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ON the MARGIN Tax ® Tax Notes Analysts © 2018 ON THE MARGIN Tax ® tax notes Analysts. All Off Course: Critiquing the Debate About the Corporate Tax Cut rights reserved. by Alan D. Viard investment and wages. Unfortunately, the public Alan D. Viard is a Tax resident scholar at the debate about the tax cut has largely ignored the American Enterprise relevant incentive effects. Analysts Institute. He thanks Supporters of the corporate tax cut took a Alex Brill, Cody Kallen, wrong turn by publicly accepting some Erin Melly, and Jason companies’ claims that the one-time employee does Saving for helpful bonuses they paid in late 2017 and early 2018 were not comments. due to the tax cut. Because the tax cut could not claim In this article, Viard have raised the market level of wages that quickly, companies’ attribution of the bonuses to the tax argues that the public copyright debate about the cut appears to have been a public relations corporate tax gimmick. By latching onto the one-time bonuses, provisions of the Tax supporters drew attention away from the slower- in Cuts and Jobs Act has acting incentive effects featured in the economic any ignored the relevant incentive effects, amid theory. public discussions of one-time employee bonuses and Opponents correctly argue that corporations the lack of corporate altruism. He urges that the will not altruistically share their tax savings with domain debate be refocused on the real advantages and disadvantages of the corporate tax cut, workers and will not increase investment out of a particularly the improved investment sense of social responsibility. However, they fail to incentives, the worsening of the long-term fiscal recognize that the economic theory does not rely or third imbalance, and a likely increase in inequality. on those motivations. Little attention has been paid to the incentive effects of the corporate tax party The views expressed in this article are solely rate reduction and expensing. Opponents the author’s. mistakenly cite the wave of stock repurchases as content. Copyright 2018 Alan D. Viard. evidence that the rate reduction was ineffective, All rights reserved. although the repurchases are the expected response to the allowance of tax-free repatriation The Tax Cuts and Jobs Act (P.L. 115-97) and actually shed little or no light on the effects of reduced the corporate tax rate, expanded the corporate tax rate reduction and expensing. expensing, and allowed tax-free repatriation of The debate should be refocused on the real some foreign subsidiaries’ earnings. Stylized advantages and disadvantages of the corporate economic theory lays out a clear-cut channel tax cut, which has the potential to boost long-run through which corporate tax rate reduction and growth but is likely to worsen the long-term fiscal expensing induce self-interested corporations to imbalance and increase economic inequality. invest more in the United States, thereby Attention should be focused on that fundamental enlarging the capital stock, which makes workers trade-off. more productive. Wages are gradually forced up as self-interested employers bid against each other I. Stylized Economic Theory to hire more workers. The stylized theory also predicts that tax-free repatriation of foreign Stylized economic theory, which assumes that subsidiaries’ earnings does not affect U.S. corporations seek to maximize after-tax profits in a smoothly functioning economy, make clear-cut TAX NOTES, AUGUST 6, 2018 813 For more Tax Notes content, please visit www.taxnotes.com. ON THE MARGIN © 2018 predictions about the qualitative effects of a hire more workers at the going wage. Employers’ Tax corporate tax rate reduction, expanded competition to hire more workers bids up wages, Analysts. expensing, and tax-free repatriation of foreign forcing employers to pay more to obtain workers subsidiaries’ earnings to U.S. parent companies. and drawing new entrants into the workforce. The description below draws on my earlier article The wage increases and additional hiring occur All about the economic effects of the corporate tax gradually while the capital stock expands. rights rate reduction.1 Although the levels of output and wages permanently rise, their growth rates do not reserved. A. Corporate Tax Rate Reduction and Expensing permanently increase. Section 13001 of the TCJA amended section 11 Some of the new investment may be financed to permanently reduce the corporate tax rate from by foreign savers. The increased inflow of funds Tax a graduated schedule with a top rate of 35 percent from abroad is accompanied by an increase in the Analysts to a flat 21 percent rate, effective on January 1, trade deficit. The increase in Americans’ future 2018. Section 13201 of the TCJA amended section incomes is smaller than the increase in the future 168(k) to temporarily allow full expensing of output produced within the United States because does investments in some types of business property, part of the additional output must be paid to the not generally