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Tax Policy and Economic Growth

A monograph published April 1995 by the ACCF Center for Policy Research.
ISBN: 1884032036

Introduction

As the 104th Congress, the administration, and other policymakers consider changes in federal fiscal policy, the American Council for Capital Formation Center for Policy Research presents new studies by prestigious public finance scholars on three topics sure to be at the forefront of the tax policy debate: (1) strategies for increasing the personal saving rate, (2) the incidence of the corporate income tax versus a consumption tax in an open economy, and (3) the impact of U.S. international tax rules on the competitiveness of American multinationals.

These studies were presented June 8, 1994, at a symposium sponsored by the ACCF Center for Policy Research. This book, a product of the conference, contains papers and commentaries by top public finance scholars and experts from Capitol Hill, the administration, and the business community. It is the eleventh volume published as a part of the ACCF Center for Policy Research multi-year project, "Tax, Regulatory, and Environmental Policies and U.S. Economic Growth."

Low rates of saving in the United States have perplexed economists and challenged policymakers for more than a decade. Despite widespread agreement that Americans are not saving enough, both individually to provide for their retirement as well as a society to provide the foundation for U.S. economic growth, there is little consensus concerning the appropriate policy response. Stanford Professor B. Douglas Bernheim, named by the ACCF Center for Policy Research as the TCW Fellow for 1994, prepared a research paper entitled, "Do Households Appreciate Their Financial Vulnerabilities? An Analysis of Actions, Perceptions, and Public Policy," which provides evidence on the probable effects of different information policies.

Using new survey data collected by Luntz Weber Research and Strategy Services for Merrill Lynch, Inc., Professor Bernheim concludes that while respondents indicate some awareness of relative financial vulnerabilities, they also exhibit an unrealistic degree of optimism. The survey results show that individuals' saving behavior responds to vague and unquantified senses of security and urgency, rather than to measured perception of financial needs. For example, the largest group of upcoming retirees, the baby boomers, is saving at one-third the rate required to finance a standard of living during their retirement comparable to the standard of living that they enjoy before retirement. However, the government policy of mailing Social Security benefit statements, scheduled to begin for older adults in 1995 and then continue later to younger workers, might actually depress personal saving, because virtually all saving among the baby boom generation is undertaken by those who have little or no confidence in the Social Security system. In addition, the government has, as yet, taken no steps to actively encourage saving through a promotional campaign (analogous to its efforts to discourage smoking).

Since the government's plan may well prove ineffective for raising personal saving, more ambitious information policies-including a savings promotion campaign and the provision or facilitation of explicit advice and guidance-deserve serious consideration, Professor Bernheim concludes.

As the 1994 John J. Byrne Fellow of the ACCF Center for Policy Research, UCLA Professor Arnold C. Harberger prepared a new study on the incidence of the corporate income tax (CIT) and a value-added tax (VAT) in an open economy, where capital can flow freely across international borders. This work extends Professor Harberger's seminal analysis of the corporate tax incidence, which has served as the foundation for much of the modern research on the incidence of the corporate tax burden. These new findings will be invaluable as the policy debate about the incidence of consumption taxes versus income taxes accelerates in Congress, the press, and the private sector.

Professor Harberger's study concludes that the U.S. corporate income tax causes labor's wage in the United States to fall sharply in order to absorb the tax wedge being inserted into the price structure of that part of the corporate tradables sector where final products are substantially homogenous (for example, steel, electrical wiring, and powdered milk) and whose prices are basically set in the world market. This wage fall is likely to mean that labor will bear 2 to 2 1/2 times the full burden of the U.S. corporation income tax.

If U.S. labor bears a burden equal to 2 to 2 1/2 times the revenue proceeds of the U.S. corporation income tax, it might be attractive to consider a unilateral reduction of the U.S. CIT with the aim in mind of generating a positive impact on U.S. wages, Professor Harberger states. As long as the rest of the world does not follow the United States in its reduction of the CIT, the contemplated benefits to labor will in fact ensue. The truth, however, is that the ultimate incidence effects of, say, a 10 percentage point reduction in the U.S. CIT will not be determined in Washington but in the other major capitals of the world, as they decide whether or not to follow Washington's initiative in reducing this tax, he concludes.

