Taxes pay for roads, schools, firefighters, Coast Guard rescues and a thousand other goods and services we need for our society to function.
But taxes also shape our incentives. We tax things that we deem to be harmful — like tobacco and alcohol — and hand out tax breaks to encourage things we find beneficial, like research.
According to a new white paper by Nobel Prize-winning economist Joseph E. Stiglitz, our labyrinthine tax system is skewing those incentives. We’re encouraging corporations to invest in creating jobs overseas, when unemployment remains doggedly high here at home. We’re giving US-based multinationals good reason t0 deprive our treasury of revenues when we should be investing in infrastructure and the American people.
The report, prepared for the Roosevelt Institute, offers seven concrete proposals for reforming our corporate tax system so it aligns with the greater good. We have excerpted these below. The full recommendations are available in Stiglitz’s report, Reforming Taxation to Promote Growth and Equity(PDF).
1. Raise Corporate Income Tax Rates While Providing Incentives for Investments and Job Creation in the US
The implicit assumptions of the advocates of lower corporate tax rates are that low rates induce more investment and that high corporate tax rates disincentivize investment. Both theory and evidence indicate that low corporate tax rates fail to induce investment, but that one can design a corporate income tax that will promote investment and employment creation in the US. Such a tax system will require higher tax rates on corporations that do not invest, accompanied by lower taxes on those that do. It is the difference in taxation between those who do and those who do not invest and create jobs that provides the incentives for investment and job creation.
2. Reduce Spending on Corporate Welfare
Welfare payments provide assistance to poor individuals in need. But in the US, we give large amounts of money to rich corporations that can hardly be viewed as needy. Such payments — mainly hidden in our corporate tax system — have come to be called corporate welfare.
Corporate welfare consists of the billions — over a decade, tens and perhaps hundreds of billions — of dollars to enrich the coffers of corporations, sometimes to protect them from adverse situations (as in the massive bailout of the banking system, sometimes directly, as in the current crisis, sometimes indirectly, through the IMF) and other times to “promote” particular industries. The net beneficiaries of corporate welfare are, by and large, wealthy Americans — and increasingly wealthy foreigners (since foreigners are large owners of American corporations) … Both for reasons of equity and efficiency, the elimination — or at least the reduction — of corporate welfare should be at the center of tax reform.
3. Tax the Financial Sector
There are good reasons why there should be a special set of taxes imposed on the financial sector. First, the recession caused by the misdeeds of the financial sector is a major cause of the current high level of national indebtedness. Secondly, there is an important role for “corrective” taxation — taxes that simultaneously raise revenue and provide incentives for firms not to, for instance, impose externalities on others. The financial sector has, in fact, imposed huge costs on the rest of the economy.
But in spite of the evidence that it has imposed large costs on the rest of the economy, the financial sector has been particularly successful in escaping taxation. We suggest a number of financial sector taxes that would, we believe, actually increase the likelihood that the financial sector more efficiently performs the key social functions that it should perform.
4. Tax on Monopolies and Other Rent-Based Enterprises
One of the advantages of taxing monopolies and other rent-based enterprise “profits” at a higher (“surtax”) level is the absence of adverse supply responses. Indeed, if the response to taxing rent seeking activities is to decrease the quantity of such activities, the efficiency of the economy may actually be enhanced. While in some cases it may be difficult to ascertain the extent to which there are monopoly profits, in some sectors (such as telecom and cable TV) the magnitudes and associated distortions are large.
5. Ensure that Multinationals Pay Their Fair Share of Taxes and Have Incentives to Invest in America
In the current system, we lose not just tax revenues but also jobs. In the following two subsections, we discuss two ways by which this problem can be addressed.
- Tax firms on their global income in a fair and comprehensive way:In spite of the recent assertions of the Supreme Court, corporations are not people. One of the ways that they differ from people is that where they reside can be nothing but a legal fiction. We can tell where an individual resides – an individual is a resident of the State of New York if she sleeps 50 percent of nights in New York. But a corporation can set up an office in the Cayman Islands, claim that as its home, even if little or none of its business is conducted there, and even if it has few if any employees there. Our leading technology companies have shown that they can be as innovative in tax avoidance as they have been in producing new products. The current system cannot work in a world of globalization.
- Tax Intellectual Property:Corporations whose profits are strongly related to intellectual property have been particularly effective in tax avoidance, partly because it is relatively easy to claim that the intellectual property was created in, or resides in, a low tax jurisdiction. This is so even when the intellectual property depends heavily on basic research paid for by American taxpayers. As we noted earlier, technology firms, whose very existence depends on the Internet, which itself only exists as a result of government investments in research and development, have become emblematic of this kind of “corporate irresponsibility.”
6. Increase Taxes on Industries That Produce Negative Externalities
Taxes on industries that impose costs on the rest of society actually increase economic efficiency. It is better to tax bad things (such as pollution) than good things (such as work). The market produces too much of some things (such as toxic mortgages and toxic waste) and too little of others (such as basic research).
Taxes can be particularly effective in curbing these negative externalities, and in doing so, yield double dividends. The most important category of corrective taxes are those on environmental externalities, and within this area, the most important are those associated with carbon emissions, with their impact on global climate change.
It matters less whether those generating the pollution pay a carbon tax or buy emission permits that are auctioned. Either can generate large amounts of money and simultaneously improve economic performance.
7. Make Dividend Payments Tax Deductible, But Impose a Withholding Tax
One of the distortions associated with the current tax regime is that it encourages excessive leverage, which can, in turn, contribute to excessive volatility. Firms that raise capital through debt can deduct the interest they pay, but this is not true for the dividends that firms pay to those who contribute equity. This bias would be eliminated if dividends were tax deductible. But many of the recipients of the dividends would, under the current regime, then succeed in avoiding all taxes on this income, by taking advantage of various provisions in the tax code. Hence we propose that there be a 40 percent withholding tax. Upper-income Americans who actually pay taxes on dividends received would then get a full credit for these taxes that have been withheld. There would then be no double taxation — there would be an effective integration of the individual and corporate income tax.
Download the entire report, “Reforming Taxation to Promote Growth and Equity,” which also includes Stiglitz’s plan for reforming the individual income tax.