Do the Latest GDP and Profit Data Justify Tax Cuts for ‘Job Creators’?
This week’s second estimate of US GDP shows a disappointing Q2 growth rate of 1.7 percent, just slightly faster than the 1.5 percent of the advance estimate released a month ago (see chart). These latest data ensure that weak GDP growth and what to do about it will remain major issues in the presidential election campaign.
On the GOP side, the leading proposal for getting growth back on track is to cut taxes for ‘job creators,’ to use the favored code word for top income earners. The idea has a certain logic to it. We know that growth comes from investment. We know that profits motivate investment and profits taxes reduce that motivation. It stands to reason, then, that weak profits and high taxes would be likely culprits for slow growth–except for one awkward fact.
The awkward fact is that corporate profits, both before and after taxes, are running at or close to record levels. As the next chart shows, before- and after-tax corporate profits, with inventory valuation and capital consumption adjustments, hit 30-year highs in the last quarter of 2012 and have stayed above year-earlier levels ever since. In fact, in the past three quarters, corporate profits after taxes, as a percentage of GDP, are higher than they have ever been in the 65 years since the government began reporting the series. Furthermore, when those corporate profits are passed along to individuals in the form of dividends or capital gains, they are taxed at rates much lower than at many periods in the past.
What conclusions should we draw from these data? One, certainly, would be that the ‘job creators’ have pocketed their incentive pay without creating many jobs in return. There is supposed to be a quid pro quo here, but so far all we have seen is the quid, and not much of the quo.
If there is no simple proportionality between profits and growth, or profits taxes and growth, then why not change the policy? A number of possible growth-enhancing reforms come to mind, some of which I have discussed in earlier posts.
One such reform would be to close the loopholes in the corporate tax system that make the burden of corporate taxes wildly different from one firm to another. Because of preferential treatment of foreign source income, accelerated depreciation, and other provisions of the tax code, some of the largest U.S. corporations (including General Electric, Boeing, Verizon, and Mattel, according to one report) pay no profits taxes at all, while others bear the maximum 35 percent rate. There are so many loopholes that the United States, with the highest corporate tax rates in the world, collects less profit tax revenue as a share of GDP than do many countries with lower marginal rates.
Currently, the U.S. corporate tax accounts for only 9 percent of federal tax revenues, compared with a post-World War II high of 30 percent. Eric Toder of the Tax Policy Center estimates that eliminating corporate tax preferences could potentially save $506 billion over five years and make it possible to reduce the top corporate tax rate from 35 percent to 23 percent without loss of revenue.
Another reform that would be even more effective would be to tax dividends and capital gains as ordinary income. That would make it possible to reduce the corporate tax rates even further. Ideally, reforms would end the double taxation of corporate profits altogether.
And finally as I have argued elsewhere, the current system of taxing capital gains and dividends at lower rates than other forms of income does not encourage investment in general so much as it encourages structuring investment decisions in ways that avoid taxes, even if they are less efficient. Neither is a separate regime for capital gains taxes necessary to compensate for the effect of inflation on effective tax rates. When we consider corporate income taxes and capital gains taxes jointly, a strong case emerges for revenue-neutral reform that taxes capital gains and dividends as ordinary income while lowering or eliminating corporate profit taxes.
What is blocking these reforms? Politics. Every preference and loophole in the tax code is defended by an army of lawyers and lobbyists paid for by the firms that benefit from it. Campaign contributions and super-PACs (corruption American style) reinforce the effect. The only firms and individuals left paying the full statutory tax rates are the politically powerless. Yet office seekers, with complete shamelessness, try to bring them on board, too, by flattering them as ‘job creators’ and promising them unspecified and unaffordable across-the-board rate cuts.
The data don’t support the notion that across-the-board cuts on profits and property income promote growth, but for politicians, there is always the hope that no one will notice the data.
Controversy over Romney’s Taxes Underlines the Need for Broad Reform (Discusses in detail the economics of preferential tax treatment for capital income.)
What Happened to Corporate Tax Reform? (Discusses the economics of corporate tax incidence and double taxation.)
12 Responses to “Do the Latest GDP and Profit Data Justify Tax Cuts for ‘Job Creators’?”
Corporate tax rules are badly in need of fundamental reform. Two firms with the same apparent earnings may pay very different amounts in taxes.The arcane rules provide incentives to engage in bizarre, but legal, tax avoidance schemes. The U.S. corporate tax rate of 35% is one of the highest in the world, and the U.S. is one of the few countries to tax both U.S. and foreign earnings of a corporation. More U.S. firms are re-incorporating abroad to save taxes, including the Eaton Corporation of Cleveland, that recently announced that they are moving to Dublin, Ireland. There are large potential gains from fundamental reform of corporate taxes, but piecemeal changes that ignore the fundamental contradictions are unlikely to provide significant economic gains.
Interesting idea. Here's some more data to support your proposal to tax capital gains as ordinary income. Here are approx. capital gains tax rates since 1917. Note that the two periods of low rates happen to proceed the two biggest economic crises we know.
1917 – 1921: 67 – 73%
1922 – 1934 12% — Great Depression 1929
1934 – 2002 20-30%
2003 – today 15% — Great Recession 2010
I think this supports your theory but I'll leave it to economists to explain this correlation.
a Pres.Romney will address the loopholes and firm-to-firm disparities, I've read from more than one economic source;but didn't think citation would be helpful, so would have to pass on that. Romney's the expertise on needed tax reform, not Pres Obama…he farms that stuff out.
