The Tax Debate: Where are the Principles?
Mark A. Edelman and Barry L. Flinchbaugh
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ME: Professor, the current tax debate reminds me of your definition for a “fair” tax system--one that shifts the burden from me to you. Without discussion of principles, the tax debate becomes a process of keeping track of “shiftors and shiftees.”
BF: That's right, and in the current debate we can probably change the word “shift” to “shaft.” Biofuels saved U.S. consumers $.89 per gallon on the pump price of gasoline, according to a recent Iowa State-Wisconsin study. The Midwest savings are greater at $1.14 per gallon. It makes no sense for Congress to take away $5 billion in annual tax credits from biofuels and leave more than $50 billion on the table for big oil, particularly after record profits. Even oil industry economists, suggest eliminating tax subsidies for oil would have virtually no perceptible impacts on the price of gasoline.
ME: This tax debate has become rancorous in part due to the misperceptions in the debate. I've seen public statements that big oil tax preferences are greater than $500 billion, but the decade estimates must be kept separate from annual numbers otherwise you are mixing apples and oranges. The $45 billion in reduced tax subsidies for oil as proposed by the President is a multi-year proposal, but reduces big oil taxes by $4 billion per year. The issues are made more difficult because some tax subsidies for big oil are
buried in the tax code in a manner that affects other businesses as well. A tax on business profits would normally be based on revenue minus costs of goods sold, but when you allow businesses to use the LIFO costs--last inventory items in as the cost of the goods sold, it creates a tax reduction for all businesses taxed-not just oil companies. Removal of LIFO creates heartburn for many businesses--not just “big oil.”
BF: Well you are partially right-which is enough to be dangerous. The most important facts are the big picture. Global tax facts collected by the Organization for Economic Cooperation and Development (OEDC) in 2008 show mean U.S. personal income tax rates as a percent of income are at 28%. The U.S. ranked 8th lowest out of thirty nations studied. France, Germany, and Belgium have the highest personal income rates at 50%. However, U.S. corporate tax rates are 39% of income, which is a virtually 3-way tie with Japan and Germany for the highest corporate rates in the world. Seven of the 30 OEDC nations have corporate rates below 20% with Ireland being the lowest at 13%. So U.S. corporate tax rates are too high for American businesses to be globally competitive.
ME: Nice try, but no cigar. The U.S., Japan, and Germany have higher effective tax rates in part because we have stronger economies and higher incomes. Not everyone wants to live in a low tax, low income country. Many people see a problem when some huge corporations and wealthy individuals pay absolutely no personal or corporate taxes. This can occur as wealthy individuals and corporations take advantage of the many deductions, exemptions, credits, and loopholes allowed. Remember, the difference between a tax exemption and a tax loophole is whether it shows up on my tax return or
yours. According to a 2005 CBO study, capital investments like oil field leases and drilling equipment are taxed at an effective rate of 9 percent, significantly lower than the overall rate of 25 percent for businesses in general and lower than most industries.
BF: Where are your principles? The journals from academia suggest that principles of taxation include productivity, transparency, efficiency, and there should be horizontal and vertical equity in regards to ability to pay, benefits and use-meaning that people and corporations with like circumstances ought to pay similar taxes and those who have greater ability to pay, receive greater benefits, or who use more services ought to pay
more. While tax rates are fairly transparent, it is the deductions, exemptions, and loopholes that are not. Instead of demagoguery, Congress needs to go line by line through the tax code and apply a common set of tax principles.
ME: That task is made more difficult if you are going to apply the principles to the multi-nationals that operate across the globe and in between the tax laws of multiple nations. For multi-national corporations--like oil companies--if they do business and allocate income to pay taxes in Ireland or Saudi Arabia, they don't have to pay U.S. taxes on that income. Not surprisingly, a recent news magazine program visited several companies operating mainly in the U.S. that have set up “dummy” corporate headquarters in Ireland which has the lowest tax rates in the OECD list.
BF: So there is no easy fix. The bottom line is that we either create a level playing field globally, or the sharpest business minds will figure out how to advantage themselves to differential cracks in the global tax system. For the past century, the U.S. competitive advantage in the global economy has been our investment in research and development of new innovations that create jobs domestically when new technologies are commercialized and add value to our global quality of life. Jobs go where the investment goes. However, investment tax credits are likely to be more salient than production tax credits in the long run. Subsidizing capital investment for an “infant industry” is one thing, but it is quite another to provide production or operating expense subsidies like VEETC, LIFO, and others. Congress could simplify things with a capped investment tax credit for all new domestic energy sources and technologies. Deficit reduction is the big issue. The deficit reductions proposed so far are spending cuts. Perhaps people are willing to pay 5% more taxes along with the spending cuts, if they knew it went to deficit reduction.
ME: An investment tax credit for new domestic energy sources and technologies--including blender pumps--coupled with an open fuel standard would create a level playing field and get government out of the business of trying to pick winners and losers. Your deficit reduction tax increase could also be handled as a tax credit and either way it also would be neutral across sectors. Perhaps coupling both with the President's tax rate increase for those earning more than $250,000 would be a promising compromise concept. High income taxpayers who invest in new domestic energy sources and technologies and/or deficit reduction may end up paying less tax--instead of more, and it helps solve our two biggest economic problems.
Drs. Mark A. Edelman and Barry L. Flinchbaugh are Professorsof Economics at Iowa State University and Agricultural Economics Professor Emeritus at Kansas State University, respectively.