While political debate in Australia continues to rage over whether to adopt the Turnbull Government’s plan to cut the company tax rate to 25% from 30%, a similar debate is taking place in the United States over the Trump Administration’s own corporate tax cut plan.
Mark Thoma, a macroeconomist and time-series econometrician at the University of Oregon, has penned an interesting analysis in CBS News arguing that boosting public expenditure on education and research and development (R&D) offers bigger economic dividends than cutting the corporate tax rate.
First, here’s Thoma’s take on cutting the corporate tax rate:
The idea behind cutting the corporate tax rate is that it makes new investment more profitable, so investment should increase. Lower taxes for corporations also increase the amount of cash firms have on hand, which should also lead to more investment.
Another argument holds that corporate tax cuts make U.S. businesses more competitive with foreign businesses. But it’s not at all clear such cuts are needed because the effective tax rate for U.S. businesses — the rate they actually pay as opposed to the statutory rate — is not all that different from the rate in other countries.
Although it isn’t obvious at first, this is essentially what the proposal for a border tax adjustment floated by Republicans would do. In effect, it reduces taxes on businesses that use resources located within the U.S. and shifts the tax burden to consumers. But, importantly, the border adjustment doesn’t change the relative tax rates U.S. and foreign businesses pay. That is, it doesn’t affect competitiveness (although it’s being sold as if it does).
The question then is whether the increase in investment the tax change is supposed to bring about, which would likely be small, is worthwhile, given how the tax burden would shift to consumers. If that shift came with an increase in the generosity of social programs so that consumers are better off overall, it might be worth supporting. (This is essentially how the value added tax works in Europe: It’s very regressive, but redistribution through government spending and transfers makes that system highly progressive overall.)
But if anything, the GOP-controlled Congress has hinted it would instead trim spending on social welfare programs, so this wouldn’t be a good deal for the typical American household.
There are similarities here with the problems facing Australian households.
Due to Australia’s dividend imputation system, almost all of the direct benefits from cutting the company taxes – costing the Budget an estimated $8.2 billion per year – would flow to foreign owners/shareholders.
Because of this gift to foreigners, modelling from Victoria University senior research fellow Janine Dixon has shown that Australian national income would likely be reduced from cutting company taxes:
Meanwhile, the lost Budget funds would need to be made up some how, for example by cutting welfare spending or raising personal income taxes. Indeed, the Coalition is currently trying to cut back on welfare via its Omnibus Bill, partly to make way for its company tax cut package.
With regards to providing tax credits for R&D and support for higher education, Thoma argues the following:
Tax credits that encourage corporate R&D, support basic research and foster the formation of new, innovative businesses can have large payoffs for economic growth.
According to growth theory, the only way for the the standard of living (output per person) in rise continuously in the long-run is through growth in technology. The faster productivity can increase through technological change, the faster the standard of living will rise over time.
Support of basic research — the discovery of new knowledge with no direct connection to the development of new products, at least initially — has had a surprisingly large payoff in the past. With productivity falling in recent years, bolstering this type of research is essential.
In addition, support for higher education (along with improvements in elementary and high school so students are prepared when they get there) is needed so that American has an educated workforce ready to put new discoveries into place.
To the extent that Mr. Trump’s policies lean toward encouraging R&D and investment in education and other things that will spur the development of new technology, it’s possible they’ll be successful. Reversing the fall in productivity the U.S. has experienced in recent years is the best way to raise the country’s long-run rate of economic growth.
However, if the president’s tax policy leans heavily toward cuts for the wealthy, cuts to capital gains and dividends, and a shift in taxes from corporations to households — as I suspect they will — the effects on growth will be minimal, if history is any guide.
The main effects will likely be an even faster increase in inequality, higher government deficits and pressure to cut programs such as Social Security and Medicare that workers and their families increasingly rely on.
On the issue of R&D, earlier this week MB argued that if the Turnbull Government goal is to boost business investment, it would be far more cost effective and efficient to do so directly via accelerated depreciation allowances, investment allowances, or some other measures, rather than trying to do so indirectly via company tax cuts (read analysis here).
With regards to Thoma’s second point – boosting education spending – an Economic Society of Australia survey of 31 economists showed that two-thirds agreed that it would be far more beneficial to the Australian economy than cutting the company tax rate:
Australia will receive a bigger economic growth dividend in the long-run by spending on education than offering an equivalent amount of money on a tax cut to business.
It’s not hard to see why. Raising education spending would benefit the domestic population. Unlike cutting company taxes, the money would be spent here and would not leak offshore, which comes on top of the greater long-run benefits to growth from increased productivity.
