GOP Goes With the Global Flow: Tax People, Not Companies

By Greg Ip Features Dow Jones Newswires

For decades, Republican tax reform has meant cutting the tax rate on America's highest earners. No longer.

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In the bill to be unveiled this week, House Republicans plan to keep the top personal rate at 39.6%, even as the corporate rate is chopped to 20% from 35%. It is a tacit admission of something the rest of the world has already concluded: It's better to tax people than capital.

Make no mistake: The GOP plan, if it makes it through Congress, will be generous to the rich. Taxes will be eliminated on estates and reduced on unincorporated businesses. Moreover, the top rate will hit fewer people than it does now, and while the rich will lose some breaks, they will be the primary beneficiaries of lower corporate taxes since they own most of the stocks.

Yet the central mission of tax reform is to catch up to the rest of the world, which has already cut tax rates on corporations. The middle-class tax cut so near and dear to President Donald Trump is secondary. It may also prove short-lived if, as seems likely, taxes get raised in later years to cope with the deficits this round of tax cuts would help generate.

Republicans still want lower taxes on the rich, but it's harder to show that it matters. Back in 1980, high personal taxes were a plausible disincentive to work. The top rate was 70% and because brackets weren't indexed to inflation, cost-of-living adjustments kept pushing people into higher brackets.

Ronald Reagan fixed both, and the top rate has seesawed ever since; down to 28% in 1988, back to 39.6% under Bill Clinton, down to 35% under George W. Bush and back up to 39.6% under Barack Obama.

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If the tax system has a problem now, it lies elsewhere. Since the 1990s the corporate rate has remained 35% in the U.S. while dropping in almost every other advanced economy. The trend continues: France plans to cut its top rate to 25% by 2022; Britain's is scheduled to drop to 17% by 2020 from 19% now.

The economic rationale for lower corporate rates is to reduce the cost of funding projects and thus to stimulate hiring and investment. Countries have another, more mercenary motive: to stop multinationals from fleeing to tax havens.

Reducing the corporate tax rate by 10 percentage points relative to other countries boosts reported profits by anywhere from 4% to 22%, according to a survey of research by Dhammika Dharmapala at the

University of Chicago. Most countries have concluded "it's impossible to police the shifting of profits," says Martin Sullivan, chief economist of the publication Tax Analysts. "So if you set your rate too high you're going to lose revenue."

People, however, are a lot less mobile than capital, so revenue-hungry governments tap sales, payroll and income taxes, including those on the rich.

Ireland boasts one of the advanced world's lowest corporate tax rates, but its combined top income and payroll rate rose from 43.6% in 2008 to 52% last year, while Britain's rose from 41% to 47%, according to the Organization for Economic Cooperation and Development.

While the Republican plan lowers most personal tax rates except the top one, it isn't clear individuals on net would get a tax cut, because some tax breaks would be repealed. More to the point, if they are getting a tax cut, it may not last.

It's just math. Even with no tax cuts, the budget deficit will rise from 3.6% of economic output this year to 5.2% in 2027 as an aging population and health costs inflate the cost of federal entitlements and interest rates slowly normalize, according to the Congressional Budget Office.

The federal debt, now 77% of gross domestic product, will rise to 91%, the CBO projects. The GOP tax plan would add $1.5 trillion to deficits in the coming decade, or roughly 0.6% a year.

Administration officials assert the tax cuts will spur so much growth they will pay for themselves, an argument largely lacking in historical precedent or empirical support. Congressional Republicans say they'll cut spending, especially on entitlements. Yet they have shown little appetite to do so and Mr. Trump has ruled out tampering with Medicare or Social Security. A Democratic president or Congress would be even less receptive.

History suggests that big tax cuts are usually followed by tax increases. After Presidents John F. Kennedy and Lyndon Johnson reduced taxes in 1962 and 1964, taxes were raised in 1966 and 1968. President Reagan enacted the largest tax cut in history (relative to GDP) in 1981. He then signed tax increases into law in 1982, 1983 and 1984. President George W. Bush fared better. The tax cuts he enacted in 2001 and 2003 became permanent in 2013 except for the top rate, which rose.

When the time comes to raise taxes, whose will go up? Even a Democrat in the White House would think twice about tampering with the corporate rate when business threatens to up stakes and leave.

Economists' dream of a carbon or value-added tax isn't shared by many politicians seeking re-election. Which leaves personal taxes -- perhaps the very ones now being cut. If you're a beneficiary, enjoy it while you can.

Write to Greg Ip at greg.ip@wsj.com

(END) Dow Jones Newswires

November 01, 2017 12:54 ET (16:54 GMT)