AEIdeas » Alan Viard The public policy blog of the American Enterprise Institute Sat, 25 Oct 2014 17:32:01 +0000 en-US hourly 1 Missing the point on inversions and corporate taxes Fri, 25 Jul 2014 15:25:20 +0000 read more >]]> In his CNBC interview yesterday, President Obama offered a misleading criticism of corporate inversions and missed an opportunity to call for structural reform of corporate income taxation.

President Obama began by condemning inversion transactions, in which corporations effectively swap their US charters for foreign charters. Inversions offer tax savings because foreign-chartered corporations pay US tax only on their domestic profits while US-chartered corporations also pay US tax on their repatriated overseas profits (with credit for any taxes paid abroad). The president complained that it was unfair for corporations to “move their technical address simply to avoid paying taxes” while still benefiting from “the best university system in the world, the best infrastructure [and] a whole range of benefits that have helped to build companies.” But, those services primarily aid domestic production, on which inverted corporations, like other foreign-chartered corporations, remain subject to US tax. The president did not explain why corporations that previously had US charters and inverted to obtain foreign charters should pay US tax on their overseas profits while corporations that have always had foreign charters face no such obligation.

Rather than condemning corporations that change their “technical address” to lower their taxes, we should be asking why we base tax liability on that technicality in the first place. If we tell a corporation that it must pay millions of extra dollars in tax because it has a piece of paper that was issued in the United States rather than abroad, should we really be surprised when it tries to get a new piece of paper issued abroad? The tax incentive for inversions would vanish if all corporations, regardless of their charters, were treated uniformly, paying tax solely on their domestic profits.

It would be even better, though, to replace the corporate income tax with direct taxation of shareholders. In a recent report funded by the Peter G. Peterson Foundation, Eric Toder of the Urban-Brookings Tax Policy Center and I outlined a reform option that would abolish the corporate income tax and fully tax American shareholders at ordinary-income rates on their dividends and capital gains. Accrued gains would be taxed (and accrued losses deducted) each year, whether or not the shareholder sold the stock. Tax liability would no longer depend on where the corporation was chartered or earned its profits, but only on where the shareholder lived. Although that approach would raise some challenges and face some political obstacles, it would offer the huge economic advantage of eliminating the corporate income tax’s numerous distortions in one fell swoop.

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Reforming the corporate income tax Mon, 07 Apr 2014 14:40:41 +0000 read more >]]> Last Friday, Eric Toder of the Urban-Brookings Tax Policy Center and I added our voices to the ongoing debate about corporate tax reform. We presented a report entitled “Major Surgery Needed: A Call for Structural Reform of the US Corporate Income Tax,” which was funded by the Peter G. Peterson Foundation, at a conference co-sponsored by AEI and the Tax Policy Center. Martin Sullivan of Tax Analysts and Pamela Olson of PricewaterhouseCoopers offered insightful comments on our report.

The current system bases a corporation’s tax partly on its legal residence and partly on the source of its income. Unfortunately, both of these tax bases can be easily manipulated. Corporations can avoid US residence-based taxation by operating under foreign charters, and they can avoid US source-based taxation by investing outside of the United States or by using accounting schemes to book their profits abroad, often into tax havens.

Our report presents two reform options that address these fundamental problems. The first option would seek international cooperation on defining the source of corporate income, building on the current efforts of the Organisation for Economic Cooperation and Development. Acting in conjunction with other advanced economies would allow the United States to curb the shifting of income to tax havens without putting American corporations at a competitive disadvantage.

The second, even more far-reaching, reform option would eliminate the US corporate income tax while taxing American shareholders of publicly traded companies at ordinary income tax rates on their dividends and accrued capital gains. Shareholders would be taxed on their accrued gains as stocks rose in value, whether or not they sold the stocks; they would fully deduct their accrued losses if stocks declined in value. Tax would depend only on the shareholder’s residence, not the corporation’s legal residence or the source of its income. The tax penalties on chartering corporations, investing, or booking profits in the United States would disappear. To be sure, this option would confront a host of difficult design issues, including transition, the treatment of business tax preferences, a revenue shortfall, and political obstacles. We discuss these challenges in our report and Sullivan, Olson, and members of the audience offered further thoughts about them at Friday’s conference.

