House Speaker Ryan’s tax reform plan is not ready for prime time

Posted on by Kavya Vaghul

The federal tax reform blueprint developed by Speaker of the House Paul Ryan (R-WI) and his colleagues in the majority in the House of Representatives combines lower tax rates for individuals with a “destination-based cash flow” business tax applicable to all businesses. The cash flow element means that businesses will be allowed to write off capital expenses such as machines and that routine investment returns will be exempt from taxation. The destination basis means that exports will be tax exempt and imports taxable.

The Ryan tax reform plan has several major problems. Specifically, it:

  • Is incompatible with our trade law obligations
  • Is incompatible with our tax treaties
  • Would generates large federal revenue losses
  • Would make our tax system less progressive at the proposed tax rates
  • Will not solve the problems of businesses shifting their incomes to overseas tax havens even though this is what it is designed to address

Our working paper details these problems. Here, we summarize our findings and recommend an alternative approach to tax reform that is both progressive and revenue neutral.

New Working Paper
Problems with destination-based corporate taxes and the Ryan blueprint

The “border adjustment” feature of the Ryan blueprint raises key problems. Indeed, the incompatibility of the Ryan blueprint with trade rules is no mere technicality. U.S. trading partners are likely to be hurt by increased incentives to operate in the United States and by much larger profit shifting by their businesses. Trading partners are likely to retaliate, which risks large negative effects to the world trading system as well as an uncertain investment climate. There is no easy way to solve the tax reform plan’s incompatibility with U.S. obligations under the World Trade Organization. If the U.S. government in the end were to comply with WTO rules by turning this plan into a “normal” value added tax, or VAT, then it would turn the corporate tax into a regressive consumption tax. And the border adjustment feature could not be dropped without huge revenue losses as well as enormous tax avoidance problems.

In addition, the Ryan blueprint generates vexing technical tax problems that are not easily fixed. There are important issues surrounding how U.S. exporters with losses would be handled (which could lead to inefficient tax-induced mergers), how financial transactions would be handled, how U.S. state corporate tax systems would be affected, and how the transition to the new tax system would be handled. There are also multi-trillion dollar wealth effects, with a large reduction in wealth for U.S. holders of foreign assets.

Profit shifting is not completely eliminated by the plan, contrary to claims. As an example, the Ryan plan makes it easier for U.S. corporations to move profits offshore on intellectual property, especially when the intellectual property serves foreign markets. (See Figure 1.)

Figure 1

The tax reform plan is likely to generate large revenue losses, too, estimated at $3 trillion over ten years by the Tax Policy Center. These revenue losses may be understated since they assume there will not be tax avoidance due to the large discrepancy between the proposed top personal rate of 33 percent and the business rate of 20 percent (or 25 percent for those filing pass-through business income). New tax avoidance opportunities will arise as wealthy individuals seek to earn their income in tax-preferred ways that reduce their labor compensation in favor of business income that would be taxed at a lower rate.

Further, while the border tax provisions generate more federal tax revenue over the short run, the revenue from the border adjustment is contingent on the United States maintaining its current trade deficit. Since trade deficits eventually have to be paid back in the form of trade surpluses, these revenue gains are really being borrowed from future U.S. taxpayers.

Finally, due to the tax rates that have been proposed, the Ryan tax reform plan creates a less progressive tax system. Tax Policy Center estimates show that the top 1 percent of individual income earners receive a tax cut of $213,000, while the tax cut for the bottom 80 percent averages $210. The regressive nature of these tax changes is unjustifiable given the increases in economic inequality over the previous decades. Capital income and rents (undue business profits due to market concentration), are far more concentrated than labor income. And the lower business tax rates chosen by the plan are intellectually incoherent because the plan exempts taxes on the normal return to capital and reduces profit shifting—both of which are the usual arguments for a lower rate in the first place. If such concerns are moot, then there is no reason to tax business income at a lower rate than labor income.

Given these concerns, we would recommend that Congress reject the Ryan blueprint. Instead, it should focus on revenue neutral tax reform that reduces the corporate tax rate and eliminates the major corporate welfare provisions, including taxing accumulated offshore earnings in full. Doing so would eliminate the incentive to earn income in tax havens, by treating foreign and domestic income alike for tax purposes. Pairing that reform with a lower corporate tax rate need not raise tax burdens on average. A more fundamental reform would require treating multinational enterprises as a single business entity, which would better align the tax system with the reality of globally integrated corporations.

