Do Both Liberals and Conservatives Have Taxing and Spending All Wrong?

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Texas Gov. Rick Perry (R) and Maryland Gov. Martin O'Malley (D) debate fiscal policy on CNN's "Crossfire."

Texas Gov. Rick Perry (R) and Maryland Gov. Martin O’Malley (D) debate fiscal policy on CNN’s “Crossfire.”

What if our endless political fights over taxes and public spending are based on a poor understanding of how government really works in a modern economy?

Edward Kleinbard, a professor of business at the University of Southern California’s Gould School of Law, thinks that’s largely true. Recently, he published a paper arguing that, contrary to the conventional wisdom, corporate “inversions” aren’t motivated by multinationals’ desire to establish themselves abroad in low-tax havens. And in his forthcoming book, We Are Better Than This: How Government Should Spend Our Money, he says that both liberals and conservatives get key issues wrong. recently spoke with Kleinbard; below is a transcript of our discussion that’s been edited for length and clarity.

Joshua Holland: There’s been a lot of interest in these corporate inversions. The business community says they’re a response to an uncompetitive business environment. What’s wrong with those claims?

Edward Kleinbard: We don’t have an uncompetitive business environment. It’s true that we have a 35 percent tax rate. It’s also true that that’s higher than world norms, and it’s true that it does distort behavior. But when you look abroad, that 35 percent rate simply does not apply unless and until firms return cash dividends from their foreign operations to the United States, and firms simply don’t. Today, American companies are sitting on about $1 trillion dollars of offshore cash that they’ve generated from low-tax foreign operations.

Holland: David Cay Johnston says that deferred taxation for all that cash offshore is actually a kind of stealthy subsidy to these corporations, because they don’t pay taxes on it until they bring it back in some theoretical future, but in the meantime they park it in Treasury bills and earn interest from those investments.

Kleinbard: That’s right. The pot of cash, the trillion dollars is, in fact, invested in the US in the broader sense. So the United States of America isn’t missing a trillion dollars. It’s invested in bank deposits that in turn fund bank loans to real businesses, or Treasury bills that fund our deficits and so on.

But the cash isn’t where companies really want it to be, which is in the hands of shareholders. What this is really largely about for the multinationals is getting their cash poured from their Bermuda subsidiary into the hands of shareholders to goose stock prices. That’s what these inversions are about.

Holland: Why are we hearing so much about them right now?

Kleinbard: There is a series of actions — and inactions — that explain the current mania, and it really is a mania. It goes back to 2004, [when] we first had this problem of firms generating more stateless income overseas than they knew what to do with. As a result, US multinationals were sitting on huge piles of cash. Shareholders wanted that cash, and management wanted to get the cash to shareholders. It gooses stock prices, makes shareholders happy, and makes management happy because they’ve got stock options and the like.

The Republican-controlled Congress did something pretty extraordinary in 2004. Corporate America said to Congress, “If only you’d let us bring back this stockpile of cash at a special tax holiday rate, we’d bring back the cash, invest in American business, and it will be great for everybody.” Congress believed that story and enacted a special, one-time-only tax holiday. Firms were allowed to bring back the money and pay a 5.25 percent tax instead of 35 percent. A huge amount of money came back; about $310 billion in extra cash.

Now consider how corporate executives think. They assumed that they would soon get a second one time only, never to be repeated tax holiday. And then a third.

But it turns out that even Congress draws the line at some point and Congress rightly felt that it had been lied to in 2004, to put it bluntly. The money that came back in 2004 all went to shareholders and didn’t go to build new factories, or to invest in training, and some of the largest repatriators of cash in the 2004 saga fired thousands of workers within a few months. They laid off huge numbers of workers in what turned out to be an extraordinary public relations blunder.

So then firms said, “Maybe we’ll have corporate tax reform. We’ll get corporate tax reform, and as part of corporate tax reform we’ll get a one-time deal to wipe the slate clean and be allowed to bring back our old foreign earnings again at a special discount rate.” But now they have become more and more despondent, understandably, about the prospects of getting corporate tax reform out of a dysfunctional Congress, and so that avenue seems to be closed.

Holland: How do inversions accomplish the goal of bringing that money back into the hands of, I assume, overwhelmingly American-based shareholders?

Kleinbard: Yes, about 85 percent of shares of American firms are still owned by Americans.

The mechanism is a little technical, but it’s not that hard to understand. When you do an inversion, what you’re actually doing is a merger between a US company and a foreign company, and it’s called an inversion rather than a takeover because the US company is the whale and the foreign company is a minnow in size. In a normal merger you would expect the whale to swallow the minnow, but what makes these inversions is that the minnow swallows the whale, so that the foreign company is structured as the acquirer of the US company.

By doing that, we now have a foreign parent company. And by having a foreign parent company, a different set of tax rules kicks in. And that allows them to get cash into the hands of the US shareholders and skip over the United States government — so shareholders get the cash without companies paying US corporate taxes along the way.

Holland: OK, I want to shift gears and talk a little bit about your book.

I think you make a very important point, which is that we shouldn’t talk about taxes in the abstract, as if they’re divorced from the services they pay for. One of the great victories of the conservative movement has been getting people to think about whether taxes are too high or too low, rather than asking if we’re getting enough in return for what we put in.

In Europe — and in other wealthy countries — they pay somewhat higher taxes, but then they get free health care and free or deeply subsidized education and they have much more robust safety nets.

