A good idea packaged wrong

web-gable-tax-hike04Via Memeorandum, I see that President Obama is proposing to cut corporate taxes if Republicans agree to invest in middle-class job programs. Apparently, it’s part of a Grand Bargain to ward off a budget crisis in the fall. (Quick question for all my American friends, how many Grand Bargains and budget crises can one President have?) On its face, it is a good idea.

The U.S. needs to address the quagmire that is their corporate tax regime. Nominally, they have one of the highest corporate tax rates in the world at 35%, but that’s not what corporations tend to pay. The U.S. has a system of tax breaks that results in far lower effective tax rate for corporations. It’s inefficient and opaque. The convoluted nature of the current tax system means serious, clear reform is difficult, if not impossible. The President would be wise to tackle this issue head on, not treat it as a bargaining chip.

Republicans are wise to view the President’s offer with caution. If his intent is to simply cut the nominal corporate tax rate while at the same time eliminating the the special tax breaks corporations receive, the effect will be essentially neutral. Granted, cleaning up the tax code is always a good thing, and doing so without greatly increasing the tax burden of corporations is good as well, but that’s not really much of a compromise in a Grand Negotiation. (Am I capitalizing the right words? It all seems so silly.)

Further, were I a Republican dealmaker, I’d be quite wary of any sort of “middle class job program”. First of all, if the middle class still exists (and I’m not sure it does), I really don’t know what sort of program would create “middle class” jobs. The devil, as they say, will be in the details.

There is an added danger in entangling these two initiatives. Despite what some politicians will be quick to claim, cutting corporate tax rates is not a great tool for job creation. A cut in corporate taxes, along with a simplification of the tax code, should contribute economic expansion, but it’s a leap to say that that will mean a whole bunch more jobs. (And before anyone asks, no, this isn’t some uber-Laffer argument that tax cuts are always good.) Should the jobs program fail (as so many previous attempts have, sadly) creating a smoldering crater of debt, blame for the increase to the deficit may fall upon the tax cut rather than the jobs program.

In the end, the President should try to fix the corporate tax code (not to mention the entire tax code…a boy can dream, y’know) regardless of any Grand Bargains that come along. The economic benefits are worth it even if it doesn’t help him strong-arm Republicans into supporting the jobs program.

Likewise, Republicans should take this as an opportunity to try to cut the effective corporate tax rate, while eliminating complex tax breaks. This is one of the rare times when a pro-business stance will actually result in better public policy. If the President is serious about cleaning up the corporate tax mess and cutting the effective tax rate, a trade off for a jobs program is probably worth it.

Bonus reading: Scott H. Payne discusses the significance of corporate tax cuts with Laval Professor Stephen Gordon.

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18 thoughts on “A good idea packaged wrong

  1. JML,

    I’m admittedly a noob in this area, so please forgive any ignorance I might spout. Thankfully, I’m phrasing most of this in the form of questions so that might hide my obtuseness.

    1.) When we say “corporate taxes”, are those taxes that only apply to “corporations” or all commercial businesses?
    2.) Is it more or less accurate to assume that most taxes levied on businesses and corporations get passed on to consumers?
    3.) When you, and others, question the existence of the middle class, what exactly are you questioning? How can there be no middle class? More precisely, how are you defining middle class? How would you describe people who fall in the middle 50% (or different bands within that 50%) of income and/or wealth?

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    • Middle class has had myriad definitions over the years.
      Perhaps one of the signifiers of middle classedness is homeownership, which has been cratering in this country (due mostly to poor wealth prospects for millenials).

      Another’s wealth. I’ll remind you that someone who rates as “middle class” in income can very easily be in the lower lower class in wealth. Many black/hispanic families fall into this category, and it dramatically affects their quality of life.

      Again, when someone can look at an older metric and say “Middle Class starts at $250,000 K and goes up from there” (to one would assume 6 million, which is where wealth becomes self-sustaining at the moment). It might be prudent to say “this concept has changed dramatically.”

      When only 1/3rd of Americans have a grand in their bank account — I dunno, but I’m pretty sure living paycheck to paycheck isn’t most people’s definition of middle class (particularly with the dramatic rise of health care related bankruptcies).

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    • 1. This is a gross oversimplification, but there are basically two types of businesses, where taxes are concerned. There are pass-through entities, where profits are treated as personal income for the proprietor(s), and there are businesses subject to corporate taxes, after which profits distributed to shareholders are taxed a second time as dividend income. This distinction doesn’t align perfectly with use of the term “corporation.” For example, an S-Corporation has pass-through taxation. But generally speaking, big, publicly-traded businesses are subject to corporate income taxes and small businesses are not, unless they choose to be.

      Incidentally, people often claim that the corporate income tax is the price corporations pay for limited liability. This isn’t true—Limited Liability Companies and S-Corporations have both limited liability and pass-through status, and the requirements to qualify for pass-through taxation are such that most large corporations don’t even have that option (for example, you can have no more than 100 shareholders, and all must be residents of the United States).

      2. Tax incidence theory is hard. But it’s probably shareholders and workers, rather than consumers, and it depends very much on what sorts of investment opportunities are available in other countries, taking into account labor costs, labor productivity, taxation, and other factors. Tim Worstall has a good introduction to the topic.

      3. You could have a bimodal income distribution, but I don’t what what Jonathan means.

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      • Thanks, BB. I appreciate the info.

