Representative Charles Rangel (D, N.Y.) has drafted legislation that would reduce the corporate income-tax rate from 35 to 30 percent and abolish the alternative minimum tax (AMT). Unfortunately, the tax increases in the package will more than blunt any positive long-term impact that results from these cuts.
Though Rangel’s reform is not expected to pass in the 110th Congress, the portion that seeks to reduce taxes on businesses and individuals is at first glance a positive development, particularly in light of a congressional majority that has more often than not made noise about raising taxes. Much like the individual income tax, the corporate tax is a penalty on productive and profitable activity. Judging by the rise of U.S. stock indices over the last twenty years, the corporate tax hasn’t been so onerous as to crush profitability. But what is unknown is just how many interesting business concepts never saw the light of day due to the 35 percent penalty.
Given a worldwide decline in corporate tax rates, this takes on rising importance.
Indeed, Japan is now the only OECD country that has a higher corporate tax levy than the United States. Perhaps recognizing that corporations are increasingly people-driven, rather than equipment-driven, and as such are able to migrate toward the most business-friendly tax regimes, other OECD countries have lowered corporate rates. Simply, they appear to understand that it’s better to capture business revenues at low tax rates as opposed to watching companies and revenues flee when high rates are in place.
That lower corporate tax rates will help keep jobs and companies stateside is certainly a pro-growth positive. But with a company’s geographical origin less important in an increasingly integrated world economy, what’s best about lower corporate tax rates in the U.S. is that the most valuable companies will still form here. A less punitive tax environment will only aid this process.
But Rangel’s plan is layered with punitive measures. Apparently Rangel and his friends in Congress remain wedded to the notion that companies and individuals don’t respond to tax incentives. As a result, any tax-cut legislation will include tax increases to make up for a revenue shortfall that based on static projections will reveal itself when taxes are lower.
While it’s good news that Rangel seeks a temporary measure to protect up to 21 million Americans from the AMT, the continued uncertainty of where this tax will land on the income scale is a drag on economic growth. Tax ambiguity has a chilling effect. Worse, however, is that Rangel ultimately would “pay” for full AMT repeal with increased taxes on both the private-equity industry and all those who are deemed “rich” by Congress.
Private-equity managers will face a doubling of the tax rate on “carried interest” under the Rangel plan. Carried interest is merely a euphemism for capital gains from successful investments, which means this income is by no means certain. Raising the penalty on risk-taking will surely dampen the positive impact of Rangel’s bill, although fellow New York legislators will likely oppose this measure. Why put a bull’s eye on an industry that has done so much for the city you serve?
Moving to taxes on top earners, married couples making more than $200,000 would be hit with a 4 percent income surcharge (call it a success penalty), with the fine rising to 4.6 percent for those with incomes exceeding $500,000 per annum. High-income households also would see taxes on their capital gains rise from 15 percent to as much as 19.6 percent.
At his press conference on Thursday Rangel announced that “90 million taxpayers will walk away saying, ‘I’ve got a decrease in taxes.’” Not so fast. While it may be true that many Americans will see their taxes decline under this plan, the result may be a more difficult wage environment. Wages are directly related to available capital. When the surplus income of the rich is turned over to the government for immediate consumption, the pool of available capital decreases such that workers feel the crunch in their paychecks.
And let’s not forget that many small businesses form as S Corps, LLCs, and private partnerships, and as such are taxed at the individual rates that Rangel hopes to increase. That the stock market had a lukewarm reaction to Rangel’s bill makes perfect sense: The congressman’s tax hikes will hit the entrepreneurial and job-creating portion of the U.S. economy particularly hard. The unseen here will be the various Microsofts and Googles that never form because the top income-tax rate ascended from 35 percent to a very punitive 44 percent.
U.S. manufacturers also could lose a deduction on domestic production that is presently taxed at a 32 percent rate. To be fair, this reform would be acceptable. While Lou Dobbs might blanch at such a plan, it would be bullish for the economy. Narrow tax incentives serve to distort economic activity, and in the case of deductions for manufacturers, an incentive is created whereby U.S. firms are less likely to readily access what is a growing worldwide labor force.
But rather than soak the rich to fund the good parts of his bill, Rangel could target the numerous corporate handouts that a Wall Street Journal editorial (“The Corporate Welfare Congress”) listed just this week. Congress is doling out billions of taxpayer dollars to corporate interests, ranging from agribusiness to “renewable fuels” to terror insurance. Instead of penalizing real economic activity, Congress would do well to end the process by which it reaches into taxpayer pockets to the benefit of special interests. A reduction of the latter would doubtless cover any presumed revenue shortfalls that result from the proposed cuts.
As Rep. Rahm Emmanuel (D., Ill.) wrote in a Wall Street Journal op-ed last month, “An increase in savings enlarges the pool of capital available for businesses to invest, create jobs and improve our standard of living.” High taxes reduce the incentive to work and save for the certainty that income and profits will be captured by governments rather than job-creating businesses reliant on the savings of others. Just the same, a lower tax on corporate profits and income will reduce the cost of success in the U.S. while creating greater incentives for capital to fund job-creating enterprise.
Let’s hope Congress can in fact pass the good proposals within Rangel’s bill — free of the new revenue enhancers that will diminish the economic positives.