In my view, progressive consumption taxation is the best way to raise revenue. Because we’re likely to stick with income taxation for the foreseeable future, though, we need to find ways to improve the income tax system, particularly the deeply flawed corporate income tax. Eric Toder and I have outlined two options that can promote these goals.

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Senate GOP’s Balanced Budget Amendment actually caps spending at 16.7%, not 18% Tue, 19 Feb 2013 16:26:33 +0000 read more >]]> James and Andrew, your recent posts offer some apt criticisms of S.J. Res. 7, the proposed balanced-budget amendment co-sponsored by all 45 Senate Republicans. You persuasively argue that it is unrealistic to think that a constitutional amendment can limit federal spending to 18% of GDP. Norm has made the same point elsewhere. But the reality is even more troubling than you suggest. S.J. Res. 7 would actually impose a significantly more stringent cap, limiting federal spending to about 16.7% of GDP, a level not seen since the 1950s.

The problem is the way the proposed amendment measures GDP. Section 2 states, “Total outlays for any fiscal year shall not exceed 18 percent of the gross domestic product of the United States for the calendar year ending before the beginning of such fiscal year” (emphasis added). By linking each fiscal year’s spending cap to the preceding calendar year’s GDP, the proposal builds in a 21-month lag. (For example, fiscal 2018 will begin on October 1, 2017 and end on September 30, 2018; the preceding calendar year will begin on January 1, 2016, 21 months before fiscal 2018 begins, and end on December 31, 2016, 21 months before fiscal 2018 ends.) The exact value of the spending limit depends on GDP growth. If nominal GDP grows 4.3% per year, in line with the relevant Congressional Budget Office projections, then it rises 7.6% each 21 months. So, if GDP is $1,000 in a calendar year, it is $1,076 in the following fiscal year and the proposal’s $180 cap on fiscal-year spending is 16.7% of GDP.

The version of this proposal introduced in 2011 as S.J. Res. 23 computed the spending limit in the same manner that S.J. Res. 7 now does. The fact that the proposal’s actual limit was well below 18% was pointed out at the time by Donald Marron, director of the Urban-Brookings Tax Policy Center and a member of the Council of Economic Advisers under President George W. Bush, and by Bruce Bartlett. Yet, when the sponsors reintroduced the proposal last week, they ignored these corrections, again claiming that the proposal merely limits spending to 18% of GDP. Marron recently reiterated the relevant arithmetic.

One concern involves truth in advertising. If Senate Republicans want to limit federal spending to 18% of GDP, they should rewrite S.J. Res. 7 to do that. If instead they want to limit spending to 16.7% of GDP, they should say so and stop using the 18% number.

But the bigger concern involves budget policy. The 16.7% limit is even more hopelessly unrealistic than an 18% limit. Historical budget data show that federal spending hasn’t been that low since 1956, before the creation of Medicare and Medicaid. During the last 45 years, spending has never fallen below 18.2% of GDP, the trough reached in 2000 and 2001.

The imperative goal of keeping federal spending from rising too far above 20% of GDP in the face of population aging and rising health care costs will require herculean work and tough political decisions by Republicans, including a repudiation of their recent Medicare rhetoric. The fantasy that a constitutional amendment can cut spending to 16.7% of GDP by fiat is a dangerous distraction from the hard work ahead.

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Will taxing the rich shrink the deficit? Tue, 17 Jul 2012 14:49:08 +0000 read more >]]> I pointed out last week that the middle-class tax cuts that President Obama wishes to extend and entitlement spending growth have a much larger budgetary impact than the high-income tax cuts that the president proposes to end. New calculations by the Committee for a Responsible Federal Budget, building on a recent Congressional Budget Office study, shed further light on the limited budgetary role of the high-income tax cuts.

In January 2001, CBO projected that the federal government would run $5.9 trillion of surpluses in fiscal years 2001 through 2011 under the laws then in place. Last month, CBO took a look at why the government actually ran $6.0 trillion of deficits during that time period. CBO found that $3.3 trillion of the $11.9 trillion divergence was due to unexpected economic weakness and other forecasting errors. The remainder of the divergence was due to laws adopted after January 2001 that provided $7.2 trillion of spending increases and tax cuts, plus the $1.4 trillion of interest paid on the resulting borrowing.