        So if, for instance, we raised “corporate taxes”, whatever that means, by 10%, what effect, if any, would that have on prices? On wages? A simple, “On average, they’d go up/down/stay the same,” would suffice.

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      • BB,
        I disagree. Any company in a properly functioning market (here’s a hint, there’s not many of ’em) will pass on its increased taxes to its customers. As will all its competitors, because they were all operating at pretty much “minimal pricing.” To do anything else will involve capital (or HR) improvements/investment. You may in the middle/long term incentivize such things.

        If a corporation is unable to raise the price of its product, it’s pretty much already fitting the definition of a monopoly (because it is by definition using a different metric to determine price — generally “ability to pay”).

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      • But yeah. Broadly speaking, corporate taxes are not passed on in the form of higher prices. If corporations could earn more profits just by raising prices, they would have done it already. They don’t aim for some arbitrary target profit level and set prices based on that; they set prices at whatever level they expect to maximize profits, and income taxes are unlikely to change that price level much.

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      • I’m not sure this is correct, Brandon.. It could be that Company X cannot raise the prices of their widget by x%, but only because people would then get their widgets from Company Y. If corporate taxes were raised and both X and Y were affected, then they could raise prices to the extent that the industry itself doesn’t lose business because people go without widgets altogether.

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      • I’m not sure I understand what you’re thinking here. Is it that higher taxes on domestic companies cause them to go under, resulting in a larger market share going to companies abroad? Because I don’t see how higher taxes domestic profits would cause domestic corporations to push manufacturing outside the US. It’s the same as the price argument you made below–if it was profitable to do it, they’d have done it already regardless of taxes on profits.

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      • TF, probably, not necessarily. Sometimes companies don’t make changes that would save money because of status quo bias or a temporary disruption. Theoretically, increased corporate taxes could encourage then to finally “take the plunge.”

        (To use a household example, I switched from telco to Ooma when our income fell. Ooma was always a better deal, but it was only once I had to start taking a look at expenses that I realized it was worth researching out and making the change. I would imagine that companies would me more motivated in this regard, but they’re made of humans that are sometimes change-averse even if there is a potential upside.)

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      • TF:
        The model I have in mind is that investors will invest their capital wherever they believe they can get the highest after-tax return. If two countries are alike in all ways, including tax rates, then investors will invest roughly equally in both countries. But then suppose one county eliminates its corporate income tax. After-tax returns in that country will then be significantly higher, so investors will start investing more in that country and less in others. Which means that over time there will be more production in the tax-free country and less in the other country.

        Actually, on second thought, prices may not actually rise in the country that keeps the corporate income tax. There will be fewer goods produced there, true, but wages will be lower as well. Definitely real prices relative to wages will rise, and consumption will fall, but nominal prices may not actually rise.

        Will:
        But if both companies raise prices, how can the industry not contract? Demand would have to be perfectly inelastic with respect to price at that point on the curve, but if that were the case, why haven’t they raised prices already?

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      • Blaise:
        Because investors don’t want low taxes per se—they want high after-tax returns. Wages in Bermuda are among the highest in the world, so its lack of a corporate income tax is utterly irrelevant—a manufacturer which had to pay its workers Bermuda-level wages would have no profits to tax.

        The lack of shirt factories in Bermuda is very much a testament to the success of its low-tax regime, which has allowed it to attract jobs far more desirable and lucrative than the ones found in Bangladesh.

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      • We may always rely upon you for some asinine conclusion. Bermuda has 20% of its population below the poverty line.

        Have you ever conceived an original thought in your life, Brandon? Or are you some sort of aggregator bot, posting every right-wing crackpot conclusion your search spiders can find? Stick to reactors. That you seem to know something about. There you have something to offer. Fact is, a nation’s corporate tax rate doesn’t have much bearing on investment rate, at best it’s just a minor variable. What a corporation wants is a well-run nation where things are predictable enough for them to operate, where the goddamn power stays on — that really is helpful, which dovetails nicely with what you do know about.

        That nightmare disaster in Bangladesh was caused by an diesel powered electrical generator setting up a resonant harmonic in the building. Shook it to pieces. Maybe if Bangladesh would invest a little more in infrastructure, say, a proper electrical grid, they’d kill fewer workers. Bangladesh is just chock full of enterprising people, Bengali culture is all traders and boatmen since ancient times. If their country was anything like half as well as Vietnam, they’d be a reasonably prosperous nation by now.

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  2. Sometimes companies don’t make changes that would save money because of status quo bias or a temporary disruption. Theoretically, increased corporate taxes could encourage then to finally “take the plunge.”

    That sort of behavior should be vanishingly rare at equilibrium in a competitive market, though. Companies that engage in it to any significant effect will be at a cost disadvantage to companies that don’t. Either the effect is so small that it’s not worth dealing with (like employees chewing pens that have to be replaced), or it’s just as likely to be squeezed out by competition as it is by taxes. It’s certainly down far enough into the noise floor that the problem shouldn’t be a policy consideration.

    Imagine I said that increasing income taxes might substantially change where people buy gasoline because they’ll be hard up for cash and try to find savings at cheaper gas stations. People do in fact engage in weird irrational gas price behaviors (like driving across town to save $0.01 per gallon on a 12 gallon purchase), but the efficiency gain or loss from small shifts in that behavior is negligible. It’s hard to make the argument that the possibility of a shift from Chevron to Arco would be worth considering when deciding on the income tax rate.

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