President Joe Biden’s spending plans grabbed the headlines, and rightly so. Washington’s aid package and infrastructure plan could reshape the American welfare system by strengthening the social safety net and increasing spending on transportation, broadband, and education.
Since federal government expenditures are likely to remain high even after the Covid-19 pandemic, tax revenues will have to rise because not everything can be funded through additional borrowing. So the Biden government introduced an equally far-reaching tax reform called the Made in America taxation scheme, which would increase the share of corporate taxes in tax revenues.
Raising the corporate tax is the best option in this regard. In the first decade after World War II, taxes on social and personal security income accounted for about 50% of all American tax revenues, while corporate taxes accounted for another 30%. Since then, however, the share of personal income taxes has risen steadily, reaching around 85% of total tax revenue, while the share of corporate taxes has fallen below 10%.
Corporate profits have not been very high in the United States
In addition, corporate profits in the United States have never been higher than they are today, while the share of employment in national income has decreased from about 66% to 58%. This is an indication that workers are paying a greater share of total taxes, even though the portion they receive of the economic pie is getting smaller and smaller. In my own research, I encountered a similarly large imbalance between effective marginal tax rates on labor (over 25%) and capital investments such as software and equipment (5%).
These marginal tax rates form the guiding principle for corporate investment decisions. Under the current tax structure in the United States, companies have much stronger incentives to operate excessive automation than to hire, train and pay employees appropriately. However, automation is not the only technological avenue available to US companies. In the case of other incentives, they will instead invest in technology that makes employees more productive. In general, the apparent imbalances in the current tax structure are costing the US economy, not only in terms of jobs, but also in terms of lower productive efficiency and lower growth.
While the Trump administration lowered the corporate tax rate from 35% to 21% under the 2017 Tax Act, the share of corporate taxes in total tax revenue has decreased for fifty years. Many companies have become private partnerships or S-Corporations, which are exempt from corporate tax. This trend has been supported by depreciation options, which allow companies to deduct capital expenditures from their taxable income.
Standard tax rate from 21 to 28%
Biden’s promise to raise the standard corporate tax rate from 21% to 28% is an important step, but it is not sufficient on its own. The various conditions in taxation of capital and labor have not been settled, nor have the corporations headquartered in the United States transferred to another jurisdiction for tax improvement purposes or to transfer their profits to foreign subsidiaries. Unrestricted corporate profits have been a major factor in lowering tax rates on capital and corporate profits in the long run, and multinational corporations still have tons of tricks at their disposal to reduce their reported profits, such as internal financial transactions to increase their debt obligations in the United States and through the use of corporations. Foreign affiliates that charge excessive fees to their US subsidiaries (transfer pricing).
Fortunately, there is a second pillar in the Biden plan that addresses this very problem: a global minimum corporate tax.
In theory, the idea is simple. Ideally, Ireland, Luxembourg, Switzerland, Panama, the British Virgin Islands and other countries that allow companies to arbitrage to evade their tax liabilities will raise their rates dramatically. Failure to do so will result in a US-based company subject to a minimum global corporate tax rate of 21% and reporting all of its earnings in Ireland, where the corresponding rate is 12.5%, with an additional US tax of 8.5%. Charged on their earnings.
The United States has the financial power
In practice, however, this approach will be more complicated. Low-tax countries now depend on international corporations avoiding taxes to the point that they have refused to coordinate. Given the minimum global tax rate in the United States, some international companies may be tempted to move their headquarters to these countries (which is why the Biden tax plan includes provisions to prevent corporate tax evasion). If some notorious tax havens refuse to cooperate, then any new international framework will fail.
Here comes the increase in the standard corporate tax rate from 21% to 28%. The United States has incredible financial power not only as the largest economy in the world, but also as the regulatory center of the global financial industry. If American policy proceeds forward with enough conviction, other countries will be forced to follow it. The Biden tax plan already contains provisions to avoid tax reversal and also includes limiting tax cuts for multinational corporations involved in tax arbitrage. The United States also has the capacity to take legal action against foreign financial institutions implicated in tax fraud and systematic innovation, and can work multilaterally for greater coordination of international taxes on corporate profits.
The global minimum corporate tax rate, if fully implemented, would revolutionize international capital taxation. But even this will not solve America’s financial problems. In order to reverse unfair and ineffective corporate tax cuts, the Biden government should also put an end to generous excessive consumption options and broaden the tax base so that companies cannot avoid taxes once they change their legal status.
Equation of the terms of capital and labor
Higher corporate taxes should be accompanied by other measures to encourage investment and innovation. In addition to research and development subsidies, the state could do more to increase the supply of well-trained engineers, scientific workers and skills and facilitate the spread of technological knowledge.
Through the convergence of the terms of taxation of capital and labor, companies can be incentivized to develop and implement new technologies that increase labor productivity, rather than continuing the trend of excessive automation that has characterized the US economy over the past two decades. A key part of these efforts is taking measures to end the dominance of a few companies in the technology sector.
A fairer tax system alone will not solve all of America’s economic problems. But it would be an important step in the right direction and would help workers and the economy while containing the worrying rise in the national debt.
Copyright: Project Syndicate.