Tax policy colloquium, week 14: Ray Rees and Richard Vann, "International Tax post-BEPS: Is the corporate tax really all that bad?"

Yesterday we completed Year 22 of the NYU Tax Policy Colloquium, with the above-titled article. It's still a work-in-progress, but was good to discuss; it's also to some extent Australia-focused but this creates interesting parallels to the U.S.

The portion of the title after the colon - "Is the corporate tax really all that bad?" - offers the article's main food for thought, in two distinct though interrelated dimensions: the substance of tax policy, and how tax policy gets made in real world political and intellectual settings. I see it as raising two distinct sets of issues. One is how we should think about the corporate tax today, and the other is how we should think about how the corporate tax has been discussed and debated.

1.  Defending the corporate tax
Economists have been predicting the demise of the corporate tax for decades, yet its revenues have been surprisingly resilient (looking not just at the U.S. but other OECD countries). And conceivably its demise or non-demise - whichever ends up happening - is contingent rather than inevitable. E.g., if we eliminated the existing corporate income tax by replacing it with a destination-based cash flow tax - which does not seem to be happening - that might be a contingent event that ended up affecting the ultimate playout.

The corporate income tax is often deemed the most distortionary at the margin of all major existing taxes, and the most subject to being eroded by tax competition. This, too, of course, depends on unfolding choices, e.g., with regard to OECD-BEPS efforts to address profit-shifting. But it's presently needed to defend the individual income tax (since owner-employees can otherwise incorporate, underpay themselves, and use it as a tax shelter) and also to tax rents. That's not to say those objectives mightn't hypothetically be advanced without relying on a corporate income tax, but that would require other changes.

Anyway, back to the paper's analysis. It notes the classic "small open economy" rationale for lowering corporate income tax rates (including all the way to zero). If inbound capital is perfectly elastic - hence unlimited at the global after-tax rate of return and unavailable at any lower after-tax rate of return - then all one accomplishes by taxing it, such as via an entity-level corporate income tax, is to bid up the pre-tax rate of return that outside investors demand. So in a model that has no rents and that assumes perfect elasticity at the requisite global rate of return, lowering the corporate tax rate brings in extra capital that permits local resource owners (such as workers) to generate additional positive returns (such as from higher wages).

Rees and Vann agree that this model has real world relevance. But they criticize relying on it too fast to support the conclusion that it urges for reasons that include the following:

--The benefit is deferred if inbound capital takes a while to arrive and be utilized. Meanwhile, an under-anticipated corporate rate cut yields immediate transition gains to shareholders (even if the long-run incidence of the corporate tax shifts to workers). And other taxes that are imposed to make up for the rate cut may operate more rapidly to impose burdens, depending on their character.

--In Australia but other places as well, the domestic corporate tax rate may basically be the rate that high-income residents pay, not just on their capital income in the economic sense, but also on labor income that they are able to shove into this tax environment. The taxes that pay for the corporate rate cut will often come from middle-income people (e.g., via VAT rate increases or increases in personal income tax rates that don't involve raising the top rate - both likely candidates in the case of Australia).

--If inbound capital is not quite as elastic as the model assumes, the benefits may be reduced. If domestic saving rates are somewhat elastic, and the pretax rate of return declines because not as much needs to be paid to attract inbound, Rees and Vann posit that a decline in the domestic savings rate may require more capital than otherwise to come in to fulfill the simple model's predictions, increasing the pressure on the assumption of full inbound elasticity.

--Rents are a very important and often under-emphasized part of the story. Rents earned by Australian companies often pertain to natural resources; for U.S. firms the story is often about intellectual property. Taxing rents is in principle efficient and is also likely to be progressive.

--Might taxpayer or citizen morale be adversely affected by not taxing corporations either (a) very effectively due to tax avoidance, or (b) at a rate commensurate with that paid by individuals? Views on this differ.

Turning to the U.S. context, I am opposed to lowering the corporate tax rate in isolation, which is to say without funding it in a manner that is distributionally appropriate. I also think it's vital to address the use of corporations as low-rate tax shelters by undercompensated owner-employees. Possible approaches might include: (1) allowing an allowance for corporate capital or corporate equity (ACC or ACE) in lieu of lowering the corporate rate, (2) using a dual income tax structure to ensure that only the "normal" return gets the benefit of low rates, and (3) using Grubert-Altshuler or Toder-Viard style approaches to increase taxation at the shareholder level.

2.  Assessing the terms of debate
The paper strongly criticizes the Australian Treasury Department for preparing studies of corporate tax rate cuts that do not appear to reflect fully honest and consistent modeling. This critique makes me feel, good for a change, about parallel institutions in the U.S. At least so far, and pending political interference that can't be ruled out in the upcoming tax "reform" debate, I believe that our Treasury, Joint Committee on Taxation, and Congressional Budget Office have both chosen to, and been allowed to, perform better than this. Plus we get important NGO backup, such as from the Tax Policy Center, which stepped into the breech when self-serving politicians (encouraged by some academics who should have known better) shut down distributional estimates on the Hill for proposed tax changes.

The paper also suggests an at least implicit critique, which may be expanded in later drafts, of how much (though not all) of the economics profession has tended to look at corporate income taxation, e.g., by stressing the small open economy analysis more than issues around the taxation of rents. This might parallel critiques that others have offered in the past, e.g., regarding "Econ 101ism" or the rise of neoliberalism.