January 28, 2017
The current corporate income tax is a massive cesspool. There are so many routes for avoidance that it is almost becoming voluntary. This matters not only because we don’t get the revenue we should from the tax, but also because it has created a massive tax avoidance industry.
The tax avoidance industry is a big deal. This is an industry that contributes nothing to the economy. It involves people designing clever tricks to allow corporations to avoid paying their share of taxes.
The tax avoidance industry is also an important source of inequality since it is possible to get very rich designing clever ways to avoid taxes. My colleague Eileen Appelbaum (along with Rose Batt) show how the private equity industry is largely a tax avoidance industry in their recent book Private Equity at Work. Many of the very richest people in the country got their wealth as private equity fund partners.
In his movie, Capitalism: A Love Story, Michael Moore highlighted “dead peasant” insurance policies. This is when a major company like Walmart buys life insurance policies on tens of thousands of front line workers, like checkout clerks. Usually the insuree doesn’t even know of the existence of the policy, but if they die, the company collects.
Moore emphasized the morbid nature of this game, but missed the real story. The point of these policies is to smooth profits, partly to manipulate share prices, but also for tax purposes. The real highlight of this story is that there is someone who likely got very rich by developing dead peasant insurance policies, rather than contributing anything productive to the economy.
I mention this as background to the corporate income tax discussion since to my view a major goal of corporate tax reform is to eliminate the enormous opportunities for gaming that currently exist. These opportunities are making some people very rich and are a complete waste from an economic standpoint.
For this reason, I am sympathetic to the plan the Republicans are debating. In its conception it would be enormous simplification relative to the current system. Of course, that is the conception, we will have to see the plan as it is drafted in legislation to reach any final judgement.
In this vein, I have been unhappy to see some of the attacks leveled by people for whom I have considerable respect, notably Paul Krugman. In a post yesterday, Krugman makes the case that the basic tax proposal would be a subsidy for domestic production and therefore inconsistent with free trade principles.
While I don’t disagree with the logic, I question its importance. He contrasts the border adjustment with the Republican tax proposal with the border adjustment with a traditional value-added tax (VAT), pointing out that the latter doesn’t give a domestic production subsidy in the same way. There are two important points left out of Krugman’s discussion.
The first is the issue of size. VATs in our trading partners typically raise well over ten percent of GDP in revenue and sometimes more than 20 percent. By contrast, the corporate income tax has raised less than 1.7 percent of GDP in recent years. The Republicans are undoubtedly looking to reduce this amount further in their tax reform (hopefully they will not succeed), but the imposition of a tax equal to 15 percent of GDP matters much more for trade than a tax equal to 1.7 percent of GDP. (Suppose the dollar falls or rises by 1.7 percent in a week, as it often does. This has the same impact.)
The second issue is the point of reference. We don’t currently have a VAT in the United States. We have various taxes that are assessed in the production process, including the income tax workers pay on their wages, that get passed on in the price of the product. If we snapped our fingers and replaced the income tax with a value added tax, we would then refund this tax on exported products. That would look like an export subsidy, relative to our current system. Similarly, we would slap the VAT on all items that are imported. That would look like an import tariff, relative to our current system.
Conventionally, economists urge us not to worry about this issue, since changes in currency values will even things out. This is probably true, at least over the long-run, if not immediately in a transition process. This is a situation where we should accept the economists’ conventional wisdom on the net effect on trade, remembering that the amount at stake as an export subsidy or import tariff is just not that large in any case.
The Republican tax proposal, when it is actually put on the table, should be evaluated based on the extent to which it eliminates the waste associated with the tax avoidance industry and also for the amount of revenue it raises. Arguing for its rejection based on it being an unfair subsidy for domestic production is just silly.
There are plenty of very real reasons not to like the things Republicans are putting forward in the Trump administration. We don’t have to invent fake ones.
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