U.S. International Tax Policy

Finance, How U.S. International Tax Policy Impacts American Workers, Jobs, and Investment, March 25, 2021

The main feature of the last tax reform, which I call the Tax and Job Cuts Act, was the decrease in the corporate tax rate, which was designed to bring money being held offshore for tax reasons back to the United States, where it could be used for investment in plant and materials, leading to job growth. 

To not pervert incentives toward choosing the corporate form, pass-through provisions were added to the tax code. Thus, taxing the returns from capital from any source would be within the same range, roughly 21%, give or take a to include Affordable Care Act and Pease provisions.

Generally, when doing tax reform, the idea is to lower rates while broadening the base. This was not done in the Job Cuts Act. Without cuts to tax benefits to reward profit, the Act was simply a give-away. 

The impact of the Act was to ring a starting bell in a race to the bottom for other nations to cut their corporate rates further. Now the race is on to find new sources of revenue lost due to this race, like additional tax on online profit.

Whether intentionally or not, the Act was essentially a test of trickle down economics, It failed. 

Even before the pandemic, GDP growth slumped from the 3% range experienced in the last few years of the Obama Administration, which carried over through the first two years of the next administration. The growth remained the same because tx policy had not changed. Changing tax policy took money out of consumption and put it into speculation.  

The cuts overall gave Wall Street the seed money to further fuel cryptocurrency and to bid up the price of exchange traded funds. The new feature in ETFs was the addition of mortgage backed securities which allowed Steve Mnuchin and Wilbur Ross, with their partners, to cash out the value of their single family rental holdings.

Stop me if you have heard this story before. 

Without the pandemic and the associated assistance to prop up the bonds in question, the crypto and EFT bubbles were about to burst.

Investment in savings instruments is not really investment as it exists as part of Gross Domestic Product. GDP is based on productive activity in the real economy: government purchases, household consumption, net exports and investment in plant and equipment.

As an aside, the government's impact comes in more than just buying stuff. It is a major contributor to household consumption through others and including the stuff it buys. It buys or creates natural resources (food, oil, land, and water), supplies, buildings, military assets, health care (military, civil service, old age, disabled, Indian, international, indigent), transportation infrastructure roads, airports, bridges, spaceports, and private capital used to make government purchases.

It also distributes current and future household income via employee salaries, military pay, government pensions, old age, survivors and disability income, interest on government trust funds, contractor pay and benefits, Temporary Assistance to needy Families, Food Stamps, supplemental security income, temporary disability income, refundable income and child credits, pays net interest to bondholders, and distribution of resource payments to tribal nations (land rentals and resource extraction). This amounts to more than half of household income resulting in consumption and savings.

Consumption from these income streams also creates private sector income, leading to consumption and savings (second and third order - which is private sector spending and savings resulting from private sector consumption). All of this leads to investment in land, plant and equipment for household consumption and exports.

Tax collections and double counting are the means by which all this spending goes round and round. The double and triple counting is what is known as the multiplier effect.

Investment in plant and equipment happens when households have money (for example, through a higher minimum wage or child tax credit, so they buy more goods and services. More goods and services on a long term horizon cause manufacturers to purchase what is needed to make more: plant and equipment. 

The cost of funds has no impact on the decision to invest, only on how to raise the money. Firms with an excess of money, but a smaller customer base, will not invest. Firms with an expanding base will find the money. Any investment decision which depends on bringing money back to the US. for tax reasons is probably not wise in the long run.

So where did the money go?  It certainly did not go to workers. GDP the year following the Act declined by 1% (the one year lag is how long it takes for tax and spending changes to circulate through the economy. Answering the question would require an analysis of the executive compensation information provided in the annual reports of firms whose tax rates were reduced. 

To date, I have not seen such an analysis. No think tank who is funded by donations from the holders of capital would ever fund such a thing.

Taxing labor and profit in separate systems generally distorts the allocation between labor and capital. Consumption taxes, by nature, tax all value added at the same rate. This is much better for workers and makes subsidies built into the tax code favoring one or another activity impossible. 