Good piece. Coming up with a fair way to tax multinationals versus domestic-only companies is much easier said than done, but we obviously won't succeed if we don't try. I like your proposal to treat dividends and capital gains as ordinary income and eliminate the corporate profit tax, which creates all kinds of weird incentives.
An important point most people miss is that public deficits increase (domestic) corporate profits, by injecting additional income into the economy. It's not a coincidence that high deficits correlate with increasing disparity.
I find J.L.'s comment absurd. Romney has built his career on worming out of corporate taxes especially through the carried interest exemption for PE funds and the interest deduction for LBOs. Given that many of his donors have similar histories and business plans for the future, I think we can predict with 100% confidence that if Romney wins, those tax avoidance schemes will not be reformed. Frankly I doubt Obama's promise to reform them but at least there's some possibility he would.
I think "job creators" and "corporate profits" are really two different spheres. Changing the tax rate on the large percentage of the "high earners" who are NOT CEOs of public C corps but are instead owners of much smaller businesses is a different question than changing the (bizarre) tax rules for public corporations.
And it's not just job creation, but aggregate demand that should be considered. Most of the "well off" people I know spend pretty much to the limit – if you raise their net tax rate, they will consume less of something provided by other people. (So you tax the Dr. more, so he fires the landscaping firm, which eventually fires the gardener. Will the taxes you raise be spent in a way that recovers that job?)
Hope you can expand on your derisive use of the term "job creators," because that indeed needs some attention. I know from fifteen years in venture capital that just because you hire somebody does not mean you are creating a job. Our mission in VC is usually to displace older, more labor intensive companies. The "disruptive" companies that we fund, if successful, hire at the expense of somebody else. Yes, the world becomes more efficient that way, but that delta in efficiency should be compared to the negative delta in employment, and the comparison may not always be favorable.
Thank you for this sobering example. We seem a long way from correcting the old industrial world's high labor rates (U.S., Europe, Japan) down to the world labor market. This may continue to translate to negative change in disposable income and further contraction of GDP. I'm guessing we are five to 10 years from realization and 10 to 20 years from correction. Seems like a long Kondratiev Winter and we seem to be in the January of it.
You note: "if you raise their net tax rate, they will consume less of something provided by other people. (So you tax the Dr. more, so he fires the landscaping firm, which eventually fires the gardener. Will the taxes you raise be spent in a way that recovers that job?)"
And that is mostly true as is fact that tax breaks for people earning much more than they can spend do create jobs BUT where are these jobs?
Not in high labor cost USA, but in Asia where these tax relief breaks for the super rich have build many factories more modern than those older ones in the US. The US factories could once compete when they were the world´s best, but now they are closing or outsourcing to stay open.
SUMMARY: Tax breaks for your doctor (the upper middle class) who do spend most of their income may help keep some US jobs, as you suggest BUT for the top 5% or so income group, who invest most of their income, that "job creation" is done where the rate of risk adjusted return is much greater than in the US (i.e. in Asia). Giving the top 5% more funds to invest in Asian is US "job destruction."
I think that if incomes of more than $250,000 / year were taxed MORE, then there would more US jobs and be less of the current US "job destruction" by the very rich building more modern factories in Asian etc.
Billy T – Part I of III: counterpoints to your argument (though not super related to tax policy)
First, imports of off-shore produced product do create/support substantial numbers of jobs in the US – notably the designers, marketers, sales force, fullfilment, etc. people. And it seems that at least part of the time the US jobs are the ones that pay well. So iphones are made off-shore, but does anybody think the majority of the money isn't in the hands of Apple, its employees, and shareholders? Has it escaped your notice that WalMart, a very large scale distributor of off-shore goods hires (often at low wage rates) very large numbers of people? We must never be blinded by "only the manufacturing" jobs – we must consider the entire job picture, and remember that all products have to be sold to somebody.
BIlly T – > Part II of III:
Second, "manufacturing jobs" seems to be a code-phrase for "jobs that pay well but don't require very high skills or elaborate preparation" – my personal view is that such jobs will disappear from manufacturing, more or less on a world wide basis outside of failed states and failed economies. I would guess in the next 100 to 200 years. It has already happened in agriculture – it happened to basically my father's and grandfather's generations.
Reshoring, say, the factory that makes iphones WON'T bring back to the US a number of jobs equal to what that factory provides now – instead, it will bring a number of well paid jobs for automation and automation-ops people, and a small number of "feed the hopper jobs". Off-shoring is a kind of side trip on the reduction of well paying jobs for people without advanced skills. Re-shoring (every single thing I hear or see about it) involves more modern facilities that make more product with less labor, often with more skilled labor. Employment may go up, but not in a way that addresses whatever structural problems we have.
Billy T – what turns out to be Part III of III
To the extent that our current horrible unemployment story is structural, that will have to be addressed by somehow developing skills in people, and perhaps by assuring freedom of commerce to allow business to flourish more.
To the extent it's cyclical, it will presumably be corrected when the cycle changes.
Finally – almost everybody invests (or has invested on their behalf) in large pools of one kind or another (pension funds, index funds, the stock market, individual stocks) and the management of those large pools largely decide what is off-shore versus on-shore.
Remember that the top 1.5% or so starts in the mid 200s (say $250K) which is Dr or business owner level, and NOT the class of money that decides "let's build a factory in China." The sorts of executives who make those decisions are often in "the 1%" but they're actually kind of a small part of it (so far as I can tell.)
All of which (parts I to III) make me very doubtful that any raising of marginal tax rates will have any kind of positive effect on employment or employment distribution.
THis is a great example for developing and developed economies around the world.
Great information .keep up the good work