The House Financial Servcies Committee is hearing testimony from Fed chairman Bernanke this morning. Committee chair Barney Frank, in opening remarks, acknowledged serious concerns over trade policy, and made it clear that ongoing commitment to free trade will require a compromise on social safety net issues. He explicitly mentioned health care, and made the reasonable sounding argument that the risks and benefits of trade need to be more fairly shared. Of course, the measure of fairness, and his stated objective of "trade, properly conducted", are a bit more worrisome, simply because the concepts need to be more clearly defined, and at the moment, a single party wields almost exclusive power to do so. Recall the power that the prior administration had over concepts such as ‘victory’ and ‘progress’ prior to the 2006 Congressional elections!
Still, as we noted recently, Frank’s statesmanship seems to have taken a notable leap forward since the start of this session, and he seems to have some good insights into the financial crisis (CRA and GSE’s excluded), and a very good grasp of where the regulatory gaps exist and how they ought to be filled. If he’s listening, we would simply point to some credible research by CEA chairwoman Romer that the burden of corporate taxes seems to fall disproportionately on the incomes of workers. We believe that that factor is the most compelling explanation for some Americans falling behind as global trade has expanded. If rising employment and incomes are the political objective, then the state of the corporate tax code – indeed, the entire U.S. tax code – should be the focus.
There are some aspects of our argument that I want to emphasize, lest we be called ‘Economic Flat Earthers‘. First, the U.S. corporate tax burden means little in isolation – it is the relative burden that determines the marginal impact on capital flows, investment, and ultimately, production and employment. Outside of 2003 and 2004, the trend has been disturbing:
In 2006, in the wake of the temporarily lower 2003-2004 corporate tax burden, the New York Times reported a fact that would undoubtedly surprise the hurlers of ‘flat earth’ and ‘wing nut‘ aspersions: "Tax revenues are climbing twice as fast as the administration predicted in February, so fast that the budget deficit could actually decline this year. The main reason is a big spike in corporate tax receipts, which have nearly tripled since 2003…" That outcome certainly upended the pessimistic forecasts of the CBPP in 2003. Granted, that increase was accelerated by the low but temporary rate on repatriated profits. However, we predict that a more competitive corporate tax code would have a very favorable effect on the overall production of public revenues, especially when this country’s other advantages are taken into account. We have a lot to trade on. We shouldn’t allow our tax code to prevent us from capitalizing on them.
A common rebuttal to this argument is that the effective tax rate is the one that matters, and that on that metric, the U.S. is one of the least burdensome tax authorities. Yes, effective and marginal tax rates are very different, and are both important, but let’s think this through. First, there is far less disagreement over microeconomic theory than there is over macroeconomics, meaning that marginalism is alive and well in most economic schools of thought, and that precious few economists would argue against the idea that when it comes to decision making, everything happens at the margin. Second, tax rules vary widely between countries, and the U.S. has some of the most complex ones, as well as a fairly bizarre bracket structure. This only worsens the confusion and uncertainty associated with predicting the tax effects of any business decision, whether marginal or effective, and it does nothing positive for the overall level of investment. Third, the effective tax rate argument ignores the opportunity costs imposed on a country by its corporate tax code. For example, many ventures, especially those that hire less skilled employees, do not begin until certain tax credits, subsidies, and/or other guarantees have been successfully negotiated. One way to look at this is that if all business investment were domestic and proceeded without consideration of the tax code, the effective rate would begin to converge to the marginal rate(s). Another perspective is that if the marginal statutory rate were more competitive, more domestic investment would occur; indeed, one could even hypothesize that the gap between the marginal and effective corporate tax rates is itself an indication of the opportunity costs imposed. Lastly, opponents often overlook entirely the aggregate costs imposed by all business related taxes (e.g., payroll and a variety of state and local taxes) and regulations that dictate the allocation of a significant share of resources. Left leaning critics should be mindful of the risk that these kinds of barriers are more beneficial than harmful to ‘big business’, as they tend to limit competition.
This stuff isn’t rocket science, folks, and it’s far too important to be subjected to either the airy claims of cheerleaders or the caustic jeers of opposing sycophants. We’re fiercely independent, and not trying to pick a political fight with anyone. In fact, one of the most important things we’ve learned, via ‘wing nut’ extraordinaire Jude Wanniski, is that our political system is designed to produce optimal outcomes. Thus, the way we see it, Democrats control the Executive and Legislative branches precisely because that was the best of all possible outcomes as of November 2008. We’re just throwing in our citizen’s two cents on an issue that we think is extremely pressing, widely overlooked, and poorly framed by most of its advocates, because we think it would have a broad, positive, and significant impact on our current economic malaise.