten the development of U.S. tax reform by showing that U.S. multinational ETRs are among the highest in the world. Moreover, if territorial taxation further lowers the taxes on Japanese and British multinationals, then the U.S. may be forced to provide some tax relief for its multinationals to maintain some level of international tax competitiveness.

And here is a handy table from the study listing statutory and effective corporate tax rates from around the world. Note that the median U.S. effective tax rate is 25 percent for domestic firms and 30 percent for multinational firms vs. 21 percent (DOM) and 22 percent (MNC) for European corporations and 20 percent (DOM) and 19 percent (MNC) for Asian ones.

And a study from last February by AEI’s Kevin Hassett and Aparna Mathur found the following:

The United States is currently underperforming in global tax comparisons. The United States’ top statutory tax rates will soon be the highest in the OECD, and the US effective average and effective marginal tax rates are far above the OECD average. Any effort at corporate tax reform is therefore incomplete without a push toward addressing not only the high statutory rates, but also the relatively high effective average and marginal rates. These rates are the best indicators for capital investors of their true tax liability—much more so than the statutory rates.

By our calculation, the US statutory rate is nearly 10 percentage points higher than the effective average rate and nearly 17 percentage points higher than the effective marginal tax rate. Relative to other OECD countries, the United States is one of the worst performers on this score. The effective average tax rate for all OECD countries excluding the United States is 20.6 percent, while the effective marginal tax rate is 17.3 percent. The corresponding values for the United States are 29 percent and 23.6 percent.

An outstanding American

2012-02-22T16:51:34Z

Congratulations to my friend Vivek Wadhwa, who was just named an Outstanding American by Choice:

The Outstanding American by Choice initiative recognizes the outstanding achievements of naturalized U.S. citizens. Through civic participation, professional achievement, and responsible citizenship, recipients of this honor have demonstrated their commitment to this country and to the common civic values that unite us as Americans.

Vivek wrote about America’s other immigration crisis here.

AEI Elsewhere—Mr. Right eludes the GOP, the hidden danger of substandard medicines, and more

2012-02-22T17:01:39Z

• Jonah Goldberg: “Mr. Right eludes the GOP”
• Roger Bate: “The hidden danger of fake and substandard medicines”
• Maseh Zarif: “It’s no ‘Potemkin’ nuclear enrichment plant”
• Michael Barone: “Loose lips can turn convictions to controversy”
• Michael Auslin: “Witches’ brew at the Financial Times”
• David Shaywitz, M.D.: “Can we really expect innovation from an industry stuck on white male former sales reps? Perhaps.“

Putin’s class warfare

2012-02-22T15:56:24Z

The exploitation of socioeconomic differences for political ends isn’t limited to the United States these days. Russia’s de facto ruler of 12 years, Vladimir Putin, seems to be shifting his electoral strategy a few weeks before the country’s presidential vote. Last month, Putin offered Russia’s restless urban middle class “an invitation to dialogue.” He said that the “economy must be built in a way that citizens with high education and aspirations can find a worthy place in it.” And Putin’s election program devotes plenty of attention to “modernization”—a mantra throughout Dmitry Medvedev’s feeble presidency—and various “entrepreneurial freedoms.”

At the same time, he warned that “a recurring problem in Russian history is the desire of part of the elite to take a leap towards a revolution, rather than work for sequential development.” But Putin’s definition of the elite has changed since Russia’s wave of massive protests began in December, and now extends well beyond the Moscow intelligentsia. To Putin, the elite includes an ungrateful middle class whose living standards rose substantially during the economic expansion that preceded the financial crisis—which Putin attributes to the “stability” of his “managed democracy” rather than oil and natural gas windfalls.

However, what last month seemed like Putin’s effort to placate the middle class has recently given way to an almost exclusive emphasis on the consolidation of his low-income base. These factory employees, farmers, and other blue collar workers spend much of their leisure time watching state television, where news programs depict the anti-Putin protesters as privileged urban elites.

But Putin’s attempts to galvanize support by dividing the country won’t boost his legitimacy, nor will it help him return to the Kremlin under free and fair conditions. Class warfare isn’t a winning strategy. It can’t succeed in Russia and it certainly can’t succeed here at home.

Ben Bernanke, backed in a corner

2012-02-22T15:13:37Z

Ben Bernanke, the chairman of the Federal Reserve, has been having a rough time lately. He’s received criticism from politicians, pundits, and other central bankers, and has been attacked for doing both too much and too little. The actions of the Federal Reserve have not received this much scrutiny in a long time, undoubtedly due to the rising scope of their actions and the heightened sense of urgency surrounding them.

