In judging "what will the candidate tax plans mean for me?" voters tend to focus on the promises of middle class tax cuts, despite the fact that for most Americans the cuts floated so far would amount to $1,000 or less, and despite the fact that with our huge government deficit, these tax reductions will have to be repaid by ourselves or by our children. For skilled employees, the more significant issue is corporate tax policy. The U.S. corporate tax has a powerful effect on wages. This has been demonstrated by various economists, including Senator Obama's chief tax adviser, Austan Goolsbee, in his paper "Investment Tax Subsidies and the Wages of Capital Goods Workers: To the Workers Go the Spoils?", and by the U.S. Treasury Office of Tax Policy.
The mechanism is quite simple, flowing from basic supply and demand. With the rise of world education rates and globalization, if a corporation is deciding where to place a valuable manufacturing or research operation, it may choose between placing it in the United States at a 35% federal tax rate or in a variety of other countries, several of which have tax rates ranging from 12.5% (Ireland) down to 0% incentive rates (Switzerland, Singapore, etc.). As Senator McCain noted in the first debate, given a choice between locating in the United States or Ireland, most rational corporations will choose Ireland. This reduces the demand for U.S. workers, and thus undercuts their market power. In consequence, while the U.S. has had large productivity gains over the last 30 years, incomes for 99% of the population have remained flat, on average. That effect started with less skilled jobs, but has been gradually moving up the scale and now includes most college educated employees.
In contrast, taxing high income individuals has very little long term negative effect on the economy. Professor Goolsbee has demonstrated in his paper "What Happens When You Tax the Rich? Evidence from Executive Compensation" that the impacts often cited by economists are mostly short term adjustments as wealthy individuals accelerate or postpone stock option exercises and other flexible income at the time of the rate change. Therefore, shifting the tax burden from corporations to high income individuals, without changing the overall tax take, would have a profound positive effect on the market power of American workers, encouraging corporations not only to bring home hundreds of billions of dollars in cash but to greatly expand valuable U.S. economic activity and good jobs. This would be a large and permanent effect, not a debt funded little goody that would need to be repaid later.
However, the form of any such trade off is extremely important. If corporate tax rates are reduced as such, then corporations become a way to shelter income for the rich, and cash will be even more locked up in corporations than it is now. However, if we give corporations a deduction for paying dividends while otherwise keeping the corporate tax rate intact, we would get all of the benefits of shifting the corporate tax burden to high income individuals without the bad side effects of a rate reduction.
Where do the candidates stand on this? Senator McCain acknowledges the effect of corporate taxation on American workers, but offers a limited response. He proposes to reduce corporate tax rates from 35% down to 25%, with no offset at the individual level. As noted above, this would encourage the use of corporations as tax shelters and would tend to lock up cash. Further, it is not enough. Given a choice between building in the U.S. at a 25% tax rate or in Singapore at zero, corporations would still favor Singapore. Further, since the McCain plan does not balance the revenue loss, the tax reduction would need to be repaid eventually.
Senator Obama's position is less clear. He supports a piece of legislation that would provide a limited tax credit to corporations that meet a number of hurdles. Unfortunately, corporations generally do not respond to such complex incentives, the incentive still would not match a zero foreign rate, and even if it did it would still tend to lock up cash. It is unclear if this is intended to be a serious proposal. On the other hand, he appears to hint at a desire to tax U.S. corporations currently on their world-wide earnings. His form of words is the same as that used by the AFL-CIO in advocating this proposal. The problem with that idea is that America no longer has the economic power to make it work. There are plenty of cash rich foreign multinationals out there ready to buy our international operations. If you look at the tax footnotes in the SEC filings of any multinational with a low effective tax rate, you will see that that rate is driven by low tax operations abroad. For example, Eli Lilly reduces its rate by 11.6 points through foreign operations, as shown on page 66 of its 10-K. If Lilly was suddenly subjected to worldwide tax, a foreign acquirer could harvest that huge benefit by buying out Lilly and eliminating its U.S. headquarters jobs and other operations.
The Libertarian position is similarly vague. Bob Barr notes that "America's corporate income tax is among the highest in the world, putting the U.S. at an international disadvantage" and states that the corporate tax should be reduced and eventually eliminated. However, he does not specify any fiscally realistic path for getting there given the rest of his tax reduction proposals, unless one is truly willing to repeal Social Security and Medicare and take military spending down dramatically.
The candidates state good intentions, but on this vital policy front they seem to be missing a clear path forward.
