Tax Analysts Blog

How Not to Tax the Rich

Posted on Jun 9, 2014

During the Reagan era, the debate about corporate taxes was different than it is now. Back then, liberals wanted to keep taxes high on corporations because it was a good way to tax the rich. Conservatives countered that high corporate taxes reduced capital spending. With the debate framed in these terms, what followed was a humongous, multi-decade argument about the economic effects of the corporate tax. Though these politically charged academic spats are never clearly resolved, we can say that when liberals argued that higher corporate taxes would not severely hamper economic growth, they had a lot of economic evidence to back them up.

Gradually over the following three decades, the world changed, and economists were forced to overhaul the way they thought about the effect of taxes on investment. Cross-border capital flows, previously a sideshow, now took center stage. And that entirely changed the political economy of corporate taxation. Now when making their case to politicians, conservatives no longer had to argue that corporate taxes hurt overall corporate investment; they only had to argue that high domestic taxes caused corporations to shift their investment outside the United States.

Because the effect of taxes on the location of investment is much greater than the effect of taxes on overall investment, a corporate tax that may have had relatively benign economic side effects in the 1980s now can do a lot of damage. The rest of the developed world recognizes this, and in response those countries have dramatically lowered their corporate tax rates.

The last major holdout besides the United States was Japan. As part of Japan’s most recent tax legislation that took effect on April 1, a temporary corporate tax surtax, instated to help defer the costs of rebuilding after the great 2011 earthquake and tsunami, was terminated one year early. This reduced the corporate tax rate by approximately 2.4 percentage points, from approximately 38 percent to approximately 35.64 percent (taking into account both national and subnational taxes). The change left the United States with the highest corporate tax rate in the world. The U.S. combined average federal and state rate is about 39.2 percent.

Japanese Prime Minister Shinzo Abe is not stopping there. Despite the opposition of special interests that fear their loopholes will be closed, and despite government debt that is more than twice the country’s GDP, it now appears that Abe will get the Japanese parliament next year to approve a gradual decline in the corporate rate to approximately 30 percent.

“From a tax policy point of view, it’s better to have a tax system in which footloose corporations are not heavily taxed while individual income and individual consumption should be taxed more,” said Bank of Japan President Haruhiko Kuroda in a May 24 interview with Wall Street Journal Japan.

In the United States, the data confirm what clearly is clearly evident to even the most casual observer. While most Americans are pinching pennies at Wal-Mart, high-end retailers are doing brisk business with their wealthy clientele. There is a widening gap between America’s rich and poor.

So—whether you agree with it or not--it is understandable that interest in taxing the rich is growing. But what proponents of tax redistribution must realize is that taxing corporations is not what it used to be. With so many ways to move capital across borders, higher corporate taxes will eventually only cause U.S. and foreign multinationals to move jobs and investments out of the United States. If liberals really want to tax the wealthy, instead of imposing higher corporate taxes that could backfire on American workers, they should focus on raising estate and capital gains tax rates and on taxing the unrealized capital gains of the superrich.

Read Comments (6)

david brunoriJun 9, 2014

Dr. Sullivan, I could not agree more with your analysis! Taxing capital in a
mobile, worldwide economy is difficult at best. The planning opportunities for
corporations are virtually limitless. This has been true for state taxation of
corporations for years. It is becoming increasing true for federal taxation.
Whether folks like it or not, taxing capital gains at higher levels or even
taxing unrealized gains would be more efficient and effective than taxing
corporate income. Heck, increasing personal income tax rates would be
preferably (albeit more politically difficult) to taxing corporat income.

emsig beobachterJun 9, 2014

Good posts. However, is it good policy to tax job creators at this point when
labor markets have not fully recovered from the effects of the Great Recession?

The job creators and their spokespersons will tell us that these proposed tax
increases will result in job losses in the U.S. as the job creators will have
less incentive to invest. Further, some will threaten to do a Brando and
repatriate themselves to a country which appreciates their talent and industry;
and, has no extradition treaties with the U.S.

David Carrington Jr.Jun 10, 2014

"they should focus on raising estate and capital gains tax rates and on taxing
the unrealized capital gains of the super-rich."

Sounds good to me.

edmund dantesJun 10, 2014

Funny thing about raising estate tax rates, they don't produce any more
revenue. One of the loudest advocates for higher estate taxation is Warren
Buffett. But you'll notice that his estate will pay almost no estate taxes,
because he's giving it all away to the Gates Foundation. And the Bill Gates
estate will similarly owe no estate taxes. If you really, seriously want to
raise revenue with the estate tax, step one is to eliminate, or at least
curtail, the unlimited charitable deduction. That deduction has effectively
outsourced and privatized some government functions. It lets the rich choose
how their money is spent for the social good, while the rest of us have to
funnel such money through the tax collectors.

Taxing unrealized gains is going to be very problematic. Taxed how often?
Without a transaction, who establishes the value of the unrealized gain? We
can be confident that the rich will figure out a way to dodge that one, too.

If you really want more revenue from the rich, go to where the money is, money
that can't flee to foreign jurisdictions. You have to start taxing the
investment income of the giant endowments, and you have to end the tax-free
status of muni bond income.

emsig beobachterJun 10, 2014

I believe inheritance taxes are more economically efficient than estate taxes.
There are fewer options for heirs to avoid taxes; and, possibly less incentive
to avoid these taxes. A system of inheritance taxes could still allow for
significant exemptions and a complete spousal exemption if necessary.

travis rechJun 11, 2014

Edmund makes a good point that raising estate tax rates will not raise
additional revenue. But really, the point of the Estate Tax was never about
raising large revenues, it was to prevent inherited wealth from dominating
society. I don't believe Mr. Buffet is advocating raising the Estate Tax rates
out of fiscal concern, I hypothesize he is more concerned with the social

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