Raymond Richman - Jesse Richman - Howard Richman
Richmans' Trade and Taxes Blog
Cutting the Corporate Income Tax Will Not Create Jobs, Jobs, Jobs
The corporate income tax cut being considered by the Congress will accomplish none of the goals claimed for it. It will not stimulate the economy and create jobs, it will not do anything to balance trade, it will cause the federal budget deficit to grow, it will worsen the already unequal distribution of income. The President seems to have bought the ideas of some economists called supply-siders who assert that the economic growth stimulated by the tax cut will more than offset the initial loss of revenue. Most economists disagree asserting that if growth occurs, it will because of other forces. Most economists agree that the corporate tax lacks interpersonal equity, has negative economic effects, and worsens the distribution of income. These negative characteristics can be avoided by eliminating the corporate income tax and taxing corporate earnings as the personal income of the shareholders, just as partnership earnings are currently treated.
One of the criticisms economists make of the corporate income tax is that shareholders of modest incomes pay the same rate of tax as those in the highest personal income tax bracket pay. In fact, those in the top personal income tax bracket are favored because corporate earnings are now taxed at a top rate of 35% compared with 39.6%, the top rate of personal income tax. Corporate stock is highly concentrated in the hands of the wealthy. Thus the corporate income tax makes it easier for the wealthy to become more wealthy than if they paid the personal income tax rate on corporate earnings, while those of middle income find it more difficult to provide enough for their retirement. The pension funds owned by middle income families are invested mostly in corporations whose incomes are taxed at 35% by the corporate income tax when they as individuals may be in the 20 percent personal income bracket. How much faster their retirement funds would grow if their share of corporate earnings were taxed at the rate of 20% instead of 35%/, as they would be if corporate earnings were taxed as personal income.
Corporations would pay the Treasury the top rate of personal income tax on its earnings and shareholders would be credited with the tax paid by the corporations on their behalf. The most wealthy taxpayers would pay more than the 35% to corporate rate, 39.6%. Less wealthy taxpayers, say those in the 20% personal income tax bracket would get a tax credit for the excess tax paid to use as a credit against their other taxable income. To illustrate how this would work, in 2016 Amazon Corporation had 474 million shares of stock outstanding and had net earnings before tax of $3,892 million or $3.25 per share. Suppose all the earnings were taxed at 39.6%, Amazon would pay $1,541 billion to the federal government as withholding of personal income tax or 3.25 per share. If a shareholder owned 100 shares, he would report income from Amazon of $821 and receive a tax credit of $325, while those in the 20% personal income tax bracket would pay $164 and apply the excess paid as a tax credit against his other income. The result is a substantial increase in progressivity.
There no need for government revenues to fall if the corporate income tax were eliminated. Since the wealthy own much more of the stock of corporations and since they pay a higher rate of personal income tax, their burden would increase. Shareholders in brackets below 35% would pay less in personal income taxes. On balance, not much revenue if any would be lost. There might even be some gain in total government revenue.
Negative effects of the corporate income tax as currently structured include the incentive to corporations to borrow capital rather than raise capital by the sales of equity since interest is an expense of doing business and deductible in the calculation of corporate net income subject to tax while dividends are not deductible. And, to avoid payment of the personal income tax on dividends by shareholders, corporations in recent decades have increasingly paid dividends in the form of buy-backs of their own shares which tends to raise share prices and enable shareholders to realize capital gains taxed at a lower rate than other income. Taxing corporate income as personal income nullifies such tax avoidance practices.
A corporate income tax cut will not be much of a stimulus to economic growth because it will not stimulate real investment. Corporations will have more money to spend after tax enabling corporations to increase dividends and buybacks, increase real investment, and buy existing assets. But only increased real investment provides job growth. Corporate investment in real capital—machinery, factories—has continued to be very low in spite of the fact that they have enormous cash on their balance sheets. There is a lack of investment opportunities in the U.S. for a variety of reasons. Domestic real investment has stagnated in spite of the stimulating polices pursued by the federal government, running budget deficits, and the Fed’s keeping interest rates near zero. For such policies and tax cuts to be effective, there has to be profitable opportunities for investment. They do not create new investment opportunities. The growth rate during the last quarter of 2016 was abysmal, an annual rate of 2.1% in December, 2016 and only 0.7% in January, 2017.
The proposed corporate income tax cut will aggravate the existing unequal distribution of income. Shareholder anticipation of the proposed corporate income tax cut has caused the prices of corporate shares of stock and income real estate. After all, the value of a capital asset is the capitalized value of its expected future income. The ownership of corporate shares and of commercial real estate is highly concentrated in the hands of the wealthy. Cutting the corporate income tax rate will raise asset prices of existing securities and real estate, making the rich richer and workingmen no better off.
Proponents of income tax cuts argue that cutting the corporate tax rate would make American businesses more competitive vis a vis their foreign competitors. It is claimed that reducing the corporate income tax will stimulate exports. This claim has little basis because in the absence of tariffs and non-tariff barriers and subsidies, existing relative costs of production with prospective trade partners are not affected at all by income taxes in either country. What makes businesses more competitive are lower average and marginal costs of production than its competitors. Tax cuts have no effect on the costs of producing goods.
The principal causes of the chronic trade deficits the USA has experienced during the past several decades are invisible barriers to trade, subsidies to exporting industries, and an overvalued dollar. Whatever the reason, single-country-variable tariffs, the so-called Scaled Tariffs, which we introduced in our book Balanced Trade (Lexington Books, 2014), are the appropriate policy for any country experiencing chronic trade deficits. Since all multi-country trade agreements have most-favored-nation clauses, if a tariff is reduced for one trading partner, it must also be lowered for all. Under the rules of the World Trade Organization, temporary increases in tariffs may be applied by any trading partners on another with which it is experiencing chronic trade deficits.
Tax cuts will not balance trade, but a single-country-variable tariff, will produce balanced trade and while trade continues to be unbalance, will produce substantial revenues by the temporary tariff on imports. In any case, a half dozen trade partners accounted for $677 billion or 92 percent of our total trade deficit in 2016 of $734 billion. The trade deficit for China amounted to $347 billion; the European Union; $146 billion (Germany, $65 billion), Japan, $68.9 billion; Mexico, $63 billion; S. Korea, $28 billion; and India, $24 billion. There is no need for the proposed border tax which would put of tariff on imports from countries with which we have a trade surplus, like Hungary, the Netherlands, the U.K., Hong Kong, Brazil, and Chile. Besides, our State sales taxes (average 7 percent) are already a border tax.)
Reliance on income tax cuts to stimulate economic growth is totally without any economic justification. The Congress and the administration should concentrate their efforts on the causes of the U.S. economic stagnation. They do not include high corporate income taxes (or, for that matter, high personal income taxes either. But that's a blog for another day.)
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