WASHINGTON, July 28, 2014 — Over this past weekend, President Obama said American companies that relocate their headquarters to foreign countries in order to pay lower corporate tax rates are unpatriotic. It is like the companies are renouncing their citizenship, he said.
While Obama admits that the solution is to reduce the corporate tax rate, he believes that will take too long. Rather he wants legislation that closes the “loophole”. Is there an easier and better solution that also increases economic growth, creates the perception of fairness and encourages patriotism?
The corporate tax rate, on marginal income, in the US about 40%, which is the highest of any developed country in the world. It is therefore a rational decision for companies to relocate their headquarters to countries with lower corporate tax rates. Locating to Switzerland lowers that rate to 18%. Most European countries have rates less than 22%. For a company that has an annual profit before tax of say $6 billion, changing headquarters results in an increase in net income in excess of $1 billion annually.
We must also consider other factors when changing the tax code to solve this problem. The IRS tax code is so complicated virtually no one has read it and fully understands it. There is also the perception that the IRS is run without any real oversight and appears to be abusing their power without any accountability to US citizens.
There is a very simple solution. That is, change the current progressive federal income tax which has numerous loopholes and special deductions, to a single rate tax which is applied to all income above a livable minimum, with no deductions for anything. All income is treated the same whether it is ordinary income, capital gain or any income received from rent, interest, profit or dividends. The rate is the same for individuals and corporations.
One way to structure this is to set the livable minimum for individuals at twice the poverty rate. That would mean, for a family of four, the first roughly $50,000 of income requires no federal income tax payment. For every dollar above $50,000, the tax rate would be 15% and applied only to the dollars above $50,000. This simplifies the tax filing. An individual simply adds up all of her income from all sources, then subtracts the livable minimum which is based on family size. The remaining number is just multiplied by 15% and that’s the amount of tax liability.
With a 15% tax rate on both individuals and corporations, there would be no incentive for any US companies to relocate outside of the US. Billions in lost tax revenue would return to the US and foreign companies may now be induced to locate their corporate headquarters in the US for exactly the same reason that US companies now leave: the lower tax rate.
This proposal should give the perception of fairness. Higher income earners will pay proportionately more tax dollars than lower income earners, instead of disproportionately more. All of us would be treated exactly the same.
This proposal would add significantly to economic growth, perhaps adding as much as ½% to the average long term growth rate. In the short term, this policy would unleash the American Enterprise machine and we could see growth in excess of 5% for the next year or so. Unemployment would fall dramatically as many new full-time jobs would be created and the labor force participation rate would rise dramatically as adults are drawn to the labor market by new higher paying jobs.
The budget deficit would be reduced. Spending on social programs would fall and tax revenue would increase. Preliminary estimates indicate that this change in tax policy would add about $200 billion to tax revenues every year. In addition the increase in output and increased competition would put downward pressure on prices thereby reducing any potential inflation threat. Literally everyone wins.
Changing the federal income tax code to a single rate tax on all income above a livable minimum would not only bring US companies back to the US and would attract foreign companies to locate here, but it would also increase tax revenue, add significantly to economic growth, reduce unemployment, reduce inflation, virtually eliminate the IRS and create fairness. This seems like a no-brainer.
Webster’s dictionary defines patriotism as “love for or devotion to one’s country.” Wouldn’t every taxpayer feel more love and devotion to this great country with a single rate tax?Click here for reuse options!
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