Canada: Tax Competition from the North

Canada’s Ministry of Finance has rolled out a nice set of tax measures for 2008. Some of the tastier morsels are excerpted below. The full report can be read here.

  • An historic reduction in the general federal corporate income tax rate to 15 per cent by 2012, starting with a 1-percentage-point reduction in the rate in 2008 beyond already scheduled reductions.
  • A reduction in the small business income tax rate to 11 per cent in 2008, one year earlier than scheduled.
  • An increase in the lifetime capital gains exemption for small business owners, farmers and fishers to $750,000.
  • A reduction in the tax remittance and filing requirements for small business.

Economist: “Agflation”

Interesting cover story and series on rising food prices from The Economist. From the lead-in of "Cheap No More":

Rising incomes in Asia and ethanol subsidies in America have put an end to a long era of falling food prices…

And from "The End of Cheap Food":

Rising food prices are a threat to many; they also present the world with an enormous opportunity…

In the latter article, the magazine provides no cover to government policy makers, especially in the developed world:

With agflation, policy has reached a new level of self-parody. Take America’s supposedly verdant ethanol subsidies. It is not just that they are supporting a relatively dirty version of ethanol (far better to import Brazil’s sugar-based liquor); they are also offsetting older grain subsidies that lowered prices by encouraging overproduction. Intervention multiplies like lies. Now countries such as Russia and Venezuela have imposed price controls—an aid to consumers—to offset America’s aid to ethanol producers. Meanwhile, high grain prices are persuading people to clear forests to plant more maize…

And it provides some important guidance on the direction farm agricultural (and by extension, energy) policies ought to take, in a section entitled "Where government help is really needed":

Three-quarters of the world’s poor live in rural areas. The depressed world prices created by farm policies over the past few decades have had a devastating effect. There has been a long-term fall in investment in farming and the things that sustain it, such as irrigation. The share of public spending going to agriculture in developing countries has fallen by half since 1980. Poor countries that used to export food now import it.

Reducing subsidies in the West would help reverse this. The World Bank reckons that if you free up agricultural trade, the prices of things poor countries specialise in (like cotton) would rise and developing countries would capture the gains…And because farming accounts for two-thirds of jobs in the poorest countries, it is the most important contributor to the early stages of economic growth…the really poor get three times as much extra income from an increase in farm productivity as from the same gain in industry or services…

In our view, "agflation" has also been helped along by easy policy stances among the world’s major central banks, and increasing investment and growth in developing economies. Note that food prices are not the only commodities experiencing historically high price levels. Non-food agro, gold, and oil are also higher by double digits in The Economist’s latest commodity price index.

7th District Court: North Pole Next?

A recent U.S. Tax Court ruling determined that income earned at the South Pole is not exempt from U.S. taxes:  

As Antarctica is not a foreign country for purposes of the Code, we conclude that petitioner is not entitled to exclude the wage income he earned in Antarctica… http://www.bigdeadplace.com/seventhcircuit.pdf

While the case is certainly of interest to those who make a living at the South Pole, our immediate concern was what this might mean to denizens of the North Pole. Is it time for Santa and his elves to file W-2’s with the IRS, and start paying withholding? What about back taxes?! This could get ugly, folks.

No one at the North Pole was available for comment. Too busy trying to figure out if they can afford a good tax attorney, perhaps…

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WSJ: Corporate Tax War

With polling data indicating that the U.S. economy is becoming the most pressing topic for voters, the Wall Street Journal offered an important editorial yesterday on corporate tax rates: http://online.wsj.com/article/SB119673397691112663.html (subscription required). The article focuses on a growing body of research on the economic effects of high relative corporate tax rates, citing a recent NBER study:

The authors conclude that "corporate taxation reduces the return on capital and thus discourages investment" and "reduces the cash flow of the firm" in such ways as to reduce the after-tax capital available for reinvestments.

That would be good enough, but the editorial board included a critical observation on the proposed tax reforms coming out of Congress, where lower corporate tax rates are proposed, but alongside higher personal tax rates. This is despite the fact that many forms of business, especially among small to medium size firms (including ours), are subject to the personal income tax schedule, and not corporate taxes. The obvious implication is that, using Chairman Rangel’s proposal as an example, the business tax burden would be tilted away from large corporations and onto smaller businesses (hardly a populist prescription). Furthermore, it is highly questionable whether the Rangel proposal lowers corporate tax rates to a level that would meaningfully improve America’s competitive position in business taxes. In all, the net economic effects of the Rangel plan do not appear to be desirable in the least, as its hoped-for redistributive effects simply can’t work in a competitive global financial economy:

…raising the U.S. personal income tax rates would also stunt small business entrepreneurship…In Mr. Rangel’s case, the benefits of his cut in the corporate tax…to 30% would be offset…by raising the top marginal tax rate on individuals and small businesses to as high as 44%. The NBER research suggests this could discourage hundreds of thousands of small businesses from being formed in the next few years.

Of course, the WSJ is outlining the extreme case here–few new businesses are likely to incur the top marginal tax rate right away, after all. And most would simply reorganize once they start approaching that level of profitability. However, imposing such a necessity on highly productive enterprises is an undeniable misallocation of capital, with dead weight costs for the national economy.

Summing it up, there are at least three critical takeaways. Ideally, our tax code would not extract income from productive activities, but as long as it does, the following objectives would help to ensure the best long-term economic results: 

(1) level the playing field between the U.S. and all other economies with respect to business taxes

(2) level the playing field between large and small businesses in the U.S.

(3) make the choice of corporate organization independent of the tax code

An additional benefit that is rarely ever mentioned in regards to the tax code, is that these objectives would also support the value of the U.S. dollar, another issue that promises to play a role in the 2008 elections.

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