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The Dirt On the Corporate Income Tax

23 Tuesday Mar 2021

Posted by pnoetx in Fiscal policy, Tax Incidence

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Alan D. Viard, Biden Administration, Compliance Costs, corporate income tax, Edward Lane, Investment Incentives, Joseph Sullivan, L. Randall Wray, Milton Friedman, Off-Shoring, Peggy Musgrave, Physical Capital, Pricing Power, Regressive Tax, Richard Musgrave, Shifting the Burden, Tax Avoidance, Tax Foundation, Transfer Pricing, Transparency

The Biden Administration is proposing a substantial increase in the corporate income tax rate from 21% to 28%. This is another case of a self-destructive policy that serves as a virtue signal to the progressive Left. See? We’re taxing the rich and their powerful corporations! What none of them realize is that the tax on corporate income is actually a regressive tax on consumers and workers; it is a disincentive to the formation of productive capital; and it is a highly wasteful tax due to compliance costs and the impact of avoidance. And the Biden proposal would make the U.S. less competitive internationally, as the chart above from Joseph Sullivan demonstrates. Maybe some of the proponents realize it, but they still like it because it sounds so good to their base!

It’s not as if all these unhealthy characteristics of the corporate tax are new findings. Milton Friedman explained some of the basics in 1971 when he said:

“The elementary fact is that ‘business’ does not and cannot pay taxes. Only people can pay taxes. Corporate officials may sign the check, but the money that they forward to Internal Revenue comes from the corporation’s employees, customers or stockholders. A corporation is a pure intermediary through which its employees, customers and stockholders cooperate for their mutual benefit.”

In 1984, two giants of public finance economics, Richard and Peggy Musgrave, investigated how the corporate tax was shifted to households. Here’s a description of their findings from a recent paper by Edward Lane and L. Randall Wray:

“… the bottom quintile pays 4.6–5.5 percent of its income toward the corporate profits tax, the top decile pays 2.5–3.7 percent of its income, and the ninth decile pays 2.4–2.9 percent of its income. They conclude that the corporate profits tax is largely regressive while the federal personal income tax is progressive.”

The incidence of the corporate tax rate falls primarily on workers in the form of lower wages and lost jobs, and on consumers in the form of higher prices. Lane and Wray cite several influential studies over the years showing a substantial negative association between corporate taxes and wages. As the authors note, major corporations often have pricing power in both product and labor markets, at least relative to their power in capital markets where they must raise capital. Capital markets are highly competitive, so they don’t provide much opportunity for shifting the burden of the tax to owners of equity and debt. There are limits on a firm’s ability to pass the tax along to customers and workers as well, of course, but shareholders are relatively well-insulated from the burden of the tax.

There are still other reasons to avoid increasing the corporate income tax rate. It currently raises about $200 billion annually for the U.S. Treasury, or about 7% of estimated federal tax revenue for the 2021 fiscal year. It also has extremely high compliance costs. Lane and Wray quote a 2016 Tax Foundation estimate that U.S. businesses face tax compliance costs on the order of $193 billion a year. Not all of that figure applies to corporations, and not all of it is for federal tax compliance, but a great deal of it is. There are also a number of ways the tax can be avoided, such as off-shoring operations and using overstated transfer prices of inputs obtained from units overseas. This is not an economically efficient way to generate tax revenue.

Moreover, the corporate income tax creates perverse incentives. When new investment in productive, physical capital is penalized at the margin, you can expect less capital investment, lower wages, and fewer jobs. Alan D. Viard explains that the dynamics of this mechanism take time to play out, but the longer-run decay in the capital stock is perhaps the most damaging aspect of a high corporate tax rate. And indeed, while there are probably short-run effects, the reduction in the incentive to invest is the real mechanism linking a higher corporate tax to reduced wages and higher prices, not to mention reduced economic growth.

