Can Tax Reform Create Jobs?
There is perhaps nothing so politically fraught in this country as taxes. The size of government, the purpose of society, human freedom -- taxation brings up some heavy stuff. Our country was founded thanks to taxes, after all. So naturally, in the political debate over our jobs crisis, taxes has become a recurring theme.
Last year, Tim Pawlenty put forward an economic plan, which claimed that by cutting the top individual tax rate from 35 percent to 25 percent, the top corporate tax rate from 35 percent to 15 percent, and eliminating all taxation on capital gains, interest and dividends, he could double the GDP growth rate and balance the budget.
That's impressive. And widely slammed as impossible.
Most tax specialists are a little more tempered when they talk about the power of tax reform. It'll take time, they say, for any changes to filter down into the decision-making of businesses and entrepreneurs. But changes would happen.
Here are three of the main political talking points on taxes, and what tax experts have to say about them:
Lowering The Corporate Tax Rate
The top marginal corporate tax rate in America is 35 percent. In 19 states, the combined federal and state rates in the highest bracket is over 40 percent. This is the highest marginal corporate tax rate in the Organization for Economic Cooperation and Development (OECD). Many developed countries have been knocking down their corporate tax rates in recent years to seduce multinationals into staying on their soil, but the U.S. hasn't changed its own top tax rate since 1993.
Many conservatives in particular argue that America's high marginal corporate tax rate pushes companies overseas, giving the U.S. no taxes, and no jobs, at all.
"If we lower our corporate tax rate by just a little bit, it's not going to make us more competitive than Switzerland on taxes," says Daniel Mitchell, a senior fellow at the libertarian think tank The Cato Institute, and former economist for Senator Bob Packwood and the Senate Finance Committee. "But we don't have to lower the corporate tax rate to Swiss levels to get benefits."
The last major cut in corporate taxes came under George W. Bush, who lowered taxes on dividends (from 39.6 to 15 percent) and capital gains (from 20 to 15 percent) in 2003. A report from the Congressional Research Service found that average unemployment was the same in the four year period after the tax cuts as in the period 1993-2000.
Bush also signed $136 million in corporate tax breaks into law in 2004, specifically to buttress the American manufacturing industry.
"I signed a bill that's going to help our manufacturers -- that will save $77 billion over the next 10 years for the manufacturing sector of America," Bush said. "That will help keep jobs here."
The U.S. has lost a total of 5.5 million manufacturing jobs since October 2000, but it's difficult to say what, if any, impact Bush's tax package had on this decline; technology has had probably the largest role in displacing workers, particularly ones with jobs that are easily computerized such as assembly line workers.
According to some, the impact of the corporate tax rate on American jobs is overstated. Joseph Rosenberg, a research associate at the non-partisan Tax Policy Center, argues that its effect "on actual investment and hiring decisions is often exaggerated, simply because it's a second-order effect."
"The reason that they have overseas operations is a combination of factors: where demand is, where the price of labor and other inputs are, and other considerations. I would include taxes in that decision, but I wouldn't place it very high up."
Several analysts and organizations, like the conservative nonpartisan American Enterprise Institute, believe that one should look at the effective tax rate, not the marginal one. The "effective" tax rate is the actual tax paid by a corporation, and so is predictably lower. For example, General Electric had $5.1 billion in U.S. profits last year, and paid nothing in taxes. Its marginal tax rate: 35 percent. Its effective tax rate: 0 percent.
America's average effective tax rate, at 23.6 percent, is still above the OECD average, but is lower than the effective tax rates in Spain, Mexico, France, and Japan, according to AEI.
Bruce Bartlett, who held senior policy roles in the Reagan and H.W. Bush administrations, points out that the effective tax rate, when calculated as the amount of GDP that comes from federal revenues, is one of the lowest in the OECD.
"If taxes are low historically and in comparison with our global competitors, how are Republicans to maintain that taxes are excessively high?" Bartlett writes. "They do so by ignoring the effective tax rate and concentrating solely on the statutory tax rate, which is often manipulated to make it appear that rates are much higher than they really are."
