India’s finance minister this week released a budget that includes , among other things, a five per cent reduction in the corporate income tax. Narendra Modi, the Prime Minister of India, won a landslide election last May on a pro-growth agenda. The proposed budget would move India, one of the world’s largest economies, from a 30 per cent base rate to 25 per cent. (There are some surcharges that push the rate a few points higher by some measurements, including the ones we use at Tax Foundation. We measured the rate at 34% in our last report .) While Indian tax news is not directly relevant to U.S. policy, it’s important to remember that this fits into a broader picture: the rest of the world has built a sort of consensus that corporate income is a poor tax base, and corporate income tax rates around the world have been steadily falling. I expect this trend to continue with time. There’s nothing wrong with taxing income people earn from investments in corporations. But there’s a right way and a wrong way to do it. The 401(k) structure, for example, taxes investment income in a fair and elegant way. The corporate tax doesn’t. And that’s why it is in a long, steady decline throughout the world.
Here are some great links from this week: The Texas Public Policy Foundation has a new report about repealing the Texas Margin Tax . They find repeal would produce $10.8 billion in new real personal income in the first year and $16 billion over 5 years. The state would be one of just four states without direct business tax or individual income tax. We have some similar findings in our paper on the Texas Margin Tax here . Barbara Shelly at the Kansas City Star has a review of the Kansas income tax exclusion for pass through entities that blew a hole in the budget. Kansas expected 191,000 people to take advantage of the exclusion, but 333,000 people ended up taking it, for a loss of $207 million in revenues. I testified today to the Ohio House Ways & Means Committee on a similar provision being considered by Gov. Kasich. Jason Mercier of the Washington Policy Center noticed that the Washington Department of Commerce has pulled “no capital gains taxes” from its list of reasons to live in Washington. Gov. Inslee and others have proposed taxing it, and the Commerce Department doesn’t want to be “disingenuous.” More on Washington from my colleague Jared Walczak.
Earlier today Senators Rubio and Lee released their “ Economic Growth and Family Fairness Tax Reform Plan .” We have modeled the economic and budgetary effects of the plan and will release our full results Monday, but the following is a preview. On the business side, the plan is strongly pro-growth by design. Instead of taxing net business income at our current high rates, it taxes business cash-flow at a top rate of 25 percent. This is the essential way to reduce the most growth-slowing aspects of our federal tax code: It cuts the corporate and non-corporate (or pass-through) business tax rate to 25 percent. It eliminates the double-tax on equity financed corporate investment, by zeroing out capital gains and dividends taxes. It allows businesses to immediately write-off their investments, instead of requiring a multi-year depreciation. It also takes interest out of the tax code for non-financial businesses, neither allowing interest deductions nor taxing interest income. This is a dramatic simplification. On the individual side, it simplifies the income tax code by reducing the brackets from 7 to 2, with a top tax rate of 35 percent and bottom tax rate of 15 percent. It also introduces a generous child tax credit of $2,500, on top of the current $1,000 child tax credit. On both the business and individual side, the plan eliminates a number of tax preferences. After modeling the plan, we find it to be indeed strongly pro-growth. As the table below shows, it would grow GDP by 15 percent by the end of the adjustment period, roughly 10 years. That means the economy would be 15 percent larger than CBO predicts under current law. As well, relative to a current law, we find the capital stock would grow by almost 50 percent, wages by almost 13 percent, hours worked by almost 3 percent, and jobs by 2.7 million. Second, the growth in the economy would eventually boost tax revenue, relative to current law. We find after all adjustments (again, about 10 years) that federal tax revenue would be about $94 billion higher on an annual basis. This is our dynamic estimate. Our static estimate, i.e. assuming the economy does not change at all, shows a tax cut of $414 billion per year. We believe the dynamic estimate is much closer to reality. Our full analysis will be out Monday, and there we’ll provide a distributional analysis, and also an estimate of the 10 year budget effects. Table: The Rubio-Lee Tax Reform Plan Would Grow the Economy by 15 Percent Economic and Revenue Estimates for the Rubio-Lee Tax Reform vs. Current Law (2015 Dollars) GDP 15.0% GDP ($ billions) 2,658 Private Business GDP 15.6% Private Business Stocks (Machines, Equipment, Structures, etc.) 48.9% Wage Rate 12.5% Private Business Hours of Work 2.8% Full-time Equivalent Jobs (in Thousands) 2,667 Static Federal Revenue Estimate ($ billions) -$414 Dynamic Federal Revenue Estimate after GDP Gain or Loss ($ billions) $94 Weighted Average Service Price % Change Corporate -26.9% Noncorporate -11.5% All Business -22.3% Source: Tax Foundation Taxes and Growth Model. Follow William McBride on Twitter
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Lately, we have seen good job growth numbers which has led to a reduction in the unemployment rate. At first glance, this is an encouraging sign for the economy. But when we have a closer look at data on business dynamics, it is clear that the overall economy has not come back to its full strength. Specifically, the economy is still not creating as many new firms as it did before the recession. For example, around 560,000 new firms were created in 2006. By 2012, after what was called an “encouraging recovery,” the number of new firms created had declined by almost 37 percent, according to a report from Kauffman Foundation . While the causes of declining new firm creation still remain a conundrum, it may shed more light on our problem by presenting the geographic distribution of new firm formation rates. New firms measured in this data are less than 1 year old employer firms, no self-employed individuals. New firm formation rates are calculated as the ratio of new firms to the total number of existing firms. North Dakota is the only state with positive change. This is undoubtedly due to the economic boom fostered by shale gas drilling. At the other end, Nevada, Utah, Idaho, Arizona, Florida, Washington, Colorado were among the 10 states with top new firm formation rates in 2006 and dropped most significantly in 2012. The anemic growth of new business can be infectious and impact the overall dynamism of the economy. A pro-growth tax code beneficial to promote entrepreneurial activity.