Finally, there is a pernicious political-economic aspect of the corporate income tax owing to the difficulty for the general public in identifying its true incidence. This was also discussed by Milton Friedman:

“… Indirect effects make it difficult to know who ‘really’ pays any tax. But this difficulty is greatest for taxes levied on business. That fact is at one and the same time the chief political appeal of the corporation income tax, and its chief political defect. The politician can levy taxes, as it appears, on no one, yet obtain revenue. The result is political irresponsibility. Levying most taxes directly on individuals would make it far clearer who pays for government programs.

If the government intends to tax the owners of corporate wealth (a significant share of which is held in retirement savings accounts), it should be honest about doing so. That would mean taxing capital income in a more consolidated way, as Lane and Wray put it, at the individual level. That kind of transparency might be too much to hope for because the politics of doing so are much less favorable.

Meanwhile, the Biden Administration wants to have it all: higher corporate taxes and higher taxes on relatively high-earning individuals. But a significant burden of the corporate tax increase ultimately is shifted to individual workers and consumers. It is a regressive tax, and it is an inefficient tax with outrageously high compliance costs. It is a destructive tax because it undermines the economy’s growth in productive capacity. And it offers tax revenue to politicians who have little budgetary resolve, and with little political consequence.

The Incredible Glibness of Being Gruber

16 Tuesday Dec 2014

Posted by pnoetx in Uncategorized

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ACA, Darrell Issa, federal subsidies, House Oversight Committee, Jonathan Gruber, King vs. Burwell, Obamacare, Peter Suderman, Reason, Transparency

Gruber Comic

Jonathan Gruber is apparently a man of contradictions. He told a congressional committee last week that he “did not write any part of the Affordable Care Act.” He was asked at the hearing why he had claimed in 2012 that he did write part of the law. According to Peter Suderman, writing in Reason, Gruber replied “that it was ‘an effort to seem more important than I was,’ and that he was ‘speaking glibly.’” Video evidence of Gruber’s glibbery keeps stacking up in the wake of his sworn testimony.  He made the same “glib” claim at least twice in 2010 and again in 2012. In those videos, Gruber seemed pleased to issue disclaimers to his econ classes at MIT and other audiences that he “helped write” the ACA (Obamacare). From Suderman:

“There is no way to reconcile his multiple past statements with the statements he made this week while under oath. Either Gruber spent two years lying about his role in writing the law, or he was lying this week in his sworn congressional testimony.”

Now, Gruber has been subpoenaed again by the House Oversight Committee, this time in relation to his work and the income he earned as an Obamacare advisor. However, the subpoena covers all documents and exchanges with government employees, including work product, the results of economic model simulations, and any communications related to contracts and the funding of his research. Poor Gruber is in hot water. Lying to Congress, if that charge were pressed, could earn him up to five years in prison.

Of greater importance is that he very likely furnished the administration, as the law was being drafted, with economic projections showing that some existing private health plans would be cancelled. In his testimony last week, he admitted that his model simulations showed as much. Of course, President Obama was quite glib in his repeated assertions that “if you like your health plan, you can keep your health plan.” From Reason:

“Shouldn’t that mean that Gruber knew that administration’s repeated promises that those who like their health plans could keep their plans under the law weren’t true? 

Gruber was asked about the promise…. ‘I interpreted the administration’s comments as saying that for the vast majority of Americans the law would not affect the productive health insurance arrangements that they have,’ he said. ‘I did not see a problem with the administration’s statement.’

Of course he didn’t. Gruber is, after all, someone who argued that ‘lack of transparency’ was key to passing the health law.”

In fact, on the question of lost coverage, Gruber’s own comic book on the ACA made the same assurances as the Administration. See the frame at the top of this post! More contradiction.

Another crucial point is that Gruber claimed to have written the part of the ACA related to state health insurance exchanges. He stated on multiple occasions (captured on video) that the federal health insurance subsidies created by the ACA were intended as incentives for states to create their own exchanges. The “plain language of the law” is consistent with that claim; it is explicit in providing for subsidies only when a policy is purchased through a state exchange, not a federal exchange. Next year, the Supreme Court will hear the case King vs. Burwell, which turns upon whether the law itself disqualifies ACA insurance buyers in 36 states from collecting federal subsidies. Gruber’s videos appear to be quite damaging to the government’s case.

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