Chris Edwards from the Cato Institute counters that this measure of corporate taxes isn't very meaningful. America's low rate just means fewer businesses classify themselves as "'C' corporations" in the U.S., so the government gets less money from them in total.
The Bottom Line: Only one thing is clear: not a lot is clear. There is no robust research on how changes in the corporate tax rate affect employment, and tax policy analysts have a lot of numbers to play with to argue many different points of view.
Cutting Payroll Taxes
Slashing the payroll tax is one of Obama's top initiatives, as laid out in his American Jobs Act, and makes up over half of the bill's cost. He proposes cutting Social Security payroll taxes in half for employers, to 3.1 percent, and taking a similar slice out of workers' share for the company's first $5 million in wages. This "holiday" would expire in 2013.
A Bloomberg News survey found that economists largely support the jobs plan as a whole, and estimated on average that it would add or keep 275,000 workers employed. 85 percent of Americans support the tax cut, according to Gallup, although if the survey question points out that its a Social Security tax cut, support drops to 47 percent.
The Congressional Budget Office Chief Doug Elmendorf gave his own nod of approval, ranking payroll tax cuts, benefiting both employers and employees, as the tax cut with the greatest stimulative power.
Tax experts are more skeptical about the impact of such a short-term tax cut to create jobs. "You have to believe there are a lot of firms who for a small tax cut this year, it's suddenly worth it for them to expand their business and higher a lot of people," says Rosenberg.
"At the end of the day, they need customers, they need people buying their products," he continues. "I'm a little skeptical of claims that taxes will have these dramatic effects, when the real problem is loss of demand."
Mitchell agrees: "The fact that it's just for one year makes it a bit gimmicky. Some companies are probably unlikely to react to a one year gimmick by making permanent changes in their hiring and production considers."
The word from the small businesses is mixed. According to an August survey by the National Federation of Independent Business, 18 percent of respondents said taxes were the single most important problem for business right now. 19 percent said government regulations and red tap, but over a quarter said poor sales.
The Bottom Line: Low consumer demand is the real kicker for business right now, and getting more people on payrolls is one of the solutions. Cutting pay roll taxes may help with that, but we won't know unless the bill can get bipartisan support.
The Estate Tax
The estate tax is the 35 percent tax on a person's "taxable estate" when he or she dies. Only people with taxable estates worth over $5 million, or $10 million for a married couple, owe any estate tax.
Mitt Romney's jobs plan argues that the estate tax kills jobs, because certain family-owned businesses, when they pass down to the next generation, end up breaking apart under the burden of the tax.
This argument isn't so compelling to some tax experts. "I'm sure it has happened," says Rosenberg. "I'm sure you could find a business effected by it. But there are already a lot of provisions in the estate tax code for closely-held businesses and family farms. There already are some special rules."
In general, Rosenberg believes that eliminating the estate tax would have minimal effect on jobs, since it impacts only a small number of people. "These are very large estates, very wealthy people who are affected."
It is precisely this fact that leads Mitchell to believe the estate tax worsen the jobless rate. "I think the estate tax kills jobs," he says matter-of-factly. "You know how left-wing people always complain about how we have a concentration of wealth in our economy? They're right. And they're the ones who have full-time accountants and lawyers."
Mitchell believes that the estate tax wastes resources, since wealthy individuals will employ people to figure out ways to circumvent it. That's a job perhaps, but not an economically productive one. In fact, it's a job that actively takes money away from the government.
"There isn't anyone with income of over $100 million who doesn't have someone working for the full-time with issues like the death tax."
The Bottom Line: The 2011 Congress has introduced at least five bills to repeal the estate tax, but given that the majority of American support increasing taxes on the rich right now, that's unlikely to happen.
In the end, for every tax reform proposal, there will always be a voice out there to protest it and a fist to hammer it down. The political discourse around taxes is just as divisive as tax theory itself.
Rosenberg thinks we should reframe the debate. "There is this bigger context," he says. "We have to raise revenue somehow and cut spending. We have to do a combination of both. The question is not is it good or bad, but is it better than the alternative."
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