Monday, January 06, 2014

Time to abolish the corporate tax? Learned professor creates huge tax model to illustrate . . . nothing

Professor Laurence Kotlikoff, a professor of economics at Boston University, has written an opinion article in the New York Times headlined Abolish the Corporate Income Tax. It begins:
"In recent decades, American workers have suffered one body blow after another: the decline in manufacturing, foreign competition, outsourcing, the Great Recession and smart machines that replace people everywhere you look. Amazon and Google are in a horse race to see how many humans they can put out of work with self-guided delivery drones and driverless cars. You wonder who will be left with incomes to buy what these robots deliver. What can workers do to mitigate their plight? One useful step would be to lobby to eliminate the corporate income tax."
And on what basis does he make this claim?
Making, rather than just stating, this case requires constructing a large-scale computer simulation model of the United States economy as it interacts over time with other nations’ economies, and then seeing how the model reacts when you change the American corporate income tax. I’ve developed such a model with three colleagues through the Tax Analysis Center, a nonpartisan research group. Our findings make a very strong, worker-based case for corporate tax reform.
A worker-based case for abolishing the corporate tax? Interesting.

There is just one teeny problem with his learned analysis. It's pointless.

How do we know this? Well, there's this, for starters.
"Fully eliminating the corporate income tax and replacing any loss in revenues with somewhat higher personal income tax rates leads to a huge short-run inflow of capital, raising the United States’ capital stock (machines and buildings) by 23 percent, output by 8 percent and the real wages of unskilled and skilled workers by 12 percent."
This sentence reveals that Kotlikoff has overlooked one of the most basic aspects of the corporate income tax: that it's an essential backstop for the personal income tax. The more you cut corporation taxes, the more wealthy individuals will re-classify their income as corporate income, so as to pay the lower rate. And once they start doing that, then you have to cut your top marginal personal income tax rates to prevent this. The fact that he is advocating higher personal income tax rates demonstrates that he hasn't considered this unalterable fact.

Actually, there isn't just one teeny problem with this article. There is a multitude of them. Let's now look at the abstract from the paper on which he bases his article:
We simulate corporate tax reform in a single good, five-region (U.S., Europe, Japan, China, India) model, featuring skilled and unskilled labor, detailed region-specific demographics and fiscal policies. Eliminating the model’s U.S. corporate income tax produces rapid and dramatic increases in the model’s level of U.S. investment, output, and real wages, making the tax cut self-financing to a significant extent.
This tells us two things. First, it is just a "five-region model" - and recent experience has taught us to treat such things with great caution. Give us the real world, please! Second, by saying that the tax cut is self-financing, he is advocating the Laffer Curve! And the Laffer Curve, as we know, has been so thoroughly debunked by the evidence - particularly in the United States - as to make its adherents a laughing stock. Former president George H.W. Bush called it "Voodoo Economics" - and his son's council of economic advisers, Greg Mankiew, called its adherents "charlatans and cranks." For an irreverent look at the history of the Laffer Curve, see Deep Voodoo, an earlier article in the New York Times.

Just for example, a 2012 study by the nonpartisan US Congressional Research Services (CRS) concluded:
“Changes over the past 65 years in the top marginal tax rate and the top capital gains tax rate do not appear correlated with economic growth. The reduction in the top tax rates appears to be uncorrelated with saving, investment, and productivity growth.
. . .
However, the top tax rate reductions appear to be associated with the increasing concentration of income at the top of the income distribution.”
We could go on at length about the numerous flaws in this article. There is the fact that the corporate income tax prevents corporations (and those wealthy who have turned themselves into corporations) from free-riding on the backs of other taxpayers. Or there's the fact that abolishing corporate income tax would require an increase in other taxes especially VAT and similar indirect taxes, as well as payroll taxes - further widening inequality gaps and reducing job creation as the tax charge falls away from capital and onto labour - making labour relatively more expensive and reducing employment.

Oh, and there's the small matter that U.S. corporations are sitting on oceans of idle cash at the moment - $5 trillion in 2011 and surely more than that now - and they aren't investing it. What on earth would make anyone think that adding to their prodigious cash piles through corporate tax cuts would add a single job to the U.S. economy? What kind of unworldly model disregards five trillion dollars? See these arguments discussed here, for instance.

And let's not forget the horrific effects that abolition of U.S. corporate taxes would have on the tax systems of other countries, elsewhere - which would feel pressured to follow suit, thus making all those supposed benefits to the U.S. disappear in any case. Not to mention all these other reasons.

(And don't try the tax 'incidence' argument with us: it won't wash.)

We wish learned professors would sometimes get out into the real world. Or at least if they don't - please keep their research to themselves, and not go blasting their unbalanced, ethereal curiosities into the pages of the New York Times.

We expect that U.S. organisations will weigh in on this shortly; we'll provide links as and when they appear.

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