In contrast, if the United States were to implement a VAT, which more than half of the world already has, and simultaneously lower individual and corporate income tax rates by a moderate amount, it seems unlikely that the rest of the world would follow. Such a change has the potential to increase both investment and wages in the United States, Professor Harberger observes.

As multinational corporations play a larger role in the business activities of the global economy, interest in international aspects of capital income taxation has been stimulated as well, Columbia University Professor R. Glenn Hubbard notes in his new study, "U.S. Tax Policy and Foreign Direct Investment: Incentives, Problems, and Reform." In the United States, debate has centered on the competitive position of U.S. firms in international product and capital markets. This concern is accompanied by complaints that U.S. international tax rules have become more complex and more distorting in the past several years, particularly since the passage of the Tax Reform Act of 1986.

Some of the most complex and troublesome issues in the U.S. tax code arise from the corporate alternative minimum tax (AMT), the rules relating to the allocation of expenses related to interest, and research and development allocation rules.

Professor Hubbard's analysis shows that the investment decisions and capital costs of U.S. multinationals are profoundly impacted by the tax laws in both the host country and in the United States. Professor Hubbard modeled the impact of tax parameters on foreign direct investment by U.S. multinationals. He finds that: (1) taxes are very significant in determining investment and (2) firms' investments are sensitive to changes in the tax-adjusted cost of capital. Each percentage-point increase in the cost of capital leads to a 1 to 2 percentage-point decrease in the subsidiary's annual rate of investment. He also finds that the AMT can create an incentive for U.S. firms to invest abroad rather than at home. Finally, he concludes that careful consideration should be given to the substitution of a broad-based consumption tax for domestic capital income taxes.

Keynote addresses were given by the Honorable Roger C. Altman, then-Deputy Secretary of the U.S. Department of the Treasury, and Senator Sam Nunn (D-GA), coauthor of the Nunn/Domenici "Saving-Exempt Income Tax" (SEIT) proposal [now called the Unlimited Saving Allowance tax]. In his remarks, Secretary Altman addressed the linkages between savings, investment, productivity, and real incomes. Discussing the SEIT proposal, Senator Nunn said this tax system would eliminate the bias against savings, increase investment, equalize the tax treatment between exports and imports, make the tax code understandable and efficient, and eliminate the payroll tax.

The ACCF Center for Policy Research is grateful to our presenters and respondents whose contributions made this symposium and book possible. We are also grateful to the underwriters of our 1994 conference series and this book. Through a generous grant, John J. Byrne, prominent business leader and philanthropist, made possible the selection of Professor Harberger as the John J. Byrne Fellow of the ACCF Center for Policy Research. Mr. Byrne is chairman of Fund American Enterprises Holdings, Inc. and a member of the board of directors of the American Council for Capital Formation. Professor Bernheim was named the TCW Fellow for 1994. The TCW Group, Inc., a leading investment management company, provided a major grant to underwrite the Center's project on the study of personal saving.

Additional financial support was provided by the American Business Conference; American Petroleum Institute; Chemical Manufacturers Association; Dean Witter, Discover & Company; Edison Electric Institute; Ernst & Young; Exxon Company, USA; Grocery Manufacturers of America; Hewlett-Packard Co.; Investment Company Institute; J. L. Kirkpatrick Foundation for Pension Actuarial Education and Research; Marisol, Inc.; Merrill Lynch, Pierce, Fenner & Smith Inc.; National Association of Manufacturers; National Association of Securities Dealers, Inc.; National Coal Association; Nestle USA, Inc.; Prudential Securities, Inc.; John and Lolita Renshaw; Securities Industry Association, Inc.; Shell Oil Company; Starr Foundation; Synthetic Organic Chemical Manufacturers Association; Texaco Foundation; Thermo Electron Company; and Weyerhaeuser Company.

Charls E. Walker
Chairman

Mark A. Bloomfield
President

Margo Thorning
Director of Research