The existence of corporate income tax subsidies carry with them the very justified impression that less well connected industries must pay higher taxes in order to preserve these tax subsidies. Worse is the perception, which would arise with their use in an invoice or subtraction value added taxes (IVAT and SVAT), that such subsidies effectively result in lower wages across the economy. Such a perception, which has some basis in reality, would be certain death for any subsidy.

One must look deeper into the nature of these activities to determine whether a subsidy is justified, or even possible. If subsidized activities are purchased from another firm, the nature of consumption taxes alleviate the need for any subsidy at all, because the VAT paid implicit in the fees for research and exploration would simply be passed through to the next level on the supply chain and would be considered outside expenditures for subtraction VAT calculation and therefore not taxable. 

In the oil industry, if research and exploration is conducted in house, then the labor component of these activities would be taxed under both the IVAT and the SVAAT, as they are currently taxed under personal income and payroll taxes now.

The only real issue is whether the profits or losses from these activities receive special tax treatment. Because profit and loss are not separately calculated under such taxes, which are essentially consumption taxes, the answer must be no. The ability to socialize losses and privatize profits through the SVAT would cease to exist with the tax it is replacing.

To return to the corporate, pass-through, dividend, Pease, Affordable Care Act SM taxes and capital gains taxes, a uniform tax rate will limit gaming. We propose enactment of an Asset Value Added Tax, as described in Attachment Two.

The range of acceptable rates has been narrowing over the past 40 years.  President Reagan set the tax to 28% at the top, with a 33% bubble. Bush 41 settled on a 31% rate, which raised more from the highest incomes but, in a quirk of math, when combined with the impact of the FICA cap, left a proportional tax rate of 30.9% in place for everyone. The increased money from the wealthy still caused later growth.

President Clinton took rates higher (with a top rate on capital at 39.6%). He then cut that rate to 28%, which fueled the tech bubble (our best minds were working on IPOs, not innovation). This led to recession as the bubble burst - and the further cutting of capital tax rates by Bush 43 to 20% (but leaving corporate rates at 35%). Obama put individual capital rates back to 25% (including Pease and ACA SM), which Trump-Ryan notched down by  a bit over 1%. President Biden now proposes a 28% rate for everything (as far as I know - not moving it all to the same rate invites gaming).

We propose an asset value tax with a compromise 26% rate (halfway between the current 24% and the Biden 28%. We also propose higher tier subtraction VAT rates for salaried income, with a top tier rate of 26% on all income over $340,000. At $425,000, additional salary surtaxes paid by individuals would kick in, with a top surtax rate of 26% for salaries over $680,000. At this level, all additional dollars received, whether through asset or salary income, would be taxed at 26%. Shifting to a separate business entity would result in a 26% top rate after $340,000. Setting up multiple businesses to minimize taxation would be penny wise and pound foolish. It would cost more to pay the accountants than to pay the full tax, and anti-abuse language could guard against this.

Why would wealthy taxpayers agree to such reforms? We cannot simply vote in more than the cosmetic reforms proposed by the President and not expect backlash in 2024. As was the case with establishing Social Security, the rich need to want this. I discuss why they should in Attachment Three on the national debt. The issue has come up recently. Let me provide light to balance the heat.

The table is a bit out of date. It is based on the debt figures from last summer and the 2017 tax year. Revisions are ongoing and will be released (with copies to the Committee) within the next six weeks.

Attachment Four discusses how tax reform affects trade, both in terms of union rights and in joining everyone else in using the zero rating of value added taxes for export, making American manufacturing more attractive. We also note how internationally based employee ownership of both subsidiaries and supply chains discourages wage and currency arbitrage, which is the best way to share the gains of reform with workers internationally while removing the incentive to send production outside our borders.

Note that adding border-adjustable goods and services taxes allows the removal of other trade barriers with no loss of jobs. The last four years have shown us an extreme example of how not to use tariffs. The prior administration used economic policy as gunboat diplomacy, but without having a navy.

Attachment: Tax and Job Cuts Act

Attachment: Tax Reform

Attachment: The Debt as Class Warfare

Attachment: Trade Policy