Obama's Ignorance When It Comes to the Benefits of Tax Cuts.

I recently read an article by Sterling Terrell of Ludwig Von Mises Institute in response to Barack Obama's following comment:

"I've seen no evidence that …[cutting taxes] ... would actually boost the economic growth and productivity."[1]

 Really!!!

Well, I thought it would be a great article to post here for you to read at your leisure.  Let me know what you think about Terrell's response.

The cover story of the June 17, 2008 issue of the Wall Street Journal is, "Obama Plans Spending Boost, Possible Cut in Business Tax." The story indicates that presidential hopeful Barack Obama would consider lowering the corporate tax rate if tax breaks and loopholes were eliminated. It reads,

He stressed the idea was not a broad move toward Sen. McCain's broader tax-cutting philosophy. While Sen. McCain has argued that tax cuts — particularly on business — spur growth, Sen. Obama dismissed that as flawed economics. "I've seen no evidence that … would actually boost the economic growth and productivity."[1]

No evidence? Really? Maybe I can help.

The historical and current belief is that taxes in America are low, compared to the world in general. America is the model of free markets, low regulation, and economic freedom. Right? This is simply not the case. The United States has high taxes in general and higher corporate taxes in particular.

In the 2008 Index of Economic Freedom, assembled by the Heritage Foundation, personal income taxes and corporate tax rates are compared across the globe — along with many other economic measures. In regard to personal income taxes, the United States ranks 87th out of 156 nations. And in corporate rates, it ranks 125th out of 156. In other words, 86 nations have lower tax rates on personal income than the United States, and 124 nations have lower corporate tax rates.[2]

Venezuela, India, Finland, Haiti, Burma, Canada, Mexico, Egypt, Cambodia, and Russia are among the many nations whose top personal income tax rate is lower than the rate in America.

The only nations who have a higher corporate tax rate than America are Suriname, Pakistan, Togo, Benin, Republic of Congo, Cameroon, Chad, Libya, and Vietnam. No information was available for The Democratic Republic of Congo, Iraq, North Korea, Montenegro, Serbia, or Sudan. I cannot imagine why.

Lower corporate taxes are associated with economic growth. This can be shown a priori and empirically.

A Priori

Corporate taxes reduce the profits of business owners. This is true because net income is reduced by the tax rate. For example, Firm X, with a $100 investment, earning a 7% return has an income — before taxes — of $7. With a 10% corporate tax rate, net income — after taxes — is $6.30. Firm X now has earned a 6.3% return. In contrast, a corporate tax rate of 40% reduces net income after taxes by $2.80 to $4.20, or a 4.2% after-tax return. This rise in taxes, on the margin, reduces the profit-seeking incentive to take business risks. Why risk starting a biotech company when inflation-protected T-bill's will give you the same return? Entrepreneurs and venture capitalists less willing to take risk means less innovation and fewer innovative ideas being economically viable. This results in less economic growth. Conversely, higher returns on invested capital encourage investment and savings. All of this leads to more capital savings, more innovation, better technology, and higher wages.

Further, the above example of Firm X is true if the firm does not have the pricing ability to transfer the tax to its customers. If the ability does exist, an increase in the corporate tax rate is really a tax on customers of the firm. In this case, consumers now have less to spend and save and the end result is the same.

Finally, a firm unable to pass on a tax increase or bear the reduced profit will either attempt to cut costs by reducing wages (among other costs) or be forced to go out of business.

The main point is this: by definition, corporations do not pay taxes — people pay taxes. A corporate tax is either a tax on shareholders of the firm, customers of the firm, or employees of the firm. Less corporate tax means more innovation, capital savings, and spending by these groups — also known as economic growth.

Empirically

After theory and logic tell us what is true, empiricism can confirm our result.

Thankfully, Professors Young Lee (Hanyang University) and Rodger Gordon (UC — San Diego) have done the work for us. In a 2005 journal article they concluded,

This paper finds that the corporate tax rate is significantly negatively correlated with economic growth in a cross-section data set of 70 countries during 1970–1997, controlling for many other determinants/covariates of economic growth.

More specifically, they continue, "The estimates suggest that cutting the corporate tax rate by 10 percentage points can increase the annual growth rate by around 1.1%."[3]

Using these figures, Andrew Chamberlain of the Tax Foundation opines,

by cutting the U.S.'s combined federal and average state corporate tax rate from roughly 40 percent to 30 percent we could boost U.S. economic growth by around 1.1 percent per year — enough to double our nation's wealth every 63 years.[4]

Even better, a cut from the actual corporate tax rate of 35% to a rate of 10% would double our nation's wealth every 30 years.

$25 $19

A corporate tax is really a tax on shareholders, customers, or employees of the firm.

Life Savers moved production to Canada. Nabor Industries and Tyco International moved to Bermuda. Halliburton has announced a move to Dubai. In a globalizing economy, is it really a puzzle that firms prefer to operate in lower-taxing, less-regulated environments?