Of the $7.2 trillion of legislated deficit increases, $4.3 trillion, or 60 percent, were spending increases, including boosts to discretionary outlays, entitlement programs, and refundable income tax credits paid in cash to households that do not owe income tax. The other $2.9 trillion, or 40 percent, were revenue reductions arising from the 2001 and 2003 tax cuts and other tax laws adopted during this period.

Last week, the Committee for a Responsible Federal Budget, a prominent bipartisan fiscal watchdog group, broke down the CBO numbers to isolate the effects of the high-income tax cuts that President Obama wishes to end. They found that the high-income tax cuts totaled $0.5 trillion, a mere 7 percent of the legislated deficit increases.

Although high-income tax cuts added to the deficit over the last decade, they played a far smaller role than tax cuts for the remainder of the population and spending increases. As our nation moves toward a bipartisan agreement to address the long-term fiscal imbalance, proposals to raise taxes on affluent households will undoubtedly be on the table. But, taxing the rich will not eliminate the need for hard choices about entitlement spending and middle-class taxes.

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Norquist organization admits that some entitlement-cuts-and-tax-increase deals can be enforced Mon, 25 Jun 2012 15:07:24 +0000 read more >]]> Many Republicans resolutely oppose bipartisan budget agreements that trade even the smallest tax increases for spending cuts, contending that Democrats inevitably renege on the spending cuts. A leading proponent of this argument, Grover Norquist’s Americans for Tax Reform, has now acknowledged, however, that some agreements that trade tax increases for entitlement benefit cuts can be seen through to implementation.

I examined this issue last year in a blog post responding to the Republican candidates’ statements that would reject a deal that traded one dollar of tax increases for 10 dollars of spending cuts. I noted that agreements to cut annually appropriated discretionary spending can be hard to enforce over an extended period, but emphasized that agreements to cut entitlement benefits are much easier to enforce. I observed that Democrats have scrupulously honored the preeminent agreement that traded tax increases for entitlement cuts: the 1983 Social Security compromise. And I pointed out that entitlement cuts are exactly what’s needed to tackle the long-term budget imbalance.

Yet, the claim that spending-cut deals are inherently unenforceable continues to flourish, with Norquist recently reiterating the argument to Ramesh Ponnuru. After Ezra Klein responded, citing my blog post, Ponnuru obtained a candid and illuminating reply from Ryan Ellis, the ATR tax policy director.

Ellis acknowledged the “distinction between vague and ultimately unenforceable discretionary spending cuts on the one hand, and a defined Social Security benefit formula change on the other” and agreed that “the latter is far, far easier to see through.” Ponnuru emphasized the obvious implication, commenting that “Ellis’s point means that if the right kind of grand bargain came along–one that involved the right kind of changes to the entitlement laws–one of Norquist’s main arguments for opposing all tax-increasing deals might not apply.”

Of course, as James Pethokoukis has noted, it’s not clear whether Democrats are prepared to make a deal that includes significant entitlement cuts. On this front, Congressional Democrats appear to be less flexible than the Obama administration. But Republicans should accept a bipartisan agreement that combines modest tax increases with substantial entitlement cuts if one is offered. Modest tax increases today are preferable to the crushing tax increases that future Americans will face if entitlement spending growth continues unchecked.

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Another abusive and dishonest attack on oil companies Thu, 29 Mar 2012 13:16:12 +0000 read more >]]> Last year, I blogged about a Senate bill that would have singled out five unpopular oil companies—ExxonMobil, Chevron, ConocoPhillips, Shell Oil, and BP—for harsher tax rules than those that apply to any other companies in the economy. Last year’s bill failed when it received 52 votes on the Senate floor, falling short of the required 60. The rejection of the bill reaffirmed the rule of law, particularly the principle that a free society does not single out particular companies for extra taxes based on political hostility.

But, some bad ideas never go away. With high gas prices again stoking rage against “Big Oil,” the Senate is now considering a bill with oil tax provisions identical to those in last year’s bill. Of course, the bill’s flaws are unchanged from those I described last year—among other things, it denies the five companies a tax break available to all other goods producers and it fraudulently purports to deny the five companies the percentage depletion loophole, a loophole for which they have actually been ineligible since 1975.

This year’s bill is also likely to fail for lack of the required 60 votes. A good thing, too, because the bill illustrates the worst way to play politics with the tax code. Americans who are better off should certainly be taxed to support those who are in need. But, no individual or company should be singled out for disparate taxation based on political unpopularity.