—Reuven Avi-Yonah is the Irwin I. Cohn professor of law at the University of Michigan Law School, and Kimberly Clausing is the Thormond A. Miller and Walter Mintz professor of economics at Reed College

For further details on the authors’ tax reform proposals please see an accompanying fact sheet and the following background materials:

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"Problems with destination-based corporate taxes and the Ryan blueprint" (Fact Sheet)

View the fact sheet in your browser

Local economic decline affects marriage and fertility rates, but in a surprising way

Posted on by Bridget Ansel
Photo of a gear from an air compressor that provided plant air for the former Ormet plant lies on the ground at the site in Hannibal, Ohio. Manufacturing’s decline has impacted local marriage and fertility rates, but in different ways depending on whether the affected industry is male- or female-intensive.

Scholars have long thought about how our jobs shape our identities both in an out of the workplace. But a new paper shows the extent to which one’s job—or lack thereof—also impacts the roles we assume within our family life. The research, by Massachusetts Institute of Technology’s David Autor, University of Zurich’s David Dorn, and University of California-San Diego’s Gordon Hanson looks at what happens to families in the United States when work disappears, specifically in areas with a high concentration of manufacturing that are hard-hit by trade.

Men and women have both paid the cost economically speaking, but they have reacted differently to their changing fortunes. Whether an affected industry is male-intensive versus female-intensive has a profound effect on local marriage and fertility trends. Traditional marriage patterns are more common in areas where men’s economic status remains superior to women’s, but less so where men’s jobs have taken the largest hit.

Manufacturing has historically been a “good job” in the sense that it was steady and well-paying for someone without a college degree. Men have always been more likely to hold these jobs, partially due to the perception that “it’s still dirty and dark and dangerous.” Women who do work in manufacturing tend to be concentrated in certain industries, such as textiles, apparels, and leather. In the 1990s, the share of female manufacturing workers peaked at 32 percent and has since fallen, as women-dominant sectors were hit especially hard during the Great Recession.

The gender gap in manufacturing matters because manufacturing jobs tend to pay more—17 percent on average—than non-manufacturing jobs, which contributes to a gender gap in pay. In fact, the male-female gap in annual earnings is much larger in areas in which a large share of adults (men and women) working in manufacturing. In these areas men take home, on average, a much bigger paycheck than their female counterparts.

But over the past few decades, manufacturing has been on the decline due to increased competition and trade, leaving many men—and women—out of a job or earning less. But with all the anxiety that’s accompanied this shift, it’s easy to overlook another key trend—growth in the service sector has added more jobs than were lost in manufacturing. These jobs tend to be low-paying, however, which is one reason many men are reluctant to take them, along with the perception that they are too feminine.  Whatever the reason, one thing is clear: Manufacturing’s decline has diminished many men’s economic status in comparison to women, especially men in the bottom quarter of the income spectrum.

The story of what happens next is familiar. Families struggling to make ends meet. Men dropping out of the labor force all together. An explosion of drug and alcohol use, and, for some, premature death, alongside the rise of incarceration during the same time period. The authors of the paper found that all these phenomena were more prevalent among men in areas where manufacturing declined.

It’s no surprise, then, that entire families would be affected, especially considering that these demographic and social shifts resulted in fewer men overall in these hard-hit regions of the country. Areas that were economically affected most by trade saw a reduction in the number of young adults who are married. These regions also experienced a declining birth rate and a higher rate of babies born to single mothers (and because of that, more child poverty). The authors find that these trends are pervasive across all racial and ethnic groups.

It could be that women are unwilling to legally bind themselves to men who are facing financial, legal, or health problems—or that there are fewer men to marry. Autor and his coauthors believe that these are all valid reasons for the decline in marriage, but also point to research by Marianne Bertrand and Emir Kamenica of University of Chicago, and Jessica Pan of the National University of Singapore. In their paper, they find that marriage becomes less likely between men and women if a women’s income is likely to exceed that of her future husband. The three scholars find that “standard economic models […] cannot account for this pattern. Instead, we argue that gender identity norms play an important role in marriage.”

This hypothesis is further born out by looking at regions that only saw a decline in female-intensive industries, which are fewer in number but have faced enormous upheaval, especially during the Great Recession. Not only did marriages in these areas not decline, but instead marriage rates went up while reducing the number of children who live in single-headed households.

Of course, the overall declines in marriage and single-headed households aren’t driven exclusively by the decline in manufacturing. But this research does speak to how much workers’ identities are tied up with presumed work roles in life, whether that’s one’s job, economic status, or gender. What is clear is that these norms are increasingly costly in the face of a changing economy. The inability of policymakers to help workers adapt is creating a crisis that has a ripple effects for the entire U.S. economy, political system, and prosperity of future generations.

