How to stop inversions: increase the corporate tax rate. Yeah, you heard me.

I’m not going to write about the Netherlands today, even though Craig said I should.  He said that because I’ve had an inexplicably large number of blog hits from the Netherlands lately, and he wanted to see what would happen if I actually wrote about the Netherlands, just as an experiment.  Maybe just using the word “Netherlands” a lot of times in this first paragraph will be enough to conduct at least a minor experiment on this question.  (Just to be clear, for casual visitors who arrived here by taking a wrong turn at Google, an “inexplicably large number” in the case of this blog is 40 or so on several recent days.  Other than my friends, I get only  a few visitors.  Which is ok; I’m just one more economics blogger in the vast universe of economics bloggers, and many of the best economists on earth have excellent blogs.  But here are the numbers: even though I haven’t posted anything since July 20^th, and have only written four entries this year, I’ve had 515 hits in the past month on this blog.  241 of them---nearly half---were from the Netherlands.  I don’t have any idea why.)

Here’s what I am going to write about: Charles Krauthammer, Dean Baker, Jared Bernstein, Matthew Yglesias, Josh Barro and a whole bunch of other responses to the recent excitement about “inversion”, corporations moving their headquarters to other countries to escape high tax rates here in the United States.  I mention Krauthammer first because (and this shakes my faith in myself to the core; if this keeps up I’m going to stop reading my blog altogether) I agreed with almost everything he said.  Almost.  I also agree with Baker and Bernstein, mostly, although they were writing to dispute each other.  After a couple words about inversion, or maybe tomorrow, I’m going to add a word or two about the relationship between taxing corporations, which is what this issue is about, and taxing capital, which is way more interesting than it sounds, and is sometimes mistaken for the same issue.  (Hint: they are not at all the same issue.)

The first thing I want to say about inversion is to speak as a liberal to my brothers and sisters on the liberal side of the political spectrum, and to the White House.  What I want to say to them is this: chill freakin’ out! If you keep hyperventilating you’re going to faint.  Obama’s fevered reference to “corporate deserters” is irrational, and unfair.  It’s silly to blame corporations for doing whatever is in their best interest to do, as long as it’s not illegal or immoral, and seeking out the best legal tax environment is neither.  It makes no more sense to blame corporations for seeking most advantageous location to settle in than it does to blame rivers for flowing downhill instead of up.  Water seeks the lowest point it can find, and corporations seek profits.   After-tax profits.  That’s what they’re created to do. 

Here are the raw numbers from the OECD on total corporate tax rates.  The table combines “Central and Subcentral” taxes, which means that state and local taxes are included.  There’s a scroll-bar at the bottom so you can move through the years from 1981 to 2013.  If you do that you’ll notice that the issue is not that our tax rates are historically high, but that other nations have reduced their corporate tax rates over time to draw businesses.  There’s been a race to the bottom in corporate tax rates, and we have chosen not to compete in the race, or not to compete as vigorously as other countries have.  In 1981 our corporate income tax rate was 49.7%; now it’s 39.1%.  By contrast, Sweden’s corporate tax rate in 1981 was 57.8%, and now it’s 22%; Ireland’s was 45% in 1981, and now it’s 12.5%.  We have the highest corporate tax rate in the OECD table now, not because our taxes have gone up---they haven’t---but because everyone else’s tax rates have come down so much farther than ours have.

Krauthammer says that the solution to the problem of corporate flight from high tax rates is tax reform here, rather than building a legal wall to keep corporations from leaving.  So far I agree completely with Krauthammer, which is, as I said, disturbing. Later in his column he does recognize that the 35% top federal corporate tax rate is not really the effective rate that corporations pay: because of loopholes some of the larger corporations, according to Krauthammer, have effective tax rates of 13%.  I’m not sure where he got that figure.  Some corporations, some years, pay no taxes at all.  And this matters: corporations’ decisions on whether to move to another location will be based (in part) on the effective overall tax rates they pay in each place, not on an imaginary top possible rate.

