Transcript Tax Reform Sept 19 2008

Tax Reform:
Theory and Evidence
Professor John A. Spry, Ph.D
University of St. Thomas
[email protected]
The views expressed herein are solely those of the author and do not
necessarily represent the views of the State of Minnesota or the
University of St. Thomas. All errors are my own.
Revenue-Neutral Tax Reform
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The goal is to increase the size of the economy while
meeting the needed revenue goal
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Reduce reliance on costly inefficient taxes
Increase reliance on less distortionary taxes
Generally,
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avoid high tax rates with narrow tax bases that are
highly responsive to tax rates
use low tax rates on broad bases that are less
responsive to tax rates
The inefficiency of a tax increases
with the square of the tax rate
“Marginal distortions associated with the tax code tend
to rise with the square of the tax rate, so that as the tax
rate gets into higher and higher territory, the marginal
dead-weight losses tend to grow rapidly. Going from a
30 percent to a 40 percent marginal tax rate, for
example, doesn’t increase the marginal efficiency cost
of taxation by a factor of 1.33, but by the ratio of 16
over 9—close to 75 percent.”
Source: Professor James Poterba, MIT and NBER
A Tax Theorist’s Guide to Spotting “Better” and
“Worse” Taxes for Economic Growth
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“Better” Taxes for Growth
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Minimally reduce gains from trade
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An inelastic tax base
Small tax rate wedge
(from combine federal and state rates)
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Low administrative costs
Low compliance burden
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Large distortions in the decisions of people and businesses
“Worse” Taxes for Growth
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Multiple ways for creative individuals to change behavior
A large tax rate wedge
(from combine federal and state rates)
A highly mobile tax base
High administrative costs
Large compliance burden
Minnesota is a Small Open Economy
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Minnesota has 0.08% of the world population.
Minnesota GDP is about 0.33% of world GDP.
We should compare our taxation of
capital internationally, as capital is
highly mobile today.
 We should compare our taxation of
labor and savings nationally, because high
human capital workers are very
mobile today.

How does Minnesota compare
Internationally? What decisions face huge
combined Minnesota and federal tax rates?
Minnesota is a Small Open Economy
-but Minnesota has a Tax Code Designed
for a Closed Economy
 Minnesota’s 41.4% combined statutory federal and state
corporate income tax rate is 50% higher than the OECD
average of 27.6%.
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Original idea - place the burden of the state corporate income tax on
the owners of capital invested in Minnesota
Minnesota taxes intended to fall on capital miss in an open economy
• Minnesota workers, consumers, and land owners get hit by
taxes designed to burden owners of capital
• How we tax Minnesota source-based capital determines how
much capital is invested in Minnesota
- but not the world rate of return on capital.
The pre-tax rate of return hurdle for investments in
Minnesota is higher because competition in the capital
market equalizes after tax rates of return across jurisdictions
adjusting for risk.
Specifically, how do we learn what are
“better” and “worse” taxes for economic
growth and prosperity?
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Even an ideal tax system would create
some extra tax burden in excess of tax
receipts to meet our need revenue target.
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Analysis should be grounded in the
economic theory of taxation
Rely on the serious, scholarly empirical
research on the effects of taxes on
economic decision making and economic
performance
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Specific problems caused by the
Minnesota Corporate Franchise Tax
1.
2.
A high rate (41.4% ) even before considering the double
taxation of corporate income
Strong disincentive for C-corp investment in Minnesota
-Foreign Direct Investment in a state falls one percent for every one percent
increase in the state corporate income tax rate.
Source: Prof. Claudio A. Agostini, Public Finance Review, 2007
-” ... the effective corporate tax rate has a large adverse impact on
aggregate investment, FDI, and entrepreneurial activity. For example, a 10
percent increase in the effective corporate tax rate reduces aggregate
investment to GDP ratio by 2 percentage points. Corporate tax rates are also
negatively correlated with growth, and positively correlated with the size of
the informal economy.
–Prof. Andrei Shleifer, et. al, Harvard University
3.
