Capital Formation Newsletter
January - February, 2006, Vol. 31, N0. 1

Noted Washington Post Columnist David Broder Speaks at ACCF Forum

International Comparison of Individual Long-Term Capital Gains Rates

ACCF in the News... Investor’s Business Daily

Déjà-vu on Windfall Profits Tax on Oil Industry

ACCF Hosts 140th Economic Policy Evening

(PDF Version)

Noted Washington Post Columnist David Broder Speaks at ACCF Forum

The war in Iraq casts a huge shadow on the U.S. economy, the presidency, and the shape of the country,” David S. Broder, national political correspondent and political columnist for the Washington Post, told ACCF members at the kick-off session of the 2006 Capital Formation Forums on February 15. “At the Post we do ‘shoe leather reporting’ with real people,” Mr. Broder said, adding that his recent conversations with people in Columbus, Ohio, had helped form his perspective on where the U.S. is now politically. When asked how they think the country is doing, respondents’ views were colored by what’s happening in Iraq. Service people in Iraq tend to be more optimistic about the war, but it’s hard to find a member of the press corps covering the war who shares that optimism. In addition, some experts question if the Iraqis can create a nation, since their loyalties lie with their tribes, he said. Of course, Iraq is not the only global hot spot; other problem areas around the world include Iran, Palestine, andNorth Korea.“The world is a dangerous place and the cost of addressing these challenges is driving the U.S. budget,”

David S. Broder speaks at the ACCF’s February 15 Capital Formation Forum.

“The steady drumbeat of news out of Iraq is sapping the confidence of the country,” Mr. Broder said. But for the fact that the U.S. economy is doing extremely well, the outlook for the GOP might seem dim. “If we could find our way forward to progress in Iraq,” other important issues on the U.S. agenda such as the lingering fallout from Katrina would be less daunting.

Recounting his conversation with a governor of one of the Western states about the impact of the Iraqi war on the U.S., Mr. Broder said, “Every death in Iraq tears a hole in the community. Its impact is shaping the political moment we are in and, because of that, 2006 will be a difficult year for the GOP.” Although the President has put forward some important new proposals on science and technology that might get bipartisan support, other GOP initiatives will be harder to achieve. However, he added, thus far the Democrats have been inept at shaping their own strategy.

Will Congress Allow the U.S. to Lose Its Global Competitive Edge by Raising Taxes on Capital Gains?

Congress has a choice to make – extend the current 15% tax rates on capital gains and dividends or allow them to expire at the end of 2008. Does it matter? Yes, because the 2003 tax cuts on capital gains and dividends, by reducing the taxation of saving and investment, have been a boon to the U.S. economy.

A low capital gains tax rate has an important role to play in fostering economic growth. Since the historic reduction in capital gains taxes initiated in 1978 by the late Congressman Bill Steiger, lowering taxes on capital gains has been a crucial element in promoting the entrepreneurial drive on which the U.S. economy thrives.

Entrepreneurs are a major force for technological breakthroughs, new start-up companies, and the creation of high paying jobs. Many today believe that the ’78 cut in capital gains tax rates not only helped make Silicon Valley the center of technological breakthroughs but has also had a strong, positive, and lasting impact on overall investment, economic growth and job creation in the U.S.

How does the U.S., with its 15% capital gains tax rate, stack up against other increasingly competitive global economies? The U.S. stands in the middle of the pack of the 30 member countries of the Organization for Economic Cooperation and Development (OECD). In fact, 14 OECD countries have no tax at all on capital gains. Failing to extend the current 15% rate on U.S. capital gains risks slowing this country’s investment, impairing our competitiveness, and damaging U.S. economic growth and job creation.

Individual Long-Term Capital Gains Tax Rates 2005-2006

* The rates are based on long-term capital gains tax rates applicable to gains on sales of shares.
Source: Individual Taxes 2004-2005, Worldwide Summaries (PricewaterhouseCoopers), European
Tax Handbook 2005 (International Bureau of Fiscal Documentation) and various government web
sites.

Tax Threats

From Investors Business Daily, February 24, 2006

Global Economy: The U.S. tax code is so complex and burdensome that even H&R Block blundered in its filings for the last three years. More important, it’s imperiling our competitiveness in the world.

