How fiscally prudent is "lower the rate and broaden the base"?

Race to the bottom

There are several tricky aspects to the argument that rates should be lowered to eliminate any competitive disadvantage the U.S. faces in relation to other advanced economies. For one, as a 2011 Citizens for Tax Justice report points out, “U.S. corporations pay a smaller percentage of their profits in taxes than do corporations based in other developed nations.” For another, a second 2011 CTJ report noted, the U.S. in 2009 collected less in corporate taxes as a share of GDP “than all but one of the 26 OECD countries for which data are available.”

More fundamentally, the U.S. does not operate in a static international environment; countries do respond to one another. In fact, as depicted in a table in a 2008 Tax Foundation report, it was the U.S. that led the path in the mid-1980s to lower statutory corporate tax rates; it was the other member nations of the OECD (including the subset of larger nations that make up the G-7) that followed.

Why then, might not European or other competitor nations respond to another U.S. rate reduction by lowering their own rates again, in the manner of states here in the U.S. that compete with one another to offer corporations the largest tax breaks and incentives?

This was among the questions I put to a Treasury Department spokesperson who, nominally, was prepared to speak on background. But, even on background, the spokesperson refused to be responsive, declining to speak to potential future developments.

I also sought to get Senator Ron Wyden (D-Ore.) to answer the question of whether the “lower the rate” element might set off a rate-lowering arms race. Wyden has sponsored a broad tax reform bill that, on the corporate side, would lower the statutory rate from 35 percent to 24 percent and broaden the base by eliminating many loopholes and what Wyden describes as “corporate welfare.” Wyden’s office did not respond.

Kessler of Third Way, who supports the rate-lowering, base-broadening approach, agreed that the question of race to the bottom raises a “very legitimate” issue, and said, “I can’t guarantee you that that won’t happen.” McIntyre went much further. “If we cut our corporate rate,” he said, the other countries will reluctantly — but they’ll feel pressure to do it — lower theirs as well.  That’s what happened after [the 1986 Tax Reform Act].”

Some of those I spoke with cited factors that might militate against reactive rate cuts by others. Kessler said that European countries would be hard-pressed to lower rates when they so desperately needed revenue, and Baker pointed out that a reform that was revenue-neutral (that is, one that did not reduce the effective rate) would be understood as one that retained in many ways the relative positions between and among countries, and thus was not a change that would logically cause other nations to respond.

Baker did say that, as a political or rhetorical matter, businesses in those countries would be likely to try to use a U.S. rate cut to argue for rate reductions that they would like to see in any event. And he cautioned against over-reliance on the idea that business location decisions are motivated solely or principally by tax rate: rate is “far from the only factor and can easily be outweighed by [other factors like] the quality of the work force, the quality of the infrastructure, and being close to other businesses.” he said.

The idea that tax rate is determinative in causing companies not to locate or expand in the U.S. is a myth, Baker added. That debunking, he asserted, is readily available from “business people who are being honest.”

Multiple questions as to “neutrality”

One question about the combined approach is whether it would, in fact, be enacted as revenue-neutral. Eugene Steuerle of the Urban Institute observed that “a deficit-neutral reform of the corporate code is very difficult, because — if it’s really deficit-neutral — you’re going to create a lot of losers out there, and they’re going to scream bloody murder, which is why that debate hasn’t even proceeded very far.”

But another issue is what happens down the road.

Things could work out as proponents hope, but what if they did not? “It wouldn’t be the first time that the Congress passes changes to the tax code that [turned out] not beneficial to the U.S. economy,” Kessler acknowledged. “I would say that the Bush tax cuts were a horrible mistake for the economy. It didn’t get the revenue that the supporters said it was going to get and arguably it helped create a bubble.”