It doesn’t collect much revenue for a tax with a 9.8% rate.
Specific problems caused by the
Minnesota Corporate Franchise Tax
4.
“The domestic distortions that the corporate income tax induces are
large compared with the revenues that the tax generates…Overall, on
the basis of a survey of estimates derived from published corporate
tax studies, Gravelle concludes that the combined cost of the first five
domestic inefficiencies discussed in this chapter could exceed the
total amount of corporate tax revenues collected. – CBO, 2005
“Corporate income taxes appear to have a particularly negative
impact on GDP per capita. This is consistent with the previously
reviewed evidence and empirical findings that lowering corporate
taxes raises TFP growth and investment. Reducing the corporate tax
rate also appears to be particularly beneficial for TFP growth of the
most dynamic and innovative firms. Thus, it seems that corporate
taxation affects performance particularly in industries and firms that
are likely to add to growth.
Source: OECD Tax and Economic Growth
Specific problems caused by the
Minnesota Corporate Franchise Tax
5.
6.
7.
It distorts firms’ decisions between equity and debt finance
It has the highest administrative cost for the DOR per
dollar raised
It is a regressive and probably highly regressive tax that
falls on in-state consumers and workers.
Perhaps shockingly, the current Minnesota CFT, or any heavily sales
apportioned state income tax, acts to place a hidden, and somewhat arbitrary
form of sales tax on everything sold in the state by corporations, including
food, prescription drugs, clothing, and other goods that may be popularly
thought to be tax free.
“in the long-run a $1 increase in the tax bill tends to
reduce real wages at the median by 92 cents.”
Source: Oxford University Centre for Business Taxation “The Direct Incidence of
Corporate Income Tax on Wages”
The State Corporate Income Tax and Sales
Tax Bases are Becoming More Elastic
Source “On The Relative Distortions of State Sales and Corporate Income Taxes” Profs. Donald Bruce, John
Deskins, and William Fox. Paper to be presented at the 2008 Annual Conference of the National Tax Association
1.
Specific problems caused by the
Minnesota Personal Income Tax on Wages
Minnesota’s has a 40.1% current combined statutory
top federal and state personal income tax rate.
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2.
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5.
The original idea is to place the burden of the state personal
income tax on households with high personal income in
Minnesota as if Minnesota was a closed economy.
A large disincentive to supply additional hours of effort
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Iceland’s Natural Experiment
A large disincentive to invest in education and on-the-jobtraining
A large disincentive to take risky, disagreeable jobs that
receive a compensating wage premium for less pleasant
working conditions
A strong incentive to take compensation in tax preferred
forms (perks, exotic business trips, benefits, ect.)
Specific problems caused by the
Minnesota Personal Income Tax on Wages
6.
Labor mobility of highly skilled individuals
”The evidence presented in this paper supports the basic theoretical presumption
that state and local governments cannot redistribute income. Since individuals can
avoid unfavorable taxes by migrating to jurisdictions that offer more favorable tax
conditions, a relatively unfavorable tax will cause gross wages to adjust until the
resulting net wage is equal to that available elsewhere. The current empirical
findings go beyond confirming this long-run tendency and show that gross wages
adjust rapidly to the changing tax environment. Thus, states cannot redistribute
income for a period of even a few years. The adjustment of gross wages to tax
rates implies that a more progressive tax system raises the cost to firms of hiring
more highly skilled employees and reduces the cost of lower skilled labor. A more
progressive tax thus induces firms to hire fewer high skilled employees and to hire
more low skilled employees. Since state taxes cannot alter net wages, there can be
no trade-off at the state level between distribution goals and economic efficiency.
Shifts in state tax progressivity, by altering the structure of employment in the state
and distorting the mix of labor inputs used by firms in the state, create deadweight
efficiency losses without achieving any net redistribution.”
Source: Professors Feldstein and Wrobel, Journal of Public Economics, 1998.
Specific problems caused by the
Minnesota Personal Income Tax on
Wages?
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Labor mobility of highly skilled individuals
“This paper examines the responsiveness of the rich to state income taxes.
