2008 will come down as the year we experienced a $152 Billion fiscal stimulus to ordinary taxpayers that had little effect in stanching the decline of the economy and capital markets; then we all had to embrace over $1 Trillion (and still climbing) in corporate bailouts by government fiat. Modern Keynesians will tell you that we need to provide massive government spending to create jobs and stimulate the economy, without regard to where the funds will originate from – whether it is from the individual or corporate taxpayer, or selling more U.S. debt, or printing more U.S. currency. What is ironic is that even Keynes never thought this radical implementation of government fiscal stimulus was ever going to be completely effective in resolving an economic decline, in fact he cautioned that excessive government spending would inevitably lead to inflation.

Tax rates affect how and where individuals and corporations invest capital, and how much revenue the government takes in. When the individual long-term capital gains tax rates were cut in 1997 and then again along with the tax rates on qualified dividends in 2003, investors responded by putting more money into assets that had a potential to yield a capital gain or dividend. When those gains were realized and taxed, the U.S. Treasury saw an increase in revenue.

The problem is that corporations did not get the same break, and while the rate cut for individuals had a positive effect for corporations by increasing their stock prices, it also encouraged them to take on more debt, as they did not have the same tax rate incentive as individuals to invest. This point is surprisingly overlooked, but with the demagoguery surrounding corporations and the tax they should pay, the emotion of misguided ideology gets in the way of understanding the cause and effects of tax policy.

Keeping the corporate tax rates on capital gains at the same rate as that for ordinary income (at a top rate of 35%) has forced companies to either not invest at all, or to invest within offshore entities. Both of these have negative effects on economic growth and tax revenue in the U.S. It can be envisioned that if companies were given the same tax incentive as individuals to invest in capital gains producing assets, either at the 15% rate or lower, that we would see a growth in jobs and tax revenue. All without government spending or bailouts. The private sector creates the majority of jobs through business investment, reinvestment, and growth, and it is tax policy of those investments that indirectly affects job growth in a significant way. How significant is something that should be worked out quantitatively, but we have some evidence it is significant from the lower rates in other countries, such as Ireland and the Eastern European countries, where corporate rates range from 10-22%. Companies in those countries are able to sell assets and reinvest the proceeds in their businesses without a huge tax penalty.

In early 2008, the National Association of Manufacturers (NAM) lent strong support for a cut to the corporate capital gains tax rate, citing that it would boost their competitiveness and help stave off recessionary measures [1]. Both political parties have ignored this high-profile endorsement, along with similar support for a tax cut from prominent CEOs. Instead, we are force-fed from the politicos that government bailouts and spending are our only salvation. Listening to the wisdom of the corporations that built this country – heck no! They are not to be trusted, and wherever possible, their gains should be skimmed by the government up front.

While lowering the corporate capital gains tax rates would be straightforward and might even pass in the upcoming political environment of 2009+ if it were positioned the right way, cutting the rates on ordinary corporate income (marginal rates) will be a much harder sell. Yet the same compelling arguments apply: our second highest corporate tax rates have motivated capitalists to forego incorporating within the U.S. and instead choose other overseas venues to plant their businesses. And so we in the U.S. lose out on jobs and economic growth. Some more irony: France complained for years that Ireland’s corporate tax policy was allowing the Irish to unfairly attract international investment. The nerve of the French – but even they now have a lower corporate tax rate than the U.S.

Author’s Note: As this article was going to publication, the new executive administration in Washington announced a possible $300 Billion in tax cuts as part of a new $775+ Billion government spending plan. A cut in the corporate tax rates, including the capital gains rates, was not included. The tax cuts are largely confined to a tax rebate to ordinary taxpayers, similar to the one that occurred in May 2008.

References:

[1] NAM Wants Lower Corporate Capital Gains Tax