I don’t wish to discuss the legitimacy of the Fed’s past actions. Instead, I want to discuss the actions they will have to take in the next few years. As the economy begins to tentatively recover, the Fed must walk the thin line between encouraging growth and causing uncontrollable inflation. And as Bernanke’s critics reveal, there are arguments for doing more to address both issues.

For inflation hawks, images like this are seriously frightening:

Such a dramatic increase in money supply would lead to dangerous inflation during any normal economic time. However, these are not normal economic times, and expanding the money supply cannot cause inflation while demand is suppressed. So, while the Fed should keep an eye on inflation as the economy recovers, there has been little evidence that rising inflation will warrant action in the short term.

On the other hand, the weak economy still has far to go before it is fully recovered. Improvements in employment and output are good news, but aren’t enough to bring a rapid recovery. More importantly, the lingering weakness stems from a lack of demand, which the Fed is ill-suited to address. Like the proverbial dehydrated horse, it can’t force the markets to expand growth, and further expansionary policies would only serve to feed inflationary pressures when the markets do recover.

So what can Bernanke and the Fed do? I would suggest the simple task of waiting, and making sure not to make promises they aren’t prepared to keep. While a reasoned resolution of Europe’s debt crisis, or a similar solution to our own debt situation, would be helpful, there is little Bernanke can do other than make speeches. He would be best off to let monetary policy be, and prepare a response to rising inflation or a Europe-related confidence crisis; problems that the Fed is well suited to deal with.

Joe McClintock is an intern with the economics department at AEI.

Secret Obama memo wanted the $800 billion stimulus to be—gasp!—$1.8 trillion

2012-02-22T15:40:02Z

It could have been bigger. Much, much bigger.

Back in late 2008, soon-to-be Obama White House economic adviser Christina Romer prepared a policy memo—the contents a mystery until now—about how the new administration should deal with the collapsing economy. Romer thought to really do the job, the stimulus—later called the American Recovery and Reinvestment Act—should have been $1.8 trillion (highlighting for emphasis):

This memo was dug up by Noam Scheiber of The New Republic magazine. Now, Obama never saw that $1.8 trillion number since Larry Summers, who was leading the econ team, thought it was politically impossible:

When Romer showed Summers her $1.7-to-$1.8 trillion figure late the week before the memo was due, he dismissed it as impractical. So Romer spent the next day or two coming up with a reasonable compromise: $1.2 trillion. In a revised document that she sent Summers over the weekend, she included the $1.2 trillion figure, along with two more limited options: about $600 billion and about $850 billion. … But with less than twenty-four hours before the memo needed to be in Obama’s hands, Summers informed her that he was inclined to strike the $1.2 trillion figure. Though Summers, like Romer, believed more stimulus was almost unambiguously better, he also felt that a $1.2 trillion proposal, to say nothing of $1.8 trillion, would be dead on arrival in Congress. Moreover, since Obama’s political operatives were convinced that any stimulus approaching a trillion dollars was hopeless, Summers worried that urging more than this amount would stamp him and Romer as oblivious in their eyes. “$1.2 trillion is nonplanetary,” he told Romer, invoking a Summers-ism for “ludicrous.” “People will think we don’t get it.”

When the economic team finally walked through the contents of the memo with the president-elect on December 16, Romer mentioned her preference for over a trillion dollars. Summers allowed that bigger would be better. But these points were made in passing. “I don’t remember that as part of the discussion,” conceded one member of the economic team in attendance. The final version of the memo had framed the debate around two basic choices—roughly $600 billion and roughly $850 billion—and these were the focus of the conversation. “The option of going well above $800 billion was certainly raised, but it was not discussed extensively,” Romer later recalled in an interview. “We felt the most important thing was to make sure the president-elect was on board with a plan as large as $800 billion.” Neither the memo nor the meeting would have given Obama reason to suspect this amount was arguably $1 trillion too small.

Good heavens. I recently wrote a post about Michael Grabell, a reporter for ProPublica. He documents the many failings of the American Recovery and Reinvestment Act in “Money Well Spent? The Truth Behind the Trillion-Dollar Stimulus, the Biggest Economic Recovery Plan in History.”

In reporting on the stimulus over three years, I traveled to 15 states, interviewed hundreds of people and read through tens of thousands of government documents and project reports. What I found is that the stimulus failed to live up to its promise not because it was too small (as those on the left argue) or because Keynesian economics is obsolete (as those on the right argue), but because it was poorly designed. Even advocates for a bigger stimulus need to acknowledge that their argument is really one about design and presentation.

In short, Big Government screwed up the Big Spend. Joe Biden, Grabell notes, said the stimulus would “literally drop kick us out of the recession.” But Grabell concludes that “the stimulus ultimately failed to do what America expected it to do — bring about a strong, sustainable recovery. The drop kick was shanked.”

