Tax Analysts Blog

Latest White House Tax Study Illustrates Familiar Pattern of Deceptive Economics

Posted on Oct 18, 2017

The October 16 study from the Council of Economic Advisors — which I will take the liberty here to rename “The Economic Effects of a Yet Unspecified Corporate Tax Reform: Some Theory and Some Evidence” — is a classic example of how industry and partisan interests use economic analysis to give the public the impression their views are scientifically proven. In the case of the CEA study, the purpose is to convince the public and the press that contrary to earlier studies (which admittedly, primarily because of their age, do not take cross-border investment into account) corporate tax cuts are the key to the “middle-class miracle” that will create jobs and raise wages. Here’s the recipe.

[1] First state facts that casual observation and simple logic easily support. In the CEA report these include the obvious need for the U.S. to lower its corporate tax rate (the developed world’s highest), the loss of some domestic capital formation if the rate is not reduced, the increase in labor productivity that results from increased capital formation, the increase in wages that results from increased productivity, and the increase in the demand for labor that accompanies increased demand for capital. The report also mentions that U.S. multinationals are shifting enormous amounts of profit to offshore tax locations (though this does not necessarily imply U.S. job losses). These phenomena have grown in relevance as globalization increases and capital becomes increasingly mobile (leaving low-wage U.S. workers in the lurch).

[2] Cite in your discussion studies, preferably peer-reviewed work of respected academic economists, which support your results. Depending how you define studies that are in direct support of a large burden of the corporate tax on labor, there are between five and nine studies that serve this function in the CEA report.

[3] Do not mention that many of these studies are subject to academic criticism. These studies have been extensively reviewed and criticized, for example, by Jennifer Gravelle in a CBO working paper, by Kimberly Clausing in the Tax Law Review and the National Tax Journal, and by Jane Gravelle of the Congressional Research Service.

[4] Do not mention that there are many other studies that find contrary results. See research reviews cited above. Importantly, more defensible “general equilibrium model” results under reasonable assumptions usually yield a smaller burden of the corporate tax on labor than “regression analysis” results.  

[5] Do not mention that there is any case enormous uncertainty about the results (that almost all the underlying studies freely admit). Instead leave the impression that the stated results are authoritative. “While there is universal agreement with the proposition that someone ultimately bears the burden of corporate taxes, there is considerable uncertainty, and indeed controversy, over exactly who this might be.” (Desai, Foley, and Hines 2007, cited by CEA.) “Distributional tables often assume that the incidence of the corporate income tax falls on the owners of capital but there is considerable uncertainty amongst economists about who bears the burden of the corporate income tax.” (William Gentry, Treasury Office of Tax Analysis Working Paper, 2007.)

[6] Finally, use supportive studies to produce easy-to-understand estimates that nontechnical readers like politicians can use in sound bites and journalists can use in headlines. In the CEA study the big takeaway is that a corporate rate cut from 35 to 20 percent will increase average household income by between $4,000 and $9,000. These are long-run estimates (which could in some models mean decades), which the CEA does point out, but is pretty much ignored in many reports on the study. But the real problem is that these estimates are based on only two (non-peer-reviewed) studies that have been subject to criticism by other respected economists. One of these studies is based on cross-state analysis (which may have limited applicability to international burden shifting). The other study does not measure foreign statutory rates paid by all taxpayers but rather average tax rates paid by multinational affiliates based in foreign countries.

The administration is selling. Caveat emptor.

For more tax talk follow me on Twitter @M_SullivanTax.

 

Read Comments (2)

Elliott J DubinOct 18, 2017

Do not point out that tax cuts in the U.S., a large and not entirely open economy, will have different effects than tax cuts in a small open economy. Do not point out that tax cuts which result in larger deficits may trigger monetary tightening which can offset any short run gais.

Mike55Oct 20, 2017

I'm glad to see a post critical of the CEA report -- which was misleading, pointless, and terrible -- and a well put together one at that. Nicely done.

I do worry the CEA's report was intended to be a straw-man. The report claims that reducing the corporate tax rate will increase "average household income" by $4K to $9K (measured on a pre-tax, pre-transfer basis). Well-meaning economists are responding with "that's way too high and, in any event, the answer remains highly uncertain. You are misleading people!" The CEA will counter with "okay fine then, call it $3K, or $500, or whatever. The point is we're busy trying to increase wages while you're nitpicking at the details and the tone. Talk about 'Ivory Tower' thinking!" From the perspective of the non-tax wonk, the CEA wins that debate.

The problem with the $4K to $9K number is that it's meaningless in the first place. As a thought experiment let's imagine a special one-time, fully refundable $5M tax credit that can only be obtained by employing Mike55. Because we are fiscally prudent we must fully offset the revenue impact; we ultimately choose a special $5M excise tax on Mike55's wages. Barring some timing benefit, the well-being of Mike55 will either remain unchanged (employer pays Mike55 $5M more to offset his excise tax) or decline (employer pays Mike55 less than $5M; let's call it $4.5M for the sake of example). By the CEA's logic, we've achieved a miracle: the average pre-tax, pre-transfer income of Mike55's household will increase by $4.5M to $5M! America is great again!

Or actually I guess the CEA would exaggerate and claim the benefit to Mike55 is $20M to draw more attention to its grand plan. Then a bunch of well-meaning people would rush to point out that it's really no more than $5M. Then everyone would say, "hey, $5M is still really good, so let's go for it!" I'm growing fearful this is pretty much how tax reform is going to play out, albeit on a larger scale.

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