These are examples of what can be seen. As Frédéric Bastiat reminds us, however, it is imperative to also account for what cannot be seen. What would the wealth of our nation be today if the corporate tax rate had always been 10% or less? What creature comforts would have been innovated? What new technologies brought to market? What diseases cured?

Due to a history of high corporate taxes these answers are not known, and we are worse off because of it.

Sterling T. Terrell is a Ph.D. candidate in the department of agricultural and applied economics at Texas Tech University. Send him mail. Comment on the blog.

Notes

[1] Bob Davis, Amy Chozich, "Obama Plans Spending Boost, Possible Cut in Business Tax", Wall Street Journal, June 17, 2008.

[2] The Heritage Foundation: Index of Economic Freedom.

[3] ScienceDirect - Journal of Public Economics : Tax structure and economic growth

[4] Tax Foundation: "Do Corporate Taxes Impede Economic Growth?"

Remaining Steadfast,

Dominique

UPDATE ON AIDS BILL!

Senate Passes Obama's AIDS Bill...

Only 16 Senators, all conservative Republicans, voted against the massive $50 billion global AIDS spending bill (S. 2731) when it came up for a final vote on Wednesday night. The outcome, which included the addition of water projects for Indian reservations, demonstrated the complicity of both major political parties in out-of-control spending designed to benefit a powerful special interest group.

The final vote was 80-16 with Senators Barack Obama and John McCain, both original sponsors of the bill, on the campaign trail and not available to cast a vote on the Senate floor.   

Dr. Paul Zeitz of the Global AIDS Alliance thanked Democratic Senators Joe Biden and Majority Leader Harry Reid and Republican Senator Richard Lugar for their “tremendous achievement” and their “fierce determination to bring the bill forward…” Zeitz insisted that the money would “save millions of lives and foster good will around the world.”

However, the $200 billion already spent by U.S. taxpayers on HIV/AIDS here and around the world has not resulted in any cures or a vaccine, and anti-AIDS drugs are coming under increased scrutiny for their ineffectiveness and side-effects.

On final passage, Senate Republican Leader Mitch McConnell of Kentucky voted with Majority Leader Reid and the Democrats.

In addition to spending $50 billion at a time of growing economic difficulties in the U.S., the bill lifts the ban on entry into the U.S. of AIDS-infected aliens, who could end up adding to the costs of the health care system.

Indeed, the Congressional Budget Office estimated that providing federal disability, health and nutrition benefits to aliens with HIV/AIDS and their children could cost the government $83 million over a 10-year period.

The 16 “nay” votes were cast by Allard (R-CO), Barrasso (R-WY), Bunning (R-KY), Cornyn (R-TX), Craig (R-ID), Crapo (R-ID), DeMint (R-SC), Ensign (R-NV), Graham (R-SC), Gregg (R-NH), Hutchison (R-TX), Inhofe (R-OK),  Kyl (R-AZ), Sessions (R-AL), Vitter (R-LA), and Wicker (R-MS).

In an earlier vote, 31 Senators voted to cut the amount of spending in the bill from $50 billion to $35 billion. In this vote, two Democrats―Claire McCaskill of Missouri and Ben Nelson of Nebraska―voted with 29 Republicans.

One “conservative” Republican senator, John Thune of South Dakota, boasted about how he managed to obtain $2 billion in the bill for “tribal needs” such as water projects and “public safety” on Indian reservations.

But the original purpose of the bill was supposed to be about helping victims of HIV/AIDS.

Any notion of this being a partisan matter was completely shattered by the Bush Administration’s active lobbying for the bill. In this legislative showdown, the Republican White House collaborated with liberal Senate Democrats and actively opposed the efforts of conservative Republican senators such as Jim DeMint, David Vitter and Jeff Sessions to reduce the size and scope of the bill. Originally, the White House had only requested $15 billion for the program.

The Senate bill now has to be resolved with the House version.

Among those speaking out against the “reckless” overspending in the bill was Senator Jim Bunning of Kentucky, who declared, “When so many Americans are facing economics problems at home, I have a hard time needlessly tripling the funding for this program.”

Bunning also declared, “We need to ensure that these funds reach the neediest countries and not those that can afford their own space and nuclear programs, such as China and Russia. At a time when China is tripling their defense budget and manipulating their currency, I have a hard time sending billions of dollars over there…”

Yet, Senator DeMint’s amendment to limit the countries in which the AIDS money could be spent was defeated 70-24.

Meanwhile, on the House side, Republican Rep. Ileana Ros-Lehtinen issued a release calling the bill a “mission of true mercy.”

 My response:

As I repeatedly state in my blog, we the people need to take a stand and use the power given us by our founding fathers.  It is time to enact time limits, impeach the offending parties who refuse to listen to the American people and start diligently working towards a government that is for the people by the people. 

Our leaders have forgotten that their work is not a “job” - it is a service to their fellow Americans.  They have also forgotten that we put them in power and we can just as quickly remove them.

For me, this bill only reinforces my belief that most of our leaders have lost any ability to discern what is right and what is wrong for America.  Dominique