And Team Obama wanted it to be $1 trillion bigger?

Why Obama’s corporate tax plan is a total bust

2012-02-22T16:09:20Z

The current U.S. economic recovery is arguably the worst in modern American history. Incomes are flat, housing is moribund, and the past three years have seen the longest stretch of high unemployment in this country since the Great Depression. Yet President Barack Obama—with the backing of Treasury Secretary Timothy Geithner—has the temerity to propose a corporate tax reform plan that would actually raise the tax burden on American business by $250 billion over a decade (and de facto on workers, too) without lowering rates to an internationally competitive level. This is a terrible, terrible plan:

1. The Obama-Geithner plan would lower the statutory corporate tax rate to 28 percent from 35 percent, currently the second-highest among advanced economies. But that would still leave the combined U.S. corporate tax rate—state and federal—at 32.2 percent, far above the OECD combined average of 25 percent. The U.S. combined rate would be a bit below slow-growing Japan and France but above the U.K. and Germany. That’s not nearly good enough. Canada just lowered its corporate tax rate, for instance, to 15 percent. So instead of having the second highest corporate tax rate in the world, the United States would probably be fourth behind Japan, France, and Belgium.

2. The Obama-Geithner plan would establish, according to the New York Times, a minimum tax on multinational corporations’ foreign earnings to discourage “accounting games to shift profits abroad” or actual relocation of production overseas.

So instead of a carrot, Corporate America gets the stick. Instead of lowering the U.S. rate to a competitive level, Obama would raise the penalty on keeping profits overseas. Indeed, the United States is a huge outlier in that it taxes the foreign profits of multinational companies. Here is Obama’s own Jobs Council:

While most other developed nations have adopted territorial systems that exempt most or all foreign income from taxes when they are repatriated, the U.S. subjects all worldwide earnings to the corporate income tax when they are brought home to the U.S. This approach actually encourages U.S. companies to keep their earnings abroad rather than investing them here at home. Adopting a territorial tax system would bring us in line with our trading partners and would eliminate the so-called “lock-out” effect in the current worldwide system of taxation that discourages repatriation and investment of the foreign earnings of American companies in the U.S.

Obama’s debt commission made a similar recommendation.

3. To pay for the lower tax rate, Obama would eliminate ”dozens of tax loopholes and subsidies,” according to Politico. But some of the money would be used to “lower the effective rate on manufacturing to no more than 25 percent, while encouraging greater research and development and the production of clean energy,” according to the Times.

First, the effective manufacturing tax rate would be higher than 25 percent once you add back state taxes. Second, the White House is sticking to its clean energy agenda even as other advanced economies like Germany and Spain are abandoning such wasteful subsidies. Again, this is ideology trumping economic reality.

4. Obama and Geithner apparently still don’t understand how harmful corporate taxes are. Here’s the OECD: “Corporate taxes are found to be most harmful for growth, followed by personal income taxes, and then consumption taxes.”

5. Obama and Geithner apparently still don’t understand who bears the burden of corporate taxes. It’s workers. AEI economists Kevin Hassett and Aparna Mathur have found that “corporate tax rates affect wage levels across countries. Higher corporate taxes lead to lower wages. A 1 percent increase in corporate tax rates is associated with nearly a 1 percent drop in wage rates.”

6. Obama and Geithner apparently don’t understand that “corporate income taxes have a highly significant and negative effect on long-term growth,” according to the Tax Foundation:

7. Obama and Geithner apparently don’t understand that U.S. corporate tax rates are so off the map that the best way to maximize revenue would be to flat out cut the top corporate rate 8.6 percentage points to 26.4 percent. You could then eliminate corporate welfare and take the rate even lower.

8. Obama and Geithner would take the top individual tax rate to 40 percent, leaving a 12 percentage-point gap with the corporate tax rate. This creates a huge incentive for tax sheltering.

Bottom line: Real pro-growth corporate tax policy would eliminate tax breaks, dramatically lower tax rates, and only tax profits earned at home. The Obama plan would actually make the corporate tax code and the U.S. economy less competitive and less productive. But the proposal does neatly fit into the president’s Occupy-inspired campaign theme that wealthy Americans and greedy corporations are to blame for the Great Recession and rising income inequality. Besides, how can Democrats ever raise taxes on the middle-class to pay for all their spending ideas without first socking it to the 1 percent and to business?

Obama had no experience in the private sector before becoming president. The free market is a sort of theoretical construct he learned about in college. But Geithner should know better. He’s had lots of contact with all sorts of executives, both at Treasury and when he ran the New York Federal Reserve Bank. If he has any doubts about this plan, he should resign. And if he doesn’t, he never should have gotten the job in the first place.