How U.S. Economic Growth Could Accelerate to 4%
Corporate tax reform would have a ripple effect across America
President Trump’s goal is to raise economic growth to 4%, and it will take tax reform to make it happen — along with regulatory reform.
It’s no coincidence that a decline in stock market indices since the beginning of the month is associated with a growing realization that Congress is moving too slowly to pass tax reform by August.
Trump has called for a corporate tax rate of 15%, and House Republicans have proposed a 20% rate. That would bring the United States rate below the OECD average, making American firms more competitive. Lower rates would attract jobs back to America. Trump would also allow a one-time repatriation of corporate profits held offshore at a rate of 10%.
Though 4% is the president’s goal, Berenberg Bank chief economist Mickey Levy told me that the economy doesn’t have to accelerate that fast to see change for the better. Lifting sustainable potential growth anywhere close to 3% would be an enormous achievement from the recent trend, he said.
Levy calculates that simply boosting growth from current estimates of 1.8% potential growth to 2.8% would lift real GDP by $1.67 trillion during the first year, and that much compounded in succeeding years. This would have a large and compounding effect on production, employment and wages, and purchasing power, and would raise living standards throughout the income distribution.
Highest tax rate in the world
Corporate tax reform is a necessary condition for growth because America has the highest corporate tax rate in the industrialized world, 35% compared with an average of 23% for our industrialized competitors. Reform is becoming increasingly urgent. Corporate profits are taxed three times, once at the business level, another time when they are distributed to individuals and a third time at death.
Not only is the U.S. corporate tax rate an outlier, but American corporations are taxed on their worldwide income — a path taken by only seven of the 34 Organization for Economic Cooperation and Development countries (including the U.S.). This places America at a competitive disadvantage.
Our worldwide tax system is uncompetitive. If an American company operates in the United States and Switzerland, its domestic affiliate pays U.S. taxes of 35% and its foreign affiliate pays U.S. taxes at 35% and Swiss taxes at 21%. America allows companies to deduct the taxes paid to foreign governments from U.S. taxes owed to the Internal Revenue Service, but this means that corporations always pay the full U.S. rate and are unable to take advantage of low-tax jurisdictions.
Territorial tax system
In contrast, a territorial tax system, common to most of our competitors, taxes only the income earned domestically. Our American company operating in Switzerland and America would pay U.S. taxes on its domestic income and Swiss taxes on its Swiss income. In this way, companies can take advantage of low-tax jurisdictions. Business decisions can be made more efficiently, since bringing profits back domestically will not result in those profits being taxed again — thus, capital can go where it is most needed.
America raised $300 billion from the corporate tax in 2016, according to the Office of Management and Budget, just 9% of all revenue, and the tax costs millions to administer.
Most important, this high corporate tax discourages investment. The gap between American and foreign rates is widening, as foreign countries are lowering their rates as the U.S. rate stays the same. In order to raise U.S. levels of investment, the corporate tax rate should be reduced to the range of 15% to 20%.
Although interest rates are close to zero, levels of gross domestic nonresidential investment have been declining. Such investment barely budged in 2016, down from a growth rate of 2.1% in 2015 and 6% in 2014.
Money held offshore
American companies hold offshore about $2.6 trillion of earnings from foreign operations. No one knows how much would be repatriated with a lower U.S. tax, but it would be higher than it is now, adding to investment and employment. These are funds that, given proper incentive, can return to America and be used for capital projects, dividends/share repurchases, consumption, or job creation — all of which represent a boost to the weak economy.
It is difficult to overstate the importance of a sensible tax system to economic growth. Failure to take into account the deleterious effects of higher taxes is one of the major reasons actual GDP growth had consistently underperformed the Obama administration’s expectations, according to AEI scholar Kevin Hassett in testimony given last year before the House Committee on Ways and Means.
A study by Mihir Desai and C. Fritz Foley of Harvard University and James Hines of the University of Michigan finds that foreign and domestic investment are complements, so additional foreign investment by multinational corporations triggers additional domestic investment.
Under the status quo, firms have every incentive to keep profits abroad and little incentive to repatriate earnings. A lower rate of corporate tax would mitigate the effect of any of these incentives, allowing for a more efficient distribution of capital. As an added benefit, the economically inefficient expenses that businesses incur trying to avoid taxes would drop significantly.
In order to achieve GDP growth of 3% or 4%, corporate tax reform is essential. No wonder that stock markets are dropping as tax reform moves further down Congress’s priority list.
This piece originally appeared on WSJ's MarketWatch
This piece originally appeared in WSJ's MarketWatch