Don’t Raise the Corporate Tax Rate

Democrats have spent the last three years complaining about “excessive” corporate profits. The Biden administration aims to remedy this situation by increasing the corporate tax rate from 21 percent to 28 percent, with the added revenue funding the president’s $2 trillion infrastructure plan. The plan’s top-down approach suffers from serious weaknesses, not least of which is that industrial policy of this kind often doesn’t deliver good results. But even if Biden’s main goal were simply to raise revenue—a reasonable aim, considering America’s rising mountain of debt—increasing the corporate tax rate is the wrong way to go about it.

In 2017, the Trump administration and Congress lowered the corporate tax rate from 35 percent to 21 percent, chiefly because the U.S. charged higher rates than most other countries, putting it at a competitive disadvantage. Unlike personal income, corporate income is easy to move overseas to jurisdictions with lower taxes. The OECD average corporate tax rate is just 23.5 percent; in the United Kingdom, it’s 19 percent, and in Ireland, a mere 12.5 percent. After the U.S. enacted the reduction, there was, as expected, significant repatriation of profits. Biden’s plans include provisions to reduce the incentive to move profits abroad, but the details of how this would work remain fuzzy. It’s extremely difficult to keep companies from moving profits abroad, which is likely why the administration is now demanding a global minimum corporate tax.

The 2017 corporate-rate cut wasn’t just aimed at enticing corporations to move profits back to the United States; it was also supposed to offer other benefits, such as higher economic growth. It has become a pervasive narrative that the tax cut didn’t work because it benefited only rich corporations and failed to boost innovation. But this argument is hard to square with the fact that, following the tax cut, wages—even at the bottom of the income distribution—grew faster than they had in a decade. The tax cut doesn’t get all the credit, since the labor market was already improving, but research indicates that workers partly bear the burden of higher corporate tax rates in the form of lower wages. We should remember, too, that half of all Americans own stocks, so any reduction in corporate earnings hurts them directly.

The argument that the corporate tax reduction didn’t boost investment is also not the slam-dunk case that its proponents believe. Fixed non-residential investment rose after the passage of the tax cut. These numbers were already trending up, so it’s again hard to tease out the exact effect of the tax cut. And the new tax rate was in place for only a few years before the pandemic hit; investment decisions often take place over a longer time horizon.

What we can be sure about, however, is that from now on, investors will be making decisions under a cloud of uncertainty. They’ll have to wonder now whether the tax rate, and thus the return on any investment, will change whenever a new president takes office.

Fans of higher corporate taxes claim that big corporations don’t pay enough—and in some cases pay nothing at all. But this is mostly because the tax system is too complex. Consider the hundreds of potential deductions and loopholes that many corporations (legally) exploit to lower their tax bills. Increasing the corporate rate just adds another distortion to the system, as it makes it more expensive to incorporate. If the Biden administration truly wants to increase revenue and make corporations pay more, it should simplify the maze of deductions, while keeping the rate low.

Photo by Alex Wong/Getty Images

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Biden Downplaying Risks of Massive Spending

A few weeks ago, the federal government enacted a $1.9 trillion stimulus bill, and another $3 trillion bill is already in the works. These once-unthinkable spending levels exceed what was spent on World War II. Yet the Biden administration’s new mantra is that the real risk lies in spending too little, citing a revisionist history of the 2008-09 recession that argues that the recovery dragged on because the stimulus was too small and too short. This position ignores the data, along with several risks: higher inflation, of course, but also destabilized financial markets and reduced growth.

The economics profession is divided on how effective fiscal policy can be in generating growth. Some consensus exists that well-targeted spending can be helpful in the right circumstances—and certainly many Americans and small businesses have suffered from the pandemic and need relief. But these bills are not well targeted to help them. Even the infrastructure bill, which in theory could grow the economy with smart investments, appears to be driven by politics, not economics. Nor is it clear why spending of this magnitude is needed, or how it will be paid for (save for tax hikes on high earners and corporations, which won’t put a dent in the debt). This time on the money-go-round also feels different, because many mainstream economists of all political persuasions are nervous. Larry Summers, normally a fan of big spending, worries about inflation or even stagflation.

Inflation is indeed a risk when the government hopes to stimulate an economy already poised to grow on its own. We’re putting money into the pockets of almost every American, from the additional $1,400 checks and the new child tax credit to potentially massive government projects. Meantime, many households saved their money last year and have considerable pent-up demand. The result could be lots of spending without a meaningful increase in output, resulting in inflation. Some economists also believe that the presence of large unfunded debt is enough to increase inflation.

Though runaway inflation may be unlikely, higher inflation remains a risk. Even at more moderate levels, inflation, when less predictable, imposes costs. The stability of inflation provides as much value as does its level. Predictable inflation helps people plan, invest, make contracts, and live on retirement income. Some members of the Biden administration admit that inflation is a (remote) risk but point out that the Fed can always lower it if it wants to.

That raises the question: who will buy all this new debt? Over the past year, the Fed was the biggest buyer, absorbing more than half of new government debt. If the Fed needs to start clamping down on inflation, it will have to start selling bonds instead of buying them, and it will be doing so in a market already awash with U.S. Treasury bonds. The risk here is that the Fed won’t be able to rein in inflation with small interest-rate hikes and won’t have the political will to cause a recession with a big hike. If inflation isn’t controlled, the Fed’s credibility could be undermined, giving it less space to run the economy hot in the future when it wants to.