In a new 580-page report , a government advisory panel calls for “bold actions” to “transform the food system” and bring about a fundamental shift in people’s diets and lifestyles. The 2015 Dietary Guidelines Advisory Committee advocates “a diet higher in plant-based foods, such as vegetables, fruits, whole grains, legumes, nuts, and seeds.” It wants people to eat fewer “burgers, sandwiches, [and] mixed dishes,” instructs them to use less salt, recommends more exercise, and suggests placing “limits on sweets and desserts.” The committee members clearly are displeased with the general public and impatient for change. “The dietary patterns of the American public are suboptimal… Unfortunately, few improvements in consumers’ food choices have occurred in recent decades… [T]he Nation’s adverse dietary pattern and physical activity trends must be reversed.” In addition to believing the changes are for people’s one good, the panel members are troubled by the nation’s high health care costs and mention those costs frequently in their report. They see modifications in people’s behavior as a way to lower those costs. The panel sees many opportunities for intervention, such as educating people about good dietary habits and asking suppliers to offer more of the foods that nutritionists recommend. The committee members think part of the solution may also lie in coercive government action, such as taxes and bans, “to encourage the production and consumption of healthy foods and to reduce unhealthy foods.” For example, the new report talks of imposing taxes on “sugar-sweetened beverages, snack foods and desserts high in calories, added sugars, or sodium, and other less healthy foods” and using some of the new tax revenue “for nutrition education initiatives and obesity prevention programs.” It will be left to others to decide whether burgers, flavored milk, and dessert should be relegated to a hall of shame. Economics, however, does offer some guidance on whether the special food taxes that the federal panel mentions are warranted. A basic economic principle is that a good or service may be overproduced or produced inefficiently if it imposes costs on third parties who are outside the market place and unrelated to buyers or sellers. (Conversely, something may be underproduced if it confers external benefits outside the market on unrelated third parties.) A classic example of a harmful externality used by the English economist A.C. Pigou nearly a century ago is “uncompensated damage done to surrounding woods by sparks from railway engines.” A so-called Pigouvian tax could correct this market failure by internalizing the cost, provided the tax is set equal to the external damage caused by the last unit of the offending product. In Pigou’s example, such a tax could have induced railroads to take account of the fires on neighboring land. (Because of difficulties in measuring external costs and concerns about the political process when it comes to taxation, a more practical alternative in many cases is internalizing the cost through clearly defined property rights, such as by making railroads in Pigou’s example legally responsible if they cause fires on adjoining land.) For an example related to eating habits, suppose that eating an extra brownie somehow causes one-tenth of a cent of harm to unrelated third parties. The externality-based tax would be one-tenth of a cent. It is important, however, not to impose a higher tax than the external damage, say 10 cents per brownie, or it would reduce both private and social welfare rather than increasing them. (If eating the brownie doesn’t harm third parties or somehow generates external benefits, the externality argument would call for either no tax or a small subsidy.) A point Pigou and later economists emphasized is that the externality argument regarding market failure and corrective taxation only applies to costs that are truly external. For instance, suppose a train ride is bumpier than passengers would like or a person biting into a brownie anticipates a tinge of remorse when stepping on the bathroom scale the next morning. These are internal costs that buyers already factor into their market decisions. Hence, they do not lead to allocative inefficiency. If the government imposes taxes to “correct” for these internal costs, the effect is to double charge buyers for the same (internal) costs, leading to inefficiently low production and consumption. Although the federal nutrition report says repeatedly that its recommended dietary and lifestyle choices would reduce “health care costs” and “economic and social costs,” the report never distinguishes between internal and external costs or even once alludes to the concept of externalities. Nor does the report note that the biggest gainers or losers from people’s diet and exercise choices are the people themselves, which means most of the costs the committee refers to are internal costs and are already accounted for in the decisions we make. In short, the committee’s tax proposal is not based on an analysis of externalities and market failure. More likely, the committee members feel they know how people should behave, and largely attribute people’s failure to comply to reasons like poor information, poor discipline, and lack of commitment. The committee may view taxes as a means of pressuring people to do what the people would do willingly if only they were smarter and more mature. To be fair, the report never articulates this paternalistic, authoritarian rationale for taxation. If the panel members are thinking along this line, however, three counterpoints should be made. First, because of a constant stream of news stories, most people are already aware of many basic diet-related do’s and don’ts. The majority of Americans have made some dietary adjustments, and a minority have undertaken major changes. However, the degree to which people adjust their diets and lifestyles depends importantly on personal preferences. A person may make choices that nutritionists deplore but that are rational given the person’s likes and dislikes. For instance, one individual may skip bacon because of health warnings while another, who has heard the same warnings, may find bacon too satisfying to forsake (although the person may eat a little less than otherwise.) Second, while people do give weight to dietary advice, they may be hesitant to accord it greater weight, especially when it strongly conflicts with their preferences, because it is not always reliable. For example, after a generation of government advice to go easy on eggs, the new dietary report informs us that, based on accumulating evidence, eggs are not so harmful after all. Third, the people whose eating and exercise habits seem most self-destructive tend to be the ones least likely to respond to tax penalties. Meanwhile, the taxes would punish everyone else too, which is unfair. Although it is never articulated in the report, the numerous references to health care costs suggest the committee members may also feel that people’s eating and lifestyle preferences should be overridden to some extent by taxes and other prods in order to economize on government health program expenditures. The panel should have explained what role, if any, government budget considerations played in its recommendations. In summary, while it is in people’s self-interest to make reasonable dietary and exercise choices, the taxes recommended in the 2015 Dietary Guidelines Advisory Committee should probably be taken with a grain of salt.