Biden’s great tax rebalancing
US President Joe Biden’s spending plans have been grabbing headlines, and rightly so. The administration’s relief package and infrastructure plan could remake the US welfare state by bolstering the social safety net and increasing spending on transportation, broadband, and education.
But with US government spending likely to remain high after the Covid-19 pandemic, tax revenues must increase, because additional borrowing can finance only so much. Hence, the Biden administration has proposed the equally sweeping Made in America Tax Plan, which would increase corporations’ share of tax revenues.
Raising the corporate tax rate is the best option. In the first decade after World War II, taxes on individual incomes and social insurance receipts made up about 50% of federal tax revenues, while corporate taxes accounted for another 30%. But since then, the former category has increased steadily, reaching about 85% of total federal tax revenues, while the corporate share has fallen below 10%.
Moreover, US corporate profits have never been higher, while the share of national income accruing to labour has declined from about 66% to 58%, indicating that workers have been paying an ever-larger share of total taxes even as they have been getting a diminishing share of the economic pie. My own research finds similarly high imbalances in the effective marginal tax rates on labour (more than 25%) and on capital investments such as software and equipment (5%).
These marginal rates are what guide corporate investment decisions. Under the current US tax structure, corporations have much stronger incentives to pursue excessive automation than to employ, train, and properly pay workers. But automation is not the only technological path open to US businesses. With different incentives, they would instead invest in technologies designed to make workers more productive. All told, the deep imbalances in the current tax structure are costing the US economy not just in terms of employment, but also in decreased productive efficiency and growth.
While the Trump administration’s 2017 tax bill slashed the corporate tax rate from 35% to 21%, the corporate share of total tax revenues has been declining for a half-century. Many businesses have become private partnerships or S-Corporations, which are exempt from corporate income taxes. Another major contributor to this trend has been depreciation allowances, which enable corporations to deduct investment expenditures from their taxable income.
Biden’s promise to increase the headline corporate tax rate from 21% to 28% is therefore an important step, but insufficient in itself. It will neither level the playing field between capital and labour, nor stop US-based corporations from engaging in “tax inversions” to flee to other jurisdictions or from shifting their profits to foreign subsidiaries. Footloose corporate profits have been a leading factor in the long-term reduction of tax rates on capital and corporations, and multinationals would still have a full bag of tricks for reducing their reported US profits, such as internal financial transactions to increase their debt obligations in the United States and using foreign subsidiaries to overcharge their US branches (transfer pricing).
Fortunately, the Biden plan includes a second pillar to address precisely this problem: a global minimum corporate tax.
In theory, the idea is simple. Ideally, tax rates would be hiked substantially in Ireland, Luxembourg, Switzerland, Panama, the British Virgin Islands, and other jurisdictions that allow corporations to evade their tax obligations through “arbitrage.” If not, a company headquartered in the US and subject to the 21% global minimum corporate tax rate that reports all of its profits in Ireland, where the corporate tax rate is 12.5%, would be assessed additional US taxes equivalent to 8.5% of its profits.
Of course, the policy would be more complicated in practice. Lowtax jurisdictions have come to rely so much on tax-dodging international businesses that they have spurned coordination. Faced with the global minimum tax rate in the US, some may be tempted to relocate their headquarters to such countries (which is why the Biden tax plan also includes provisions to prevent evasive corporate flight). If some of the most notorious tax havens refused to cooperate, any new international framework would fail.
This is where US leadership comes in. The US has incredible fiscal power, not just as the world’s largest economy, but also as the regulatory headquarters of the global financial industry. If US policymakers lead with enough conviction, other countries will be forced to follow. Biden’s tax plan already contains provisions to prevent tax inversions and includes proposals for limiting tax deductions for multinationals engaged in tax arbitrage. The US can also take legal action against foreign financial institutions involved in tax fraud and systematic innovation, and can work multilaterally to bring greater harmonisation to the international taxation of corporate incomes.
If implemented fully, a global minimum corporate tax rate would revolutionise international capital taxation. But even this would not solve America’s fiscal problems. To reverse the unfair and inefficient reduction of the corporate tax burden, the Biden administration must also end excessively generous depreciation allowances and broaden the tax base, so that companies cannot avoid taxes simply by changing their legal status.
Greater corporate taxation should be accompanied by other measures to encourage investment and innovation. In addition to subsidising research and development, the state can do more to help increase the supply of well-trained engineers, scientists, and skilled workers, and to facilitate the diffusion of technological know-how.
With a more level playing field between capital and labour, companies can be induced to develop and adopt new technologies that increase worker productivity, rather than continuing the trend of excessive automation that has shaped the US economy for the past two decades. Part and parcel of this effort will be action to end the dominance of just a few companies in the technology sector.
A fairer tax system would not solve all of America’s economic problems on its own. But it would be a significant step in the right direction, helping workers and the economy while also stemming the alarming rise in federal debt. — Project Syndicate