You argue in the book that both liberals and conservatives have it wrong when it comes to taxes. First, what do conservatives get wrong?

Kleinbard: What conservatives get wrong is the idea that government is inherently wasteful, that government basically takes our dollars, puts them into a big pile and then sets the pile on fire. That’s just false.

First, private markets are great. But they’re limited. Private markets don’t enable all of us to do the things that we would ideally be able to in the hypothetical world imagined by economists. The poor, smart kid in a rough neighborhood in Brooklyn, New York, can’t go to a bank and borrow to go to Harvard on the basis of his future earnings power.

So there are lots of ways in which private markets don’t reach all of the areas where we might enhance the happiness and productivity of individual citizens.

The other fundamental mistake that conservatives make is they don’t appreciate that there are economic payoffs to government spending when that spending is complementary to the private sector. We get big positive financial returns from infrastructure investment, for example. Remarkably little work is done by economists in this area. They largely ignore it. But the work that has been done shows that there are big economic payoffs to government spending that are simply lost in our discussions, because all we think about is, “How much tax is coming out of my pocket?” and we never think about what those dollars are buying.

Holland: You talk about how we need bigger government, and you propose a “two percent solution.” You write that we don’t need to become a high tax, big spending country like France or Sweden to invest in a more productive economy. Why two percent?

Kleinbard: What I’m arguing is that two percentage points would do a tremendous amount of good because we’ve starved government for so long — we just ignored the positive returns that come from government investment and insurance. The first additional dollars that we spend would have very large payoffs in the broad sense of our happiness, and two percentage points more would really change people’s lives.

I don’t have to argue that we become France — if we spend two percentage points more and we’re happy with the results, we can scale up.

Holland: Surveys show that when you ask an open-ended question, “What share of government spending do you think is wasted?” the average answer is 50 percent. If you look at studies of actual programs like food stamps, they’re very efficient. Around 98 percent of the money distributed in that program gets to the right beneficiaries.

But what do liberals get wrong? You argue that we do not need steeply progressive income taxes to address economic inequality.

Kleinbard: Again, what’s important is not how much we collect in taxes, because taxes are just a financing vehicle. Taxes buy something. They buy government spending of some kind. And government spending is almost invariably highly progressive in its application. People with lower incomes typically get a lot more benefit from government spending than those with top incomes.

So if I want to do something about rising income inequality in America, which is real and very complicated, I shouldn’t fixate on the progressive income tax. I should ask what the consequences of both government taxing and spending are in the real world.

The US has a relatively progressive tax system. But when you look at our government from the perspective of what effect it has on people’s lives, then the United States scores very badly compared to other wealthy countries, because it turns out that we have a progressive tax system that is financing a very small government a government that’s too small to do a lot to help people.

Because government spending is inherently progressive, a regressive tax can nonetheless have a progressive effect once you take into account what that tax is buying. So a billionaire tax that nobody else has to pay would be very progressive. Only the richest Americans would have to pay it. But it would raise bupkis by way of total revenue — it wouldn’t finance much.

Other countries have regressive sales taxes called value added taxes, but those revenues are then used to provide free health care to everybody, and to finance education and other public goods. So, yes, they take money from more pockets than we do, but they also give back far more to lower income people in the form of public benefits than they’re taking from them. And that helps level the playing field.

The effect of government taxing and spending on German lives, for example, has a much larger affect on inequality, even though the German tax system as a whole is more regressive than ours. The reason is the German system is just bigger, and therefore the spending drowns out the regressive nature of their tax system.

Progressives just keep fixating on the tax system. By not calling for more progressive spending, we’re making ourselves poorer in the economic sense—we’d have higher GDP with more government. And we’re making ourselves poorer in the larger sense of our society’s overall welfare.

Holland: We’ve been talking about taxes on wages and income. My understanding is that many of the studies that attribute rising inequality to the tax system focus on taxes on wealth rather than income.

Low estate taxes let families amass these huge fortunes. And taxing investment income at a much lower rate than income from work results in people like Mitt Romney paying, I think it was 13 percent or so on tens of millions of dollars in income. Isn’t that all a part of what we mean when we talk about the need for tax progressivity as well?

Kleinbard: Yes. Wealth inequality is doubly pernicious because today’s wealth inequality buys the next generation’s income inequality.

Holland: And also inequality in terms of political power.

Kleinbard: That’s right. There are very depressing studies that demonstrate what I think we all intuitively know, which is that slacker kids from high income families have a much higher rate of admittance to the country’s top universities than do the smartest kids from poor families. Estate taxation is very important for that reason. It has to be part of the overall package, I absolutely agree with that.

Holland: Okay. So, progressives are a little too focused on income tax progressivity, but not too focused on wealth tax progressivity?

Kleinbard: I think wealth tax progressivity has just been stalled right at the beginning by a refusal on the part of conservatives to accept the premise that estate taxation has an important social role to play in America. And by virtue of calling it a “death tax” and so on, we’ve lost sight of its underlying purposes, and therefore, there’s basically no serious engagement on what the role of the estate tax should be in our overall fiscal system. We do need to appreciate that as well.

Joshua Holland was a senior digital producer for and now writes for The Nation. He’s the author of The Fifteen Biggest Lies About the Economy (and Everything Else the Right Doesn’t Want You to Know about Taxes, Jobs and Corporate America) (Wiley: 2010), and host of Politics and Reality Radio. Follow him on Twitter: @JoshuaHol.

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