The OECD Wants Us to Be More Like Them

June 20, 2014

This month, the OECD published its annual economic survey of the United States, recommending among other things a handful of tax changes that would bring the U.S. closer to the OECD average on a few metrics. Although many of these recommendations are growth-oriented, there are others that don’t make as much sense.

Not surprisingly, the report is quick to mention that the 39.1% statutory corporate income tax rate, 13.6% above the OECD average, is not conducive to investment or recovery. We have shown that the marginal benefit of lowering this tax rate is substantial, eventually rendering a whopping 1.97% growth in GDP given a flat reduction of the rate to just below the OECD average.

The report recommends broadening the corporate income tax base at the same time as decreasing the rate in order to minimize economic distortions and support long-term growth. These are indeed wise policy objectives but must be approached with caution, as willy-nilly base broadening can potentially offset all of the growth benefits of a lower tax rate. To fully realize these objectives, unproductive tax expenditures on corporate welfare should be cut and neutral cost-recovery expenditures retained.

The report suggests a base broadening of the personal income tax system, starting with the elimination of the mortgage interest and employer-provided health insurance tax expenditures in the name of progressivity, simplicity, and neutrality.

As with corporate income base broadening, personal income tax base broadening can be done responsibly or irresponsibly. Eliminating the tax exclusion for employer-provided health insurance—while politically difficult—would be good tax policy. Under current law, that type of compensation remains untaxed. A neutral tax code would not exempt that type of compensation. Even more, we found that eliminating it would increase GDP by $125 billion

The home mortgage interest deduction is a little more complicated. Current law actually treats mortgage interest correctly. Banks that earn income from this interest have to pay taxes on it. In order to not double-tax the interest, the borrower is allowed to deduct it. However, the treatment of this capital income is better than most others. As a result, people see this as a tax subsidy towards housing investment, when in reality people should see other investment as being at a tax disadvantage in comparison. This is likely why we saw a reduction in GDP with the elimination of the provision. It is not clear that we should get rid of this tax provision, rather we should look to lower the tax burden on other capital.

To combat poverty caused by the stagnation and divergence of incomes of the bottom 10% of earners from the OECD 10th percentile average, the report recommends expanding the Earned Income Tax Credit to childless workers and non-custodial parents as well as decreasing the age threshold to 21.

While the EITC may be effective in attracting non-participants to the labor market, its incentive structure and its high level of complexity make a simple expansion questionable. The initial increase of the size of the credit with income increases the labor force and hours worked, but the “phase-out” of the credit at slightly higher levels of income negates a lot of this, especially with its interaction with many other welfare programs. Additionally, the level of complexity of the current credit leads to a consistent and substantial improper payment rate. This raises equity and efficiency concerns. It’s likely more prudent to improve the EITC and other income support programs rather than to simply expand it.

So should we strive to model our tax system like our OECD counterparts? In some ways, perhaps.

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