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IntelDigest
LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR
APRIL 5 , 2017
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We continue our discourse on Tax Reform in this issue of IntelDigest. Please feel free to look back at the March 22 and March 29 issues, where we set out important proposals which have been put forth by the Speaker of the House, and began the discussion of the importance of Tax Reform at this point in our history.
There are a number of concerns in our economy and our system of taxation which require serious action by our leaders. Most of these concerns should have been addressed in the past by many of those same leaders and their predecessors.
Debt
As we have pointed out in several issues of IntelDigest, our National Debt is now approaching 20 Trillion Dollars, and unceasing Deficit Spending adds to the Debt every year. Growing the economy out of this predicament would require sustained growth of at least 3% per year going forward, and the best way to do that is through real, serious Tax Reform.
Debt can actually be beneficial, if it is used to purchase productive assets which contribute to growth. Unfortunately, governments incur Debt much too often for use in current consumption, not for productive assets such as infrastructure.
We are deep into the third-longest “recovery” since World War II, and we are averaging over a full point of GDP growth less than in previous recoveries … primarily because of the size of the Debt. If the economy should fall into recession, it would truly blow out the budget, deficits, and debt, and suck us into a downward spiral that would leave us with no good choices.
Government Spending
Spending by governments in the United States … federal, state, local … now amounts to 35% of the Economy. At the current rate of growth of budgets at all levels, the figure will be over 40% in the near future.
Cutting government spending … something which has not been done in generations … would be a start. But, cutting spending alone would do little to reduce the National Debt.
Taxation of Productive Business
Every private Dollar which goes to paying taxes and supporting the government is a Dollar that cannot be invested in new businesses or creating new jobs. On the other hand, greater tax-saving by Americans who are capable of re-injecting those savings into U.S. businesses is a boost to the U.S. Economy.
Empirical research has shown that as capital increases in a country, so does entrepreneurial capacity. As that capital is taxed more heavily, entrepreneurial activity fades. Successful economies allow entrepreneurs to keep more of their earnings, so they can put them back to work in growing business.
Corporation Taxation
The United States has the highest corporate income tax rate in the world. That heavy corporate tax burden puts us at a serious disadvantage; as a result, more American corporations move operations or headquarters overseas every year.
The irony is that the corporate tax is only 11% of the total revenue of the United States. If all loopholes were eliminated and the rate was reduced to 15-20%, the federal government wouldn’t lose all that much revenue. Corporate pre-tax profits are roughly 1.5 Trillion Dollars. Lowering the current tax rate, or adopting a 15-20% flat tax, would replace most of the tax revenue currently collected. More importantly, the United States would become very tax-competitive internationally, attracting more multinational companies to headquarter here.
In other ways, the U.S. tax system is Short-Sighted. Key provisions of our tax code focus taxpayers on short-term goals. We need more long-term thinking in order to grow our economy out of the current predicament.
Tax System Encourages Debt
The current tax regime favors debt over equity. Companies are allowed to expense the total amount they spend on Interest. This is a significant incentive to use the Wall Street investment banks to borrow as much money as possible. It reduces the cost of capital.
Most Americans have no idea how big or dangerous the corporate-debt bubble has become. As of the second quarter of 2016, investment-grade corporations were spending $119 billion annually on Interest expenses, the most since 2000, just before the Tech Bust of 2001. However, interest rates are much, much lower today. So, the debt balances are vastly higher.
U.S. corporate debt has soared from less than $3 trillion to almost $7 trillion in just the last decade. And, a higher percentage of this debt is rated as “junk.”
Thus, American companies are now more exposed to either rising default rates or rising interest rates than they’ve ever been before.
This situation has been great for Wall Street … not so good for America.
Tax System Requires Depreciation of Assets
The U.S. tax system requires that most capital investments be depreciated over years, rather than expensed in the year of purchase.
Some items … such as computers and software … are eligible to be fully expensed in the year of purchase. However, longer-term corporate investments can only be depreciated over many years. Inflation decreases the real value of these deductions, providing companies with an incentive to avoid making big, long-term investments.
Allowing companies to reflect their actual expenses (including all investments) in the year they are incurred would provide American corporations with a major business incentive, which would be vital to economic growth over the long term.
This would be the best chance to increase productivity in the U.S. It is important that American companies make far more and far larger long-term investments in American productive capacity. Our tax policy should make this easier to achieve.
Tax System Encourages Offshoring
The current trade and tax regime makes it logical for American companies to store as much value as possible overseas, and only import what they plan to sell in the U.S.
Why does every important American software maker (including Apple and Microsoft) have its international headquarters in Ireland? By keeping their core intellectual property in Ireland, these companies can pay far, far less in taxes. Meanwhile, they can import that intellectual property back into the U.S. (after manufacturing in China) for free. This allows them to pay a tiny fraction of the taxes they would otherwise have to pay. So, a great deal of their employment and capital is kept outside the U.S. (Microsoft, for example, just spent $250 million building a new campus in Ireland.)
Change the Tax System!
Lower wages don’t drive U.S. companies to manufacture overseas. The difference in wage rates is almost irrelevant when the costs of setting up infrastructure, supply chains, and transportation costs are factored in.
The reason that most U.S. companies set up manufacturing and research and development overseas is to avoid high U.S. taxes and regulation.
Changing just these last three components of the U.S. tax code could be done on a revenue-neutral, zero-cost basis. These three changes alone would drive U.S. gross domestic product growth from around 1% to well over 3.5% … a level which we have not achieved in more than eight years.
This is why Tax Reform is so important at this point in American history. We need accelerated entrepreneurial activity to expand the economy and create more jobs.
We can achieve significant Tax Reform and move into a new era of growth (with attendant Inflation) … or … we slide back into a depression caused by a mountain of corporate and government debt.