New Mexico Governor Bill Richards, a cabinet member in President Clinton’s administration, made a wildly inaccurate statement in a CNBC interview this morning when he claimed that a President Obama would not want to make "the [existing] tax cuts for corporations permanent".
People are prone to speaking errors, myself included, so I’m not posting this to embarass Gov. Richards. Rather, it belies a fundamental and widespread misunderstanding about our federal tax code, who it falls upon and how, and what the economic effects are. Given how critically important fiscal policy will be in both the next administration and over the next four decades, I felt that this misunderstanding needed to be addressed.
Corporations did receive two significant tax breaks under the current administration, but they were both temporary, and they have both expired. First, they were able to use accelerated depreciation and full tax expensing of certain costs. And second, U.S. multinationals were also able to bring dividends from their operations abroad back into the United States (so-called ‘repatriation of profits’) at a much lower tax rate. Note that both of these provisions, while stimulative of domestic investment by corporations (which is critical to U.S. productivity and employment), did not favor all businesses. For example, non-capital intensive businesses that held no dividends offshore received no direct benefit from these provisions.
Given those facts, I can only assume that Gov. Richards had capital gains and dividend tax rates in mind. BUT THESE TAXES APPLY TO TAXABLE INVESTORS, NOT CORPORATIONS. Essentially, they encourage individuals to become stock market investors. INDIRECTLY, this can have a marginally positive effect on the cost of capital for corporations listed in the U.S., but that’s about it. It’s also very important to note that, in most cases, corporations have still had to pay the higher corporate rate on any realized capital gains and dividends.
Why does this matter? Because capital formation through private business enterprise is absolutely critical to our economic future, and the way that the U.S. taxes those activities is becoming less and less competitive with much of the world. And under the current Congress, it has become quite apparent that we will become even less competitive on that issue (assuming most other countries don’t make worse errors than we do).
Interestingly, New Mexico’s economic performance under Gov. Richards has been pretty good, and one of the keys to this performance has been lowering tax rates. Economists David and Christine Romer of UC Berkeley (we’ll point out again that Mr. Romer is reportedly an advisor to the Obama campaign) have produced research showing that taxes, especially those on corporate income, have a significant negative impact on employment and wages. Using data available on the website of a public-private organization dedicated to attracting businesses to New Mexico, we found that growth in non-farm employment from 2005 to 2006 was 1.8% lower for every 1% rise in a state’s total median tax rate (the sum of the median sales and use, personal income, and corporate income tax rates). Economists, including the Romers, have also found that markets react to the mere news of negative developments in tax policy. Although some blame an "Obama Panic" as a factor in the market’s meltdown, we have been much stronger on the idea of a "110th Congress Panic" since 2007. The possibility that a President Obama would green light some of the lousier ideas that have been emanating from Congress certainly doesn’t help market expectations.
Unfortunately, these obvious connections are not making it into the current political debate. Part of the blame for this can be laid at the feet of some high profile executives’ and directors’ incompetence, and well publicized perceptions of corporate malfeasance; however, we continue to point out that, for example, out of the 5,000 companies in the Wilshire 5000, it’s fair to say that no more than 50 (a very liberal number), or 1%, contributed to the current crisis. Despite that, the immense loss of corporations’ social and political capital mean that the critical changes needed to make our tax code and our economy more competitive are far less likely to occur.
Instead, we’re very clearly headed down a path of public spending as the way to recovery. As we’ve argued before, infrastructure investment is fine and good, but not when the cart of public revenue is placed before the horse of private enterprise. Japan has, for the most part, tried the same approach to crawl out of its longstanding, real estate driven recession that began in 1989-1991. They’ve spent vast sums on public works, while their tax code has remained uncompetitive. The country’s economic performance has been pitiful, and asset prices have yet to recover meaningfully. There is no reason to believe that this approach (as it is currently outlined) will work for the U.S. either, despite the current enthusiasm for it. Moreover, where Japan has traditionally had a healthy household savings rate, U.S. households are still very leveraged. Thus, these public spending plans will be forced to rely heavily upon the goodwill of foreign savers. And remarkably, many of the same politicians who decried the expansion of U.S. debt in recent years (especially, for some peculiar reason, its ownership by the Chinese) are the same folks who are gung-ho to embark on massive public ’stimulus’ plans. As Milton Friedman and my own mother are fond of saying, there ain’t no free lunch. Someone will have to pay the piper, and he’ll be paid through some combination of lower asset values and net worth, higher net unemployment, a marginal drain of human talent, opportunity costs if (as) capital is allocated suboptimally, and inflation or deflation along with associated exchange rate volatility.
URLs:
http://www.nmpartnership.com/data-center/critical-site.php
Uncategorized | art December 1, 2008 | 
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