effective for property placed in service foreign savers who helped finance the additional from September 28, 2017, to December 31, 2022.2 investment. claim Although the larger capital stock and higher A corporate tax rate reduction raises the after- copyright tax profitability of making U.S. investments in wages produce a positive long-term revenue any type of business property that receives capital feedback, the feedback does not fully offset the direct revenue loss from the rate reduction and cost recovery allowances less generous than in 4 expensing. Allowing investments to be expensed expensing. The corporate tax cut therefore causes any a decline in federal revenue; in colloquial terms, rather than depreciated similarly boosts the after- public tax profitability of making U.S. investments.3 The the tax cut does not pay for itself. The revenue decline must eventually be offset by tax increases rate reduction and expanded expensing therefore domain prompt self-interested corporations to invest or spending cuts of the same present discounted more in the United States. The rate reduction is value. likely to be more important than the expansion of If the tax increases or spending cuts are not or expensing because the expensing provision is adopted contemporaneously with the corporate third temporary and excludes some types of business tax cut (as they were not for the TCJA), the party property. resulting increase in the federal debt may drive up The resulting expansion of the U.S. capital interest rates. The increase in interest rates crowds content. stock makes U.S. workers more productive, out investment, offsetting at least part of the prompting self-interested corporations to seek to investment boost. B. Effects of Tax-Free Repatriation 1 Alan D. Viard, “Economic Effects of the Corporate Tax Rate Section 14101 of the TCJA enacted new section Reduction,” Tax Notes, Mar. 5, 2018, p. 1393. 2 245A, which permanently exempts U.S. Partial expensing is allowed for property placed in service in 2023 through 2026. Section 13101 of the TCJA also permanently expanded corporations from tax on repatriation of the expensing for small businesses. earnings of some foreign subsidiaries, effective 3 The expensing provision’s effect on investment location is clear-cut January 1, 2018. Although U.S. parent companies because, under section 168(k)(2)(D)(i) and (g)(1)(A), expensing does not apply to property used predominantly outside the United States. The corporate tax rate reduction’s impact on investment location is clear-cut for foreign corporations because, under sections 881 and 882, such corporations are subject to U.S. tax only on income effectively connected with a U.S. trade or business and U.S.-source income. For foreign corporations, the U.S. corporate income tax is therefore a tax only on U.S. investment and reducing the tax rate makes U.S. investments more profitable relative to foreign investments. For U.S. corporations, the rate reduction increases the profitability of U.S. investment relative to foreign investment if the corporations’ U.S. investments are taxed more heavily 4 than their foreign investments, as was true under prior law and is true A full revenue offset is theoretically possible but would only occur under the TCJA. under extreme conditions that do not now apply to the United States. 814 TAX NOTES, AUGUST 6, 2018 For more Tax Notes content, please visit www.taxnotes.com. ON THE MARGIN © 2018 pay U.S. tax on some earnings of their foreign Share repurchases or other distributions to Tax 5 subsidiaries, the tax is generally imposed when shareholders of funds previously held in foreign Analysts. the earnings occur (or at some other fixed date) subsidiaries’ bank accounts do not change the and the earnings can be repatriated without amount of funds available for investment. The additional tax liability. distributions do not remove funds from the All Repatriation involves a dividend payment capital markets because the shareholders can rights from a foreign subsidiary to its U.S. parent invest the funds that they receive, and they do not company, typically implemented by transferring inject new funds into the capital markets because reserved. money from the subsidiary’s bank account to the the funds held in the subsidiaries’ bank accounts parent company’s bank account. Both accounts were lent in the capital markets. may well be at U.S. banks,6 which makes clear that Tax C. Key Features of Stylized Theory it is generally inaccurate to describe repatriation Analysts as money coming back to the United States after Four features of the stylized economic theory having been trapped offshore. are important for understanding how the public According to the stylized economic theory, the debate has gone off course. does transfer of funds from subsidiaries’ bank accounts First, the investment effects arise from not to parent companies’ bank accounts does not anticipated tax savings on future investments, not claim change the after-tax profitability of U.S.
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