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Obama changes course on dividend taxes Mon, 13 Feb 2012 17:34:41 +0000 read more >]]> President Obama’s fiscal 2013 budget plan, released this morning, is similar in many ways to his previous annual budget proposals. One feature that wasn’t in his fiscal 2012 plan is the proposed Buffett tax, which would impose a 30 percent minimum tax on the income, including dividends and long-term capital gains, of millionaires. But there’s one other important change, which would also increase the tax burden on saving and investment, from last year’s plan.

The president now proposes that the 2003 dividend tax cut be allowed to fully expire at the end of this year for taxpayers with incomes greater than $200,000 ($250,000 for married couples), making dividends taxable at ordinary income rates for those taxpayers. As a result, the top dividend tax rate will rise from 15 percent this year to 39.6 percent next year. In his fiscal 2012 and earlier budget plans and in his 2008 campaign proposals, the president had called for most of the dividend tax cut to be preserved for these households, with the top dividend tax rate rising only to 20 percent.

The president’s earlier proposals had recognized that the 2003 dividend tax cut offers (imperfect) relief for the burden that the corporate income tax imposes on corporate equity-financed investments, an insight not reflected in his current proposal. In a prominent 2008 Wall Street Journal article, the Obama campaign’s top economists emphasized that he would increase the top dividend tax rate only to 20 percent, boasting that “this rate would be 39 percent lower than the rate President Bush proposed in his 2001 tax cut and would be lower than all but five of the last 92 years we have been taxing dividends.” Unfortunately, the president’s current proposal sharply diverges from that path.

President Obama is hardly the first president to change his tax proposals after taking office. But, it is regrettable that he has changed course in a way that will place heavier tax burdens on saving and investment.

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Stop Social Security’s raid on the federal treasury Fri, 02 Dec 2011 16:56:26 +0000 read more >]]> Although the two plans to cut 2012 Social Security payroll taxes that were blocked in the Senate yesterday differed in many ways, they shared a key feature that is almost certain to remain in the compromise plan expected to eventually emerge. Both plans included a transfer from the general federal treasury to the Social Security trust fund to compensate the fund for the lost payroll tax revenue, similar to the transfer now being made as part of the 2011 payroll tax cut. Despite the bipartisan support for such general-revenue transfers, they should be resisted because they improperly free Social Security from budgetary discipline.

Moving money around within the federal government cannot change the government’s overall financial position, but can reallocate budgetary resources between Social Security and other programs. In particular, shifting money from the general treasury to the trust fund limits future Social Security benefit cuts or payroll tax increases, at the price of deepening future cuts in other programs, such as national defense, Medicare, and Medicaid, or future increases in other taxes, such as the individual and corporate income taxes.

As I pointed out in Tax Notes earlier this year, the use of general revenue to finance Social Security undermines basic budgetary principles by improperly giving Social Security the best of both worlds. Social Security has always been spared from having to compete against other programs for resources in the general budget process on the ground that it is a self-supporting program financed by its own earmarked taxes. The natural tradeoff for that protected status was the restriction that the program could not spend more than the revenue raised by those earmarked taxes. With general revenue transfers, though, Social Security faces neither type of budgetary discipline, as it can spend beyond its earmarked tax revenue while continuing to pose as a self-supporting program entitled to protection from the general budget process.

If we continue to make these general revenue transfers, then Social Security should be required to compete against other programs in the general budget process. The better option, though, is to restore Social Security’s self-supporting status by ending the general revenue transfers. The revenue loss from any Social Security tax cut that Congress chooses to adopt should be borne by the trust fund, not shifted to other federal programs and taxes.

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Cain’s 9-9-9 tax plan: the good, the bad, and the ugly Thu, 13 Oct 2011 15:12:56 +0000 read more >]]> As Herman Cain’s 9-9-9 plan continues to draw attention, a key component of it remains misunderstood. Cain’s plan would replace the individual and corporate income taxes, estate and gift tax, and payroll and self-employment taxes with three new levies. As is well-known, one levy is a 9 percent retail sales tax and another is a 9 percent income tax.

The misunderstanding concerns the third component. Most media reports, taking the lead from Cain’s own terminology, continue to describe it as a business or corporate tax or even as a tax on corporate profits. Yet, the tax is actually a value added tax (VAT), a fact confirmed by the economic analysis circulated by Cain’s campaign.