Should-Reads: February 26, 2017

Posted on by Brad DeLong

Interesting Reads:

Should-Read: Paul Krugman: Maid In America

Posted on by Brad DeLong

Should-Read: Paul Krugman: Maid In America: “[In 1996] I argued… that menial work dealing with the physical world…

…gardeners, maids, nurses–would survive even as quite a few jobs that used to require college disappeared…. Big data has led to more progress in something that looks like artificial intelligence than I expected…. The point about the relative displacement of cognitive versus manual jobs seems to stand…. The disruptiveness of such technological change is something we should take seriously…. The initial effect of the Industrial Revolution was a substantial de-skilling of goods production. The Luddites were, for the most part, not proletarians but skilled craftsmen, weavers who constituted s sort of labor aristocracy but found their skills devalued by the power loom. In the long run industrialization did lead to higher wages for everyone, but the long run took several generations to happen—in that long run we really were all dead…. It remains peculiar how we’re simultaneously worrying that robots will take all our jobs and bemoaning the stalling out of productivity growth. What is the story, really?

Should-Read: Jonathan Chait: Trump’s Health-Care Nightmare Is Only Just Beginning

Posted on by Brad DeLong

Should-Read: Jonathan Chait: Trump’s Health-Care Nightmare Is Only Just Beginning: “Republican members of Congress do not agree with each other on the parameters of a replacement…

…Conservatives have demanded a repeal of Obamacare’s Medicaid expansion… oppose the use of refundable tax credits to subsidize coverage… the law should ban subsidies for any health-insurance plan that covers abortion…. The beliefs Republican members of Congress do agree on are not shared by their voters… [who] like Medicaid, and dislike the fact that exchange plans have high deductibles…. A belief in higher deductibles is the conservative movement’s central health-care policy conviction… forcing consumers to have “skin in the game”….

Republicans were able to paper over this yawning chasm between what their base demands and what their elites are offering for the last eight years only because they have been able to avoid a specific alternative. Republicans attacked Obamacare for its high deductibles, and Trump promised a replacement that would give everybody better coverage for less money. But their proposals would do the opposite…. Obamacare was not a perfectly designed law, but it did reflect a kind of political genius…. Obamacare did create some losers: The very rich… and young, healthy people [who] have to pay higher premiums… but they were vastly outnumbered by the winners: millions of people who could now have access to insurance who once could not afford it. The Republican plan… would create very few winners and an enormous number of losers….

The last ten polls all show net positive approval for the Affordable Care Act…. And this is all happening before Republicans have published a detailed plan. That is the most amazing aspect of all. Obamacare repeal faces dire peril, and the most painful steps have yet to come.

Weekend reading: “Adjusting to the new borders” edition

Posted on by Nick Bunker

This is a weekly post we publish on Fridays with links to articles that touch on economic inequality and growth. The first section is a round-up of what Equitable Growth published this week and the second is the work we’re highlighting from elsewhere. We won’t be the first to share these articles, but we hope by taking a look back at the whole week, we can put them in context.

Equitable Growth round-up

If you don’t pay much attention to labor law, you’d be forgiven for thinking that for a worker to be covered by a union she had to be a member of a union. But that’s not correct. And as Matt Markezich shows, the difference can be quite large in some countries.

Economists have studied extensively the effects of increasing the minimum wage on the U.S. labor market. Yet boosting the wage floor is likely to have consequences on more than the labor market. John Schmitt writes up new research on access to credit for workers affected by a higher minimum wage.

The border-adjustment aspect of the House Republican plan for corporate tax reform has drawn the most attention. But don’t forget that the plan also calls for cutting the corporate rate. Policymakers should be skeptical that’ll do much to boost business investment.

Links from around the web

Perhaps the biggest question for the U.S. economy in 2017 is how much slack, or underutilized potential, remains. Neil Irwin takes a look at the state of slack and explains how the debate about how hot the economy can get will impact policy. [the upshot]

Relatedly, the concept of a “non-accelerating inflation rate of unemployment,” or NAIRU, has come under attack recently. Simon Wren-Lewis defends the concept from attacks, saying it’s critical for talking about macroeconomics. [mainly macro]

Over the past six years or so, the International Monetary Fund has increasingly grappled with the question of how inequality affects economic growth. Prakash Loungani and Jonathan D. Ostry write on how research on inequality weighs in the IMF’s work. [imf direct]

President Trump and his administration may not be fans of running trade deficits, but they sure do like foreign investment. But as Ana Swanson, there’s some tension there as trade deficits and capital account surpluses are different sides of the same coins. [wonkblog]

Mary Amiti, Oleg Itskhoki, and Jozef Konings don’t think border adjustment aspect of corporate tax reform will do much to increase exports. In fact, their analysis finds that it may actually depress exports in the short term. [liberty street economics]

