Wayne O'Leary

Tax Policy Flimflam

There’s been much written lately, including by yours truly, about the One Percent and their outlandish levels of wealth, but little said regarding the continuing source of their money, namely, corporate profits. In light of the insistence on the progressive left that the upper end contribute to solving our long-range fiscal problems, that they pay “a little more” (in President Obama’s words) to help balance the books, it’s worth examining this corporate connection in the context of tax reform.

The recent fiscal-cliff tax increase purported to tap the One Percent and lend more fairness to the revenue-raising process; it did, but only in the short run and not to the extent advertised. The top 1% starts at $380,000 in annual household income and $6.9 million in accumulated net worth, according to the latest federal statistics, but it includes 16,000 ultra-wealthy families whose average income is $24 million a year (and whose holdings are in the billions of dollars). It is therefore obvious that merely hiking the maximum income-tax rate 4.6 points to 39.6% for households earning over $450,000 leaves something to be desired as fair and rational tax policy.

Besides creating a cavernous upper tax bracket with wide variations in income — from $450,000 to infinity — the mere return to the Clinton-era top tax rate fails to account in any way for the source of most of the One Percent’s income, which is scheduled to receive an unparalleled enhancement, courtesy of anticipated changes to US corporate tax law. As things stand, the One Percenters will pay 39.6% on their salaried income in 2013, but only 20% on their investment income (capital gains on sale of corporate stock and shareholder dividends from company profits), the source of roughly half their total annual remuneration. That’s more than in 2012 (15%), but still less than the 25% typically paid by middle-class Americans, who live for the most part on salaries and wages.

The low rate on capital gains and dividends, three-quarters of which go solely to the top 1% (including, in 2009, 22,000 households realizing over $1 million a year from investments), has literally built this class. Exhibit one is Mitt Romney, whose combined 2010-11 income of $42.6 million, made up almost entirely of investment gains, was assessed only 15% minus deductions; Mitt would owe the IRS something over $2 million more under this year’s rate, but hardly enough to impact his lifestyle.

The flawed theory behind low investment taxes, enunciated in 1997 by the Clinton administration when it foolishly lowered the capital-gains rate from 28 to 20 percent, is that more people will invest in companies, especially new ventures, thereby promoting growth and job creation. The Bush White House, which shared this view, doubled down in the early 2000s, reducing the rate on “unearned” income to 15%. What followed was not a boom, but a decade-long bust. Economists Thomas Picketty and Emmanuel Saez have exposed the fly in the ointment; corporations, they find, presented with sharply lower capital (or investment) taxes, routinely shift managerial compensation from salaries to stock options and dividends, cutting their available revenues and thereby stunting expansionary growth — except in the incomes of executive One Percenters.

While precious little job creation has resulted from America’s low investment-tax regime (now entering its fourth decade), other developments have become painfully evident to those outside the satisfied One Percent, whose members have enjoyed an extended “Thank you, Jesus” moment. US corporations, capitalizing on the movement of manufacturing employment offshore, the decline of labor unions, the replacement of workers with technology, government deregulatory policies, and the benefits of radically low borrowing costs enforced by the Federal Reserve, have reaped record profits — overall, the highest in a half-century and, according to The Economist, the largest (at 15%) as a proportion of the GDP in 30 years.

The end result is a mountain of hoarded corporate cash produced mostly by ruthless cost-cutting — $2.23 trillion at latest estimates — characterized by some as “dead money” because it’s obstinately not being directed toward job creation, but being kept available to line shareholders’ pockets. Amazingly, then, given the situation, movements are afoot in Washington to further pad corporate coffers by jimmying the business tax code. In a word, reformers, including those inside the administration, want to lower the corporate income-tax rate, which (on paper) is the developed world’s highest at 35%.

Last February, President Obama, calling the present corporate tax “outdated, unfair, and inefficient,” proposed cutting it to the current, fad-driven OECD (Organization for Economic Cooperation and Development) average of 28%, close to the 25% advocated by Mitt Romney. The dubious rationale is that US corporations need to be discouraged from using tax havens abroad and must be able to compete with foreign companies in other low-tax countries in a proverbial race to the bottom.

In fact, US firms already pay an eminently competitive tax rate when various loopholes and deductions (such as write-offs for capital-equipment depreciation, domestic-based production, and R&D) are taken into account. Analysts for The Economist reckon that the “effective tax rate” (ETR) for typical American firms (27.6% on average, including state and local levies) compares favorably to that of Britain (27.4%) and Germany (31.6%).

Further, Treasury Department data from 2000-05 indicated that US corporations were actually paying a nearly 3% lower rate on their profits than the average for OECD countries. And a Government Accounting Office study in 2005 showed that a substantial number of them paid no taxes at all. If the pending Obama proposal were to become law, it would cost the Government almost $1 trillion in lost revenue over 10 years, despite the promised elimination of unspecified tax breaks.

Besides adding to the deficit, a corporate tax cut would do something else: it would reward the One Percent who are corporate America’s prime shareholders, indirectly offsetting their newly legislated individual tax-rate increase. Under this scenario, Uncle Sam will simply be taking with one hand and giving with the other, leaving the One Percent (who have captured over half of America’s real economic growth since 1980) largely unaffected. That’s not what “tax reform” was supposed to look like in the era of hope and change.

Wayne O’Leary is a writer in Orono, Maine, specializing in political economy. He is the author of two prizewinning books.

From The Progressive Populist, March 1, 2013