We use Major League Baseball free agents who were named All-Stars at
some point in their career and who signed with a U.S. team for the 1991
through 2002 seasons. This data set overcomes some of the previous
difficulties encountered in similar studies but also has limitations representing
the general rich population. We find evidence that the wages of this subset of
players do adjust to offset the burden of state income taxes, specifically a 1%
decrease in net-of-tax rate leads to a 3.3% increase in salary.” – Professors
Ross and Dunn, Contemporary Economic Policy, 2008
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High combined state and federal tax rates leads to a high marginal cost
of public funds, even without considering labor mobility.
“An across-the board increase in personal tax rates involves a deadweight
loss of 76 cents per dollar of revenue and collects only about two-thirds of the
revenue implied by a “static’ calculation.” –Feldstein, “The Effects of Taxes on
Efficiency and Growth.” Tax Notes, 2006.
Specific problems caused by the
Minnesota Personal Income Tax on Saving
1.
2.
The effective combined effect of federal and state taxes
and inflation results in a tax rate on saving through banks
or bonds can easily exceed 100% annually!
“Taxing capital involves taxing income twice: once when
you receive it, before you save it, and then once again
when you get the return on the savings. It gives a bias
toward consuming now rather than consuming later and
depresses capital accumulation.”
Source: Nobel Prize Winner Professor Robert Lucas, in the Region Magazine
from the Minneapolis Federal Reserve Bank
Tax and Economic Growth -OECD Conclusions
“The analysis in this (OECD) paper suggests some general policy options that
could be considered:
− The reviewed evidence and the empirical work suggests a “tax and growth
ranking” with recurrent taxes on immovable property being the least
distortive tax instrument in terms of reducing long-run GDP per capita,
followed by consumption taxes (and other property taxes), personal
income taxes and corporate income taxes.
− A revenue neutral growth-oriented tax reform would be to shift part of the
revenue base from income taxes to less distortive taxes… In practical policy
terms, a greater revenue shift could probably be achieved into consumption
taxes.”
References
Professor James Poterba on taxation:
http://woodrow.mpls.frb.fed.us/pubs/region/08-06/poterba.pdf
Tax and Economic Growth, OECD Working Paper 620 Source:
http://www.olis.oecd.org/olis/2008doc.nsf/LinkTo/NT00003502/$FILE/JT03248896.P
DF
Hodge, Scott. "U.S. States Lead the World in High Corporate Taxes" The Tax
Foundation, Fiscal Fact No. 119. March 18, 2008.
http://www.taxfoundation.org/publications/show/22917.html
Claudio A. Agostini, "The Impact of State Corporate Taxes on FDI Location," Public
Finance Review 2007; 35; 335. http://pfr.sagepub.com/content/abstract/35/3/335
Congressional Budget Office, “Corporate Income Tax Rates: International
Comparisons.”
http://www.cbo.gov/ftpdocs/69xx/doc6902/11-28-CorporateTax.pdf
References
Professors Sineon Djankov, Tim Ganser, Caralee McLiesh, Rita Ramalho, and
Andrei Shleifer, "The Effect of Corporate Taxes on Investment and
Entrepreneurship," National Bureau of Economic Research, Working Paper 13756,
January 2008. http://www.nber.org/papers/w13756
“On The Relative Distortions of State Sales and Corporate Income Taxes” Donald
Bruce, John Deskins, and William Fox. Paper to be presented at the 2008 Annual
Conference of the National Tax Association
http://web.utk.edu/~dbruce/bruce.deskins.fox.distortions.pdf
Professors Feldstein and Wrobel, Journal of Public Economics, 1998
http://ideas.repec.org/p/nbr/nberwo/4785.html
Professors Ross and Dunn, Contemporary Economic Policy, 2008
http://econpapers.repec.org/article/blacoecpo/v_3A25_3Ay_3A2007_3Ai_3A4_3Ap_
3A639-648.htm
Professor Feldstein, “The Effects of Taxes on Efficiency and Growth.” Tax Notes,
2006. May 8, 2006.