The Right Way To Reform Corporate Taxes

This post is largely a comment on a New York Times editorial “The Right Way To Cut Corporate Taxes”. I disagree with the Times’s editorial board. Key parts of the editorial are

“If Republicans worked with Democrats, they could reach a compromise to lower the top corporate tax rate to between 25 percent and 28 percent, eliminated loopholes and reduced the incentive businesses have to take on debt, rather than to use equity to expand.”

Grammar Nazi notes that the compound sentence is not correct. To use an infinitive then continued with a past participle is made an error.

and

“would do even worse. The proposals would close some loopholes but create new ones, like allowing the immediate expensing of new equipment. ”

The logic of the argument is that it is more efficient to have a broad base and low tax rates. It is asserted (or rather implicitly assumed) that taxes impose dead weight losses which are convex in tax rates. This reasoning is not accompanied by any sort of economic analysis or theory (the editorial board made me praise economic theory and I will never forgive them).

In standard theory expensing investment and increasing the rate to keep revenue the same makes perfect sense. It is narrowing the base and raising the rate. By standard pundit assumptions this reduces efficiency. The assumption makes no sense.

Consider a corporation deciding whether to invest. A problem with taxing profits at rate say tau is that it discourages investment as the firm gets only (1-tau) times the pre-tax return. If it is allowed to deduct investment before paying taxes it pays (1-tau) times the cost of the investment. The tax does not distort the decision at all if investment is expensed. Tau can be 99 %m it doesn’t matter.

The Center for Equitable Growth noted that this is a standard argument and conclusion

It is well understood that the effective marginal tax rate on new investment can differ substantially from the statutory tax rate on business income. For example, in the case of a business tax system that allows full expensing—a policy under which businesses may deduct the full cost of any investment in the year the expense is incurred—the business-level effective marginal tax rate is zero, regardless of the statutory rate.

Also cutting the tax rate reduces taxes on the product of old capital. That has no effect on investment decisions which have already been made. It is a windfall for shareholders. There is no reason to give them that money — no corresponding gain in efficiency — no effect on the past. Also cutting the tax rate reduces taxes on markups due to market power (monopoly rents)- This encourages efforts to reduce compentition which the Antitrust division of the Justice Department has only some ability to fight (even assuming Trump and his political appointees don’t interfere as they surely will).

I think a large part of the appeal (aside from pundit group think) is the love of bipartisanship the “If Republicans worked with Democrats”. The problem is that the Republican proposal is almost entirely aweful (except for the one good bit which I defend from the editorial board’s criticism). The Republicans are determined to go the wrong way, Democrats would achieve a better policy outcome by voting no and trying to convince 3 Republican senators than by compromising. Compromise is not good in and of itself and nothing useful can be achieved by trying to work with Republicans.

The mantra of broaden the base and reduce the rates is a declaration of faith. It has no empirical support. It doesn’t even have any theoretical justification. The argument has no merits whatsoever.

On the other hand, I generally agree with the editorial and this op-ed is excellent.

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