Competitive Tax Policy

Joel SlemrodUniversity of Michigan

CASIC Research SummitApril 2, 2011

What is Competitiveness?

• Policies that maintain (and preferably expand) the real incomes of citizens in the face of global international markets and the policies of other countries.

• These policies vary from domestically oriented and open to international cooperation, to aggressive courting of foreign investment, to the beggar-thy-neighbor behavior of tax havens.

• It is not a substitute goal for prosperity.

How Is Competitiveness Measured?

• In the Global Competitiveness Index, taxation comprises 2 of over 100 indicator variables.

• The GCI is highly correlated with GDP per capita (rank-order correlation = 0.85).

• “No New Criteria!”• For the most part, global competition does not

add a new criterion by which to judge tax policy, but rather it changes how any given policy meets those criteria.

What is Competitive Tax Policy?

• A low-rate, broad-base tax system that establishes a level playing field; i.e. that does not attempt to pick winners.

• The cost of following a high-rate, narrow-base policy is even higher in an integrated world economy than in a closed economy.

• Some exceptions, such as subsidizing research and experimentation, can be justified.

Unpersuasive Economic Arguments

1. Lower taxes on base X are always better because they reduce the disincentive for businesses and individuals to do X.

2. Policy X is better than our current policy because most other countries do X.

3. Lower corporate taxation is always better.

The Corporate Income Tax

• The corporate tax system creates a host of well-known distortions.

• Although interest payments are deductible as a business expense, corporations cannot deduct the cost of equity financing. This causes inefficient incentives for corporations to raise capital by borrowing.

• The two levels of tax, corporate and individual, generally cause the cost of capital for corporate businesses to be higher than it is for other businesses.

• Fundamental reform plans abound, but there are formidable practical obstacles, including compatibility with other countries’ tax systems.

Lower the Corporate Tax Rate?

• This would reduce the disincentive to invest, but only for corporate businesses, unlike accelerated depreciation that applies to all businesses.

• It would reduce the incentive for MNEs to shift taxable income to low-tax countries. This could also be accomplished by cracking down on transfer pricing abuses, etc.

• But beware of Unpersuasive Argument #1.

Abandon Worldwide Taxation?

• This would eliminate the competitive disadvantage of US-based MNEs operating in low-tax countries.

• But it would exacerbate income shifting problems.

• It’s worth considering as part of corporate tax reform, if US revenue could be defended.

Some Facts

• The United States has one of the highest statutory corporate tax rates among developed countries.

• The US marginal effective tax rate on capital is the 7th highest among OECD countries.

Research Findings

• Inward FDI does seem to be influenced by domestic tax policy.

• A link between corporate tax policy and GDP level or growth—the ultimate objective of economic policy—has been very difficult to establish, in part because of the difficulty of separating out the causal directions.

• High-tax countries are high-income countries, or is it the other way around?

Promising Future Research

1. Which has a bigger “bang per buck,” a lower corporate tax rate or accelerated depreciation?

2. Does lowering the tax on US MNEs’ foreign income increase their US investment?

3. How does cracking down on outward income shifting affect FDI patterns?

4. What would be the effect of using a VAT to replace much or all of US income taxes?