Of course Dr. Krauthammer blames Obama for the lack of corporate tax reform, forgetting that there are big differences of opinion on what constitutes “reform”, and also that if Obama proposed a bill honoring motherhood and entirely eliminating corporate taxes the Republican house would be bent double in a seizure of feigned indignation, and would threaten to throw Boehner out of the House leadership if he even brought it to the floor, which, of course, he would not do.  They would turn it into a scandal of some kind, God knows how.  Darryl Issa would hold hearings on whether to impeach Obama and Hillary Clinton and possibly Bill Clinton and John Kennedy too, for proposing such things; his committee would eventually produce a final report at enormous public expense basically exonerating everyone on whatever they had decided to be upset about, and Fox News would ignore the final report and maintain their outrage on the grounds that, well, on the grounds that outrage is more fun than pretty much anything and anyone who exonerates Obama or Clinton is a poopy stupid-head.  So I disagree with him on whom to blame, but that’s secondary.  The real question is what we should do now.  And “tax reform” is as good a name for what we should do as any.  But to Krauthammer and most people on the right (and many on the left), “tax reform” means reducing the tax rate, but eliminating loopholes so that the action is revenue neutral.  In other words, reduce the top rate, but keep the average effective rate the same, more or less, which, if effective tax rate is the motive, doesn't really sound to me like it would reduce the incentive for corporations to find some other lower-tax location for their headquarters.   And also, the first part of that (lower rates) is easy, the second part (eliminate loopholes) is damned near impossible, as Matthew Yglesias points out at the link above, which is why it’s so hard to get done.  And anyway, as I’ll explain in a minute, this is exactly the opposite of what I think corporate tax reform should be.

Now, I’ve said before that I don’t like the corporate income tax anyway---if there were a way to do it I’d favor a zero tax rate for corporations.  I’ve written about that here on this blog.  Corporations are not people, so they have to pass the taxes we levy on them along to real human beings one way or another, and it’s not at all clear that the owners of corporations pay all of it, or even most of it.  From Matthew Yglesias:

“An interesting theoretical question is who actually does pay the corporate income tax? Does it fall on workers? On owners of land? On owners of capital? I can assure you that after reading a few papers on this thanks to the National Bureau of Economic Research's search tools that the answer is credible researchers disagree and the answer is highly sensitive to modeling assumptions!”

When I first said that decades ago, and even fairly recently, people on the liberal side of the world were aghast at the thought.  But apparently there’s been a revolution brewing that I never saw.  Dean Baker’s post, at the link above, comes out in favor of eliminating the corporate tax and raising the tax on the wealthy to make up the lost revenue.  Josh Barro, at the link above, suggests the same thing. 

But Jarred Bernstein raises the issue that has always actually given me some pause, and states it so well that I have to change my mind about eliminating the top corporate tax rates.  As he says (at the link above), eliminating corporate taxes:

“risks turning the corporate structure itself into a big tax shelter: If income generated and retained by incorporated businesses should become tax-free, then guess what type of income everybody will suddenly start making?”

Yeah.  Dammit.

So eliminating, or even reducing, the corporate tax rate is not a good idea.  Time to uncork the theory of the second-best, then.  If we can’t reduce rates to zero because ordinary people would suddenly become corporations, I’d suggest that corporations should pay the personal tax rate on their income, so there’s no incentive at all for people to pretend to be corporations as a way to shelter their income from taxation.  But I still think that corporations should pay zero or near-zero effective income taxes.  In other words, we should raise tax rates and increase tax deductions (which is the other word we use for “loopholes”) not just to be revenue neutral, but to drive revenue from corporate taxes down near zero.   Of course, there would be a huge fight about which deductions are worthwhile and which are not, and how to design the system so that all industries have exactly the tax breaks they need to get them to zero effective profit tax.  And yes, that means that we would need to raise the lost revenues elsewhere.  But there are plenty of good options: how about a carbon tax to fight global warming, or other Pigovian taxes to internalize production costs and promote the general welfare (which according to the preamble to the Constitution is one of the primary goals of the government that constitution created)?  How about a financial transactions tax to reduce computer driven speed trading in the stock market, which seems to have no purpose other than to make money for the computer’s owners and lose money for everyone else?  I know, those would be big political fights, but the point here isn’t what’s easy to do, it’s what might be good to do if we could.  And if we could reduce the effective tax rate to zero by adding good loopholes, that would also eliminate any reason for corporations to move somewhere else---unless the other location had effective taxes less than zero.

See?  Definitions of tax reform differ from one person to the next.

I guess I’ll talk about taxing capital tomorrow.