Friday figure

Figure from “Why is collective bargaining so difficult in the United States compared to its international peers?” by Matt Markezich

Should Reads: February 24, 2017

Posted on by Brad DeLong

Interesting Reads:

Should-Read: Marco Buti and Karl Pichelmann: European integration and populism: Addressing Dahrendorf’s quandary

Posted on by Brad DeLong

Should-Read: Marco Buti and Karl Pichelmann: European integration and populism: Addressing Dahrendorf’s quandary: “With its current competences lacking the ability to address distribution effects…

…the EU is seen as an agent of globalisation rather than a response to it.  At the same time, it is charged with undermining national autonomy, identity, and control. This column sets out five guiding principles for policy articulation at the EU level for a new positive EU narrative…. The current rise in populist parties is a wake-up call resembling what the late Ralf Dahrendorf… summarised a little more than 20 years ago as a quandary…

To stay competitive in a growing world economy [the OECD countries] are obliged to adopt measures which may inflict irreparable damage on the cohesion of the respective civil societies. If they are unprepared to take these measures, they must recur to restriction of civil liberties and of political participation bearing all the hallmarks of a new authoritarianism (…) The task for the first world in the next decade is to square the circle between growth, social cohesion and political freedom…

Should-Read: Barry Eichengreen et al.: On the fickleness of capital flows

Posted on by Brad DeLong

…Focusing on emerging markets, this column argues that despite recent structural and regulatory changes, much of this wisdom still holds today. Foreign direct investment inflows are more stable than non-FDI inflows. Within non-FDI inflows, portfolio debt and bank-intermediated flows are most volatile. Meanwhile, FDI and bank-related outflows from emerging markets have grown and become increasingly volatile. This finding underscores the need for greater attention from analysts and policymakers to the capital outflow side.

B Eichengreen and P Gupta (2016), “Managing Sudden Stops,” World Bank Policy Research Paper 7639.

B Eichengreen, P Gupta, and O Masetti (2017), “Are Capital Flows Fickle? Increasingly? And Does the Answer Still Depend on Type?” World Bank Policy Research Paper, 7972.

What’s the problem a U.S. corporate tax cut will solve?

Posted on by Bridget Ansel
Photo of the Internal Revenue Service Building in Washington.

Pretty much the entire conversation around possible U.S. tax reform this year has been around the idea of introducing a border adjustment tax to the corporate income tax by taxing imports and offering a deduction for exports. But there’s a lot more going on in the proposals to overhaul corporate taxation, never mind the planned changes for the individual tax code.

The tax reform proposal from House Republicans would reduce the corporate rate from 35 percent to 20 percent and allow for the immediate and full expensing of capital investments. Both of these changes have been pitched as ways to boost business investment and overall economic growth. Given previous tax reform efforts and trends among corporations, policymakers should be skeptical that these changes will do much on the growth front.

Before turning to the reasons for skepticism, a quick note on how the corporate income tax interacts with investment decisions today. As Kyle Pomerleau of the Tax Foundation explains, the corporate tax can be separated into two pieces: a tax on net profits that will fall on shareholders and a tax on new investments, as capital outlays can’t be immediately written off. Whether capital (investors) or labor (workers) bear relatively more or less of that tax depends on whether investment decisions are affected much by the tax on new investments. The more of a response, the more the tax falls on labor, as less investment means lower productivity and lower wages.

If a lower corporate tax rate and the full expensing of investment can boost investment growth, then we’d expect not only higher growth but also higher wages as workers are more productive. Furthermore, as the tax wouldn’t affect investment decisions and potentially fall on labor, it would fall more on capital via the tax on net profits. Yet there’s reason to be skeptical that such reforms are going to lead to such positive changes.

First, the United States tried in the recent past to boost investment by reducing the cost of capital. During 2003, the federal government cut the tax rate on dividends to help spur investment. Research by Danny Yagan of the University of California-Berkeley, however, found no such impact. Neither investment nor employee compensation changed much in response to the dividend tax cut.

Even more questionable is the idea that the cost of capital is of much concern these days. Corporations can borrow at very low interest rates, but they have become net lenders to the rest of the economy. Corporations across high-income countries have boosted their savings rates since the early 1980s and haven’t boosted investment much. Research looking at the reason for this corporate savings glut haven’t pointed to tax rates but instead at increased business concentration and increased payouts to shareholders.

The dearth of business investment in the United States and across high-income countries is a troubling trend. Less investment means slower productivity growth and a poorer future as living standards can’t grow as quickly. Policymakers in the House should be applauded for wanting to give corporations a kick start. But their preferred method of motivation might not be as strong as they would like.