November 22, 2010

Obama Should Cut The Corporate Tax Rate

This op-ed was published on on November 22, 2011.

After taking a shellacking at the polls on Nov. 2, President Barack Obama was hoping to find some success abroad pushing for trade deals for the very same U.S. companies who he has spent the past two years bashing as tax cheats and exporters of jobs. Instead, he took another shellacking at the hands of our major trading partners. Perhaps he will learn a lesson from this drubbing as well.

Despite Obama’s esteemed status as a world citizen, he has demonstrated a mercantilist view of America’s role in the global economy. He professes to increase U.S. trade, but his policies would actually punish American firms with higher taxes if they do business on foreign soil and are fortunate enough to earn profits there.

Obama’s is an antiquated, zero-sum notion of global trade that sees U.S. firms only as makers of stuff here—preferably in unionized factories—to be shipped to foreign markets. In his mind, when U.S. firms compete on-the-ground in foreign countries and make products near where their customers live, they have, by definition, killed domestic jobs in doing so.

If Obama and his advisors are looking for a Clintonesque opportunity to move back to the center in a way that would make a real difference to the economy, he should partner with Republicans to cut the corporate tax rate and reform how we tax the foreign profits of U.S. companies. The evidence suggests that such reforms would not only be good for the long-term growth of the economy, but would improve workers’ wages and living standards over time. This would be a win-win in the same way “ending welfare as we know it” was good for taxpayers and welfare recipients who went to work.

A dramatic cut in the corporate tax rate could be the best tonic for the ailing economy. As is now well known, next to Japan, the U.S. imposes the highest corporate tax rate of any industrialized country at nearly 40 percent (combining the federal and state rates). Perhaps an explanation why both economies are in the doldrums lies in a 2008 report by economists at the Organization for Economic Cooperation and Development (OECD), who measured the relationship between different taxes and economic growth. They determined that the corporate income tax is the most harmful tax for long-term economic growth.

High personal income taxes were found to be the second-most harmful tax for long-term growth, which would argue for not allowing the Bush cuts to expire on the “rich” as Obama proposes. The least harmful taxes for growth, according to OECD economists, are consumption taxes and property taxes.

Mobility is the key to the OECD’s tax-harm hierarchy. Capital and income are the most mobile factors in the global economy and, thus, the most sensitive to high tax rates. Consumers and property are less mobile and, therefore, less sensitive to tax rates.

This leads us to the next reason to cut the corporate tax rate, that workers will be the biggest beneficiaries. Economic research also finds that because capital is mobile but workers are not, labor bears a disproportionate share of the economic burden of corporate taxes—as much as 70% by some estimates. Economists such as Kevin Hassett at the American Enterprise Institute have found that workers in countries that have cut their corporate rates have seen faster growth in wages than workers in countries that have not cut their corporate taxes. (A recent Tax Foundation study found a similar relationship in our 50 states, so governors take note).

Thus, Obama can legitimately sell a deep corporate rate cut as being pro-labor because not only will it lead to an increase in wages and living standards, it will most likely lead to an increase in jobs because America will be a more attractive place for inbound investment. The OECD report found that, “Lower corporate and labor taxes may also encourage inbound foreign direct investment, which has been found to increase productivity of resident firms.”

Lastly, Obama and the Republicans should take the advice of the recent Bowles/Simpson report and change the way the U.S. taxes foreign profits away from a world-wide base to a system that taxes only domestically generated profits—known as a territorial tax system. This is the manner in which most of our major trading partners tax their multinational firms, the most recent converts being Japan and the U.K. Such a move would U.S. multinationals on a level playing field with their global competitors.

But to make the U.S. truly more competitive, lawmakers will have to cut the federal corporate tax rate much lower than the 26% rate suggested in the Bowles/Simpson report, perhaps as low as 20%. A 26% federal rate combined with the average of the state rates will still leave the U.S. with an overall corporate tax rate over 30%, still higher than France, which currently has the third-highest corporate tax rate in the OECD. But a 20% federal rate would give the U.S. the lowest overall rate of any G-7 nation and a rate roughly on par with China’s 25% corporate rate.

To his credit, Obama has signaled a openness to cutting the corporate tax rate, so long as it is accompanied by “closing loopholes.” However, there are simply not enough corporate loopholes to close to finance lowering the rate down to 20% While some might argue that the new investment generated by a 20% corporate rate would “pay for itself,” a deficit-neutral option would be to pair the rate cut with cuts in spending targeted to business—so-called corporate welfare. This approach delivers the twin benefits of economic growth and lower government spending.

In 2006, Martin Sullivan, the economics writer for the trade publication Tax Notes, predicted that “some forward-looking Democratic candidate will follow the lead of the European left and propose a major cut in the corporate tax rate” as a means of preserving the corporate tax base. Left-of-center governments in Europe had come to the practical realization that lower corporate tax rates accompanied by broader bases tend to keep more profits at home, which turns out to produce higher tax revenues. Thus, he argued, a Democrat would lead the charge for a lower corporate tax rate in this country when they come to the same realization.

Perhaps Barack Obama is that Democrat.