A VAT and a retail sales tax are conceptually equivalent consumption taxes, apart from administrative and compliance issues. The plan is therefore better described as featuring a 9 percent income tax and an 18 percent consumption tax, with half of the latter collected using the VAT methodology and the other half collected using the retail sales tax methodology.

One concern about the Cain plan has been overstated. Analysts who thought that the third tax was a tax on business profits or cash flow (in other words, a tax that allowed firms to deduct wage payments) complained that the plan would raise revenue far short of current levels. The fact that the tax is actually imposed on value added (so that firms cannot deduct wage payments) means that it would raise considerably more revenue than those analyses had indicated. Although the 9 percent rate is not quite revenue neutral, a rate around 10 to 11 percent might work, if no deductions or tax preferences are added to the plan.

If the plan was adopted at a revenue-neutral tax rate, it would increase long-run economic growth by largely eliminating the tax penalties on saving and investment. But, it would also cause a massive shift in tax liabilities towards moderate-income households, a disturbing outcome and one that is likely to make the plan politically unviable.

But, the biggest issue is one of truth in labeling. Mr. Cain should level with the voters by explaining that he’s proposing a VAT and allow them to weigh the advantages and disadvantages of this approach.

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Entitlement Spending Can be Constrained Tue, 16 Aug 2011 15:13:16 +0000 read more >]]> Charles and Nick, I can’t subscribe to your view of the Republican candidates’ uncompromising stand against tax increases at last week’s Iowa debate. Like Peter Wehner and Norm, I am deeply disturbed that all of the candidates said they would reject a hypothetical deficit reduction agreement featuring $10 of spending cuts for each dollar of tax increases. I stand by my position (see here and here) that Republicans should be willing to compromise on tax increases in order to reduce entitlement spending.

As I pointed out, the additional government debt that will be issued if we fail to reach a deficit reduction agreement today must be serviced with tax increases or spending cuts in the future. Is there any real doubt that future presidents and Congresses will turn to tax increases for more than 10 percent of the financing? If so, then rejecting a 90-percent-spending-cut deal today actually increases the long-run tax burden.

Despite Charles’s claim to the contrary, there is such a thing as a real spending cut deal. To be sure, agreements to cut discretionary spending are hard to sustain over extended periods, because discretionary spending levels must be voted on each year and frequently change in response to unexpected developments. Even in this area, though, it’s possible to achieve some savings. The two Gramm-Rudman-Hollings laws and the Budget Enforcement Act restrained discretionary spending growth in the late 1980s and early 1990s.

In any case, it’s entitlement spending that really need to be restrained. Fortunately, agreements to cut entitlement benefits are more durable than agreements to cut discretionary spending. Because entitlement spending is not voted on each year, spending reductions remain in effect unless and until the president and Congress affirmatively pass legislation to overturn them. The historical record shows that real benefit cuts adopted in a bipartisan agreement can remain in place.

In 1983, Ronald Reagan signed a Social Security compromise that included both payroll tax increases and benefit cuts. One of the benefit cuts, a six-month delay in the cost-of-living adjustment, took effect as scheduled in the year of enactment. The largest benefit cut, an increase in the normal retirement age, may have initially seemed more vulnerable to backsliding because it wasn’t slated to take effect until decades down the road. Yet, the first stage of that increase, with the age rising from 65 to 66, has now taken effect. The second stage, with the age rising from 66 to 67, is still on track to take effect in upcoming years, with nary a proposal from either party to block it.

Besides, if there were no real spending cut deals, what would be the policy implication? That entitlements will be unilaterally cut by Republicans when they control all branches of government? Republicans’ track record offers no support for such a prediction. Or, that entitlements will never be cut? In that case, tax increases are unavoidable; blocking tax hikes today merely puts them off to the future and needlessly allows deficits to crowd out investment in the meantime.

In reality, entitlement spending can be restrained. But doing so almost always requires bipartisan agreement and therefore compromise. Of course, Republicans should insist on a good deal. But a 10-1 ratio is likely to meet that standard, at least if a significant portion of the spending cuts are to entitlement benefits.

A hard-line stance may offer some short-run political benefits, as evidenced by the resounding applause that the candidates received from the Republican audience last week. Unfortunately, an absolute refusal to accept tax increases today is likely to doom efforts to cut entitlement spending, guaranteeing onerous tax increases tomorrow.

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