“It’s The Economy, Stupid” — Time To Get Tax Reform Done

(This item originally appeared at Forbes.com on November 29, 2017.)



As we get into the final rounds of the legislative process for tax reform, it is important to keep an eye on exactly what we are trying to accomplish, and why.

At base it is this: “It’s the economy, stupid.” A healthy economy solves a myriad of problems, from employment, to wages, to welfare, to healthcare, to pensions, to budget deficits. Without a healthy economy, all of these things prove insoluble, and worsen.

After many decades, since the 1930s, of attempting to produce a healthy economy through some kind of government intervention – public infrastructure spending, government investment in private industry, military spending — we should know by now that it isn’t really possible. A few possible successes are overmatched by many failures, and we don’t seem to be able to get the success without the failure. A healthy overall economy is only possible with a healthy private economy. There are many examples of successful countries with a healthy private economy, and a somewhat wasteful and corrupt government. However, there are, I would say, no examples of a successful country with a moribund private economy, that somehow makes up for this with some sort of brilliant public sector. There isn’t even a word for it: a “healthy government economy”?

A healthy economy must have healthy corporations – profitable corporations that expand and invest, and consequently hire more people. They don’t really want to hire more people. But, it is something they have to do to make more profits.

Healthy corporations emerge in an environment that allows them to exist – a business-friendly environment. With today’s high corporate tax rates, this has only been possible because corporations have lobbied for a vast array of tax exemptions, lowering their overall tax burden. However, this tends to be inefficient. Winners and losers are determined not by the value of the goods and services they provide, but by the tax code, and whether a business has been able to garner tax advantages to itself – typically old, large, low-growth businesses, while new, small, high-growth businesses, which are the primary job-creators, face the full rates and are stifled. Capital is directed at relatively unproductive channels. Despite the high rates, corporate tax revenues are meager. The arrangement – one of securing individual benefits via lobbying and campaign contributions (basically, bribery) – is inherently corrupt, and tends to undermine the state.

In practical terms, the roughly 24% effective Federal/State/Local corporate tax rate that would result from a reduction in the Federal rate to 20% is still not very low. Most OECD countries’ rates are lower. It is a rate that still, in my view, introduces considerable distortion from what would be the case if there were no taxes at all. But, it is a lot better. Also, it allows the eventual rollback of all the specific exemptions, thus leading to both a higher revenue/GDP (as Britain gets with its 19% corporate tax rate) and also a healthier economy. Eventually, we would like to emulate Hong Kong’s “Flat Tax” approach, which allows one of the most business-friendly places on earth while also generating three times the revenue/GDP of the U.S.’s corporate tax system, at a 16.5% rate.

Many complain that corporate tax rate reductions are “tax cuts for the rich.” Shareholders are the direct beneficiaries, and shareholders might be called “rich” although in many cases they are pension funds or 401(k) plans whose beneficiaries are decidedly middle-class. Second-order effects are rising wages and increasing employment.

There are many examples of countries where the rich get richer, and the poor get poorer. If you go to any basket-case country – Haiti, Venezuela, the Soviet Union – you will find there a wealthy elite class. This is a symptom of failure. However, there is no example of a successful country where the poor get richer, and the rich get poorer. The question is not whether the rich get richer – we want that – but whether the poor get richer.

There are two basic ways to get rich: to provide some useful good or service, and make a small profit margin on the revenue (the historical average is about 6%); or to steal it. The first creates more productivity, wealth, jobs and income. The pie gets bigger and everyone benefits. The second creates no new wealth; and, in practice, destroys it. The rich can get richer only if the poor get poorer.

When it is hard to make an honest buck (provide a useful good or service), then the ambitious stampede toward the second option. Scams abound, most of them amounting, one way or another, to a transfer of resources from taxpayers to various government cronies in the Military Industrial, Healthcare Industrial, Education Industrial, Public Works Industrial, Housing Industrial, Public Employee, and other such well-known complexes. Countless governments have collapsed under this dynamic.

Individual taxes have proven hard-to-reform this time around. I hope that Republicans will take it up again in 2018. At least we have made some progress on the Alternative Minimum Tax, and the estate tax, and have gained some experience that will be useful in the future. The idea of lowering rates and eliminating exemptions is a good one – but the rates need to be much lower. The end of this discussion is something like Steve Forbes’ 17% Flat Tax, a concept already proven by dozens of countries that have adopted it since 2000. That might seem like too much of a leap for now, but it won’t seem so odd when corporations are already at 20%. (That will be a nice opportunity to also lower the corporate rate to 17%, while simplifying the corporate tax code.)

I will leave you with the words of the fourteenth-century Arab genius Ibn Khaldun, who served in high office (including Prime Minister) in a variety of North African states, led armies into battle, did time in prison for his views, wrote some of the great works of history and government of his era, and eventually retired as Egypt’s Minister of Justice:

In the early stages of the state, taxes are light in their incidence, but fetch in a large revenue; in the later stages the incidence of taxation increases while the aggregate revenue falls off. …

But the effects on business of this rise in taxation make themselves felt. For business men are soon discouraged by the comparison of their profits with the burden of their taxes, and between their output and their net profits. Consequently production falls off, and with it the yield of taxation.

The rulers may, mistakenly, try to remedy this decrease in the yield of taxation by raising the rate of taxes. . . . This process of higher tax rates and lower yields (caused by the government’s belief that higher rates result in higher returns) may go on until production begins to decline owing to the despair of business men, and to affect population. The main injury of this process is felt by the state, just as the main benefit of better business conditions is enjoyed by it.

From this you must understand that the most important factor making for business prosperity is to lighten as much as possible the burden of taxation.

Let’s get it done, Republicans.