The bigger risk may be the turmoil in bond markets that all this big spending could trigger. The odds are that most of the borrowing for these bills will be short-term debt. Without the Fed buying bonds, there is a risk of dislocations in the fixed-income market, causing higher and more unpredictable interest rates. If rates continue to rise, debt payments will become an even larger part of the federal budget and potentially require cutting spending—or, more likely, sharp tax increases. High interest rates will also crowd out other forms of investment in the private sector and depress stock prices, causing a rude awakening for retirement savers, who have become accustomed to watching their portfolio values continually rise.

Potentially even more worrying than interest-rate levels are their volatility and unpredictability. In the past, unforeseen spikes in bond yields have resulted in financial crises that destroyed growth. Bond prices touch everything, from asset valuations to how much investors are charged for credit. This is not a market you want to take chances with.

It’s possible that everything will work out. A likely economic boom this year will paper over many fiscal sins. And if we see a big productivity boost from the new technology we’ve been adopting, the U.S. could get enough real growth over the next few years to outrun all these risks. Still, it is a big gamble.

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The Pandemic Has Undermined Our Sense of Risk

We all have different tolerances for risk, and the pandemic has thrust these differences to center stage. Because the choices we make based on our personal risk profiles inevitably affect others, shaming and judgement have been prevalent.

I witnessed this firsthand at my weekly bridge game. My bridge partner, in her early forties and fully vaccinated, insisted that we play outside, in cold, damp weather. My opponent, in his sixties and also vaccinated, asked why we should suffer. She explained that the evidence was not yet established that indoor activities with vaccinated people were safe. The discussion got heated, and my friend later asked me if she was being unreasonable. I shrugged and said that we all have to do what makes us comfortable, but the evidence is encouraging that vaccinated people not only can’t transmit the virus but also face essentially no risk of severe illness. She nodded—and said that she’d play bridge inside when there was definitive evidence that it was completely safe. Such evidence may never come. Science is rarely that definitive.

The episode made me realize how the pandemic has undermined our sense of risk. No doubt the government made many mistakes during the pandemic. Some blame all 500,000 American deaths on Donald Trump, but countries fared differently in part due to luck, geography, and population.

In one area, however, we clearly have failed: how media and public-health authorities choose to communicate risk. At every turn, we have asked people to make sense of misleading and incomplete information and instructed them, variously, either to avoid all risks or to dismiss them altogether. Despite the good news of not one, but several, miraculous vaccines coming online, we are communicating the nature of risk so poorly that it is threatening the credibility of our public-health institutions, which will leave us more vulnerable to future health crises.

It has become conventional wisdom that individuals are terrible at managing risk. Countless books and studies prove that human beings are burdened by behavioral biases that cause them to overestimate some risks, underestimate others, and make decisions not in their best interests or that are harmful to others. Awareness of these biases has given rise to policies that aim to “nudge” us to make better decisions. (The British government even created a nudge unit.)

These nudging policies can sometimes induce better behavior. For example, automatically enrolling people in workplace pension accounts increases savings rates because it removes the hassle of signing up and picking investments yourself. But nudges also have limitations and can even backfire. Some evidence suggests, for instance, that workplace pension auto-enrollment can also lead to lower savings rates, either because the default rate is too low or because it is so high that people opt out altogether.

Perhaps most damaging, however, has been the idea arising in the last few years that people simply can’t be trusted to make sensible risk assessments—that they must be guided or even manipulated into making smarter choices. The idea that we need to be “tricked” into good behavior was pervasive throughout the pandemic. First, we were told masks weren’t effective, in what turned out to be an attempt to protect supplies for health-care workers. Last spring, we were told that coming into contact with others in just about any environment was unsafe, despite data showing the risk of outdoor transmission was very low. Over the holidays, rather than telling people that they should reduce their risks at holiday gatherings by taking steps like getting a test beforehand, public-health officials said that we should all just stay home, because tests can’t guarantee safety. Even today, the FDA refuses to approve cheap, at-home rapid tests without a prescription because the government doesn’t trust individuals to assess risks based on good, albeit imperfect, information.

The worst, most consequential failure in risk communication concerns the current vaccine rollout. The media constantly instruct us that, even weeks after receiving the second shot, it’s still not safe to socialize without masks. President Biden and Anthony Fauci have warned that we may not be able to resume “normal” life for another year. Fauci recently counseled against vaccinated people eating in indoor restaurants or playing mahjong together. Public-health officials today gave the green light for vaccinated people to gather together—but only after weeks of confusing and contradictory guidance.

We can’t go on like this forever, much less for another year. At a certain point, we have to learn to live with low-grade Covid risk. Indeed, we should have been doing so the whole time. Research from psychologists such as Gerd Gigerenzer suggests that people are good at weighing risks against rewards; we tend to make mistakes only when the data are presented in a confusing way or when it seems untrustworthy. Unfortunately, the media and public-health authorities have repeatedly failed on both counts.

The failures in risk communication about the vaccines may have serious consequences for public health. To many people, getting injected with a new vaccine feels like a risk. We should be communicating to people that the risk is worth it. Evidence shows that the various vaccines on offer nearly eliminate the risk of severe disease, hospitalization, death, and even transmission, yet public-health authorities have effectively been downplaying these benefits by telling people that they shouldn’t change their behavior even after getting vaccinated. If we aren’t upfront about both costs and benefits, how can we expect people to make sensible risk choices?

So far, demand for the vaccine is outpacing supply. But there’s a growing concern that, as supply catches up, fewer people will take it because of all the mixed messaging from public-health authorities.

The authorities should know better. The CDC’s own website addresses the importance of communicating risks and uncertainties in a clear and honest way. We need to move beyond the idea that we are all flawed risk-takers who need constant nudging and manipulation by our betters.

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