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Choose Lower Taxes for Economic Recovery

June 14, 2012

By Diana Furchtgott-Roth

Senate Finance Committee Chairman Max Baucus’s tax reform speech on Monday to the Bipartisan Center, a Washington think tank, indicted the American tax system. Too bad the Montana Democrat didn’t propose specific remedies.

Mr. Baucus aptly identified many of the problems that have accumulated in the federal tax code. For example, in response to globalization, he said, other countries have modernized their tax laws, but America has not. The last major revision of the Code occurred in 1986, and some of those reforms have been undone piecemeal by rate increases.

In contrast to other industrial economies, competitors to the United States, Mr. Baucus said, "the U.S. has one of the highest statutory corporate tax rates in the world. We give countless tax breaks to business, but many don’t attract or retain investment."

Corporations pay a top tax rate of 35 percent on taxable income. Of course, how taxable income is calculated matters. Average effective tax rates, taxes paid divided by gross income, are lower. But what matters for investment decisions are marginal effective tax rates, the tax rates paid on the last dollar of income.

Mr. Baucus pointed out, disapprovingly, that Washington taxes companies on their worldwide income rather than on income they generate in the United States. As a result, he lamented, we’re losing revenues to tax havens and jobs to foreign companies.

Tellingly, Mr. Baucus said, "the number of U.S.-based companies on the Fortune Global 500 list has declined by 20 percent...When it comes to international tax rules, we seem to have the worst of all worlds. We haven’t kept up, and its time to change."

How right he is.

So it would have been fitting if he had proposed moving to a territorial system, as has House Ways and Means Committee Chairman Dave Camp (R-MI). Or lower corporate tax rates. Or a move to a consumption tax. Or the tax proposals of the Simpson Bowles deficit reduction commission.

Alas, the 70-year old senator, a member of Congress since 1973 and now the vice chairman of the Joint Committee on Taxation, offered no proposals to lower rates.

Mr. Baucus is important for two reasons. If the Democrats retain control of the Senate in November, he will continue to chair the tax-writing Finance Committee. Even before that, in this session of Congress or in the widely-expected lame-duck session after Election Day, it would be wise for Congress to act to avert tax increases now scheduled to take effect January 1, 2013.

If those increases occur, they could make America even less competitive in world trade and further harm our slow rate of economic growth. They could tip the U.S. economy into another recession and discourage employers from hiring. This was shown demonstrated by Mr. Obama’s first chair of the Council of Economic Advisers, Christina Romer, in a paper published in the American Economic Review in 2010 with her husband, economics professor David Romer.

Senator Baucus’s silence on remedies can be read as keeping his options open, and being cannily noncommittal on the tax policies recommended by the Democrat-in-Chief, President Obama.

Mr. Obama supports raising the two top income tax rates on individuals from 33% to 36%, and from 35% to 40%. That would be a blow to the many proprietors of unincorporated businesses, who pay taxes on their earnings as individuals.

A second kind of tax increase favored by the Obama White House is a further limitation on the deductions that upper-income taxpayers may take, for example, for charitable gifts and mortgage interest.

Raising taxes, whether to take effect in 2013 or 2014, would be the wrong way to help America recover from the recession, because higher taxes cramp economic growth.

The Romers, both professors at the University of California (Berkeley) entitled their paper "The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks." The innovative feature of the paper is to distinguish between the effects of tax changes arising from legislation and those tax changes that occur automatically as rising income lifts individuals into higher tax brackets.

After looking at data from 1947 to 2006, and studying the legislative record behind the tax changes, the Romers concluded that legislated tax changes have far more effect than automatic tax increases. They write, "Our estimates suggest that a tax increase of 1% of GDP reduces output over the next three years by 3%." A major reason is that higher taxes have a markedly negative effect on investment.

Mr. Obama: Heed your own economic adviser.

In another finding that argues against raising rates, Arizona State University Nobel Prize-winning economist Edward Prescott has shown that the higher the tax rates, the lower are the hours of work. In highly-taxed France, for example, people on average worked only three-fourths of the American workweek. In the early 1970s, when American tax rates were higher, the French worked more than the Americans. Mr. Prescott’s results also hold for countries as diverse as Japan, Chile, and Italy.

Rather than raise taxes, Chairman Paul Ryan of the House Budget Committee has incorporated lower taxes into the Republican Budget, entitled Path to Prosperity. It would lower all income tax rates and reform the complex tax code by simplifying it.

Corporations would be taxed at 25 percent, and not on their worldwide income, but only on income generated in the United States. Details have to be worked out by the House Committee on Ways and Means, but Mr. Ryan supports deducting purchases of capital goods in the year they occur.

Mr. Ryan would have two tax brackets for individuals, 10 percent and 15 percent, with income thresholds to be determined by Ways and Means. The system would be more progressive than two rates might suggest due to retention of standard deductions and personal exemptions. The alternative minimum tax would be eliminated.

Senator Baucus said on Monday, ""Most economists agree that lowering rates and paying for it by getting rid of tax expenditures generates growth." Yet he proposed no new rates, no elimination of tax expenditures, and no movement to a territorial system of taxation.

Mr. Baucus has correctly identified multiple problems with the U.S. tax code. Now, perhaps he could join with Chairmen Camp and Ryan to enact a legislative solution.

Original Source:



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