The company that prepares the returns of millions of American taxpayers just reported tillion in back taxes after miscalculating its state effective tax rate. The firm’s shares were down significantly after the news.

This raises an obvious question: If H&R Block can’t handle our monstrous tax code in preparing its own returns, how can companies who aren’t in the tax business?

Complexity in and of itself carries a hazardous price tag. “With globalization and the increasing importance of international capital flows, the distortions and complexity generated by the current U.S. system are increasingly costly to the U.S. economy,” said the Economic Report of the President published earlier this month.

In particular, the report cited the tax treatment of foreign-source income for multinational companies, one of the most complex facets of the U.S. tax code. “This complexity itself imposes a burden on these companies, causing them to allocate substantial resources to tax planning and compliance,” the report noted.

As if being complicated and impossible to understand wasn’t enough, there are our comparatively high rates to contend with. According to the report, “most countries making changes in their tax systems since 1999 have lowered personal and corporate income tax rates.”

Yet Congress is lollygagging at making President Bush’s tax rate cuts permanent. Inaction will have especially negative consequences in regard to capital gains and dividends. “Not extending the capital gains and dividend tax cuts will put the United States in the fiercely competitive global economy with one hand tied behind its back,” according to Mark Bloomfield, president of the American Council for Capital Formation.

The ACCF found that among countries in the Organization for Economic Cooperation and Development (OECD), the U.S. now has the ninthhighest rate of taxation for individual and corporate dividends, at about 51%. But if the tax cut on dividends is allowed to expire, the U.S. shoots up to a combined tax rate of about 58% —third highest, behind only Japan and Denmark (see chart). What’s more, our high corporate income-tax rate is itself a competitive disadvantage. “The United States has a combined (federal and state) marginal corporate income tax rate of 39%,” the president’s report found, “well above the OECD average of 30%, and second- highest to that of Japan.” And our competitors are taking advantage: “The OECD average corporate income tax rate fell from 33.6% in 2000 to 30.8% in 2003,” according to the report. In today's global economy, capital is more mobile than ever and businesses no longer just have to sit and accept tax increases. As the Economic Report points out: “It is increasingly easy for companies to move their productive activities, including physical capital, export/import operations, research and development activities, and other forms of knowledge creation, around the world in response to tax incentives.” The message for Washington politicians: The jobs will go where the taxes are low.

Déjà-vu on Windfall Profits Tax on Oil Industry

By Dr. Margo Thorning, ACCF Senior Vice President and Chief Economist

Outraged over current oil prices (crude oil is averaging $60 per barrel and retail gasoline $2.38 per gallon), some members of Congress want to impose windfall profits taxes on U.S. oil producers. Many policymakers seem to have forgotten that hurricanes Katrina and Rita are still impacting U.S. energy output in the Gulf Coast region and full production may not be restored for months.

It’s natural to feel frustrated by the sharp rise in energy prices faced by U.S. households and industry, but will “punishing” the oil industry with higher taxes do anything to make prices fall? Most experts believe that is not likely, for the following reasons.

First, U.S. oil producing firms are “price takers,” not “price makers” in a global market. They are not members of the price-fixing body, OPEC, whose oil production decisions are made, at least in part, collectively, and heavily influence the world market supply. The price of a barrel of oil, like most commodities, is set on the international markets by traders making sales between willing buyers and willing sellers.

Second, the United States tried a windfall profits tax (WPT) from 1980 to 1988; a report by the non-partisan Congressional Research Service concluded that the WPT reduced domestic oil production by 3 to 6 percent and increased oil imports in the range of 8 to 16 percent over the 1980-86 period. Hence, history has shown that a windfall profits tax increased U.S. dependence on foreign oil and would do so again if repeated.

Third, U.S. Department of Energy (DOE) data from 1986 to 2003 show that capital expenditures by the oil industry tend to strongly correlate with the price of crude oil.

In 2003, the trend in oil prices and capital expenditures diverged and DOE’s Financial Reporting System suggests that the harsh and unreliable investment climate in 2003 in countries like Indonesia, Venezuela, and Libya caused a cutback in capital expenditures by US oil firms for that year. In fact, Indonesia, which may well have 7 or more billion barrels of oil yet to be discovered (or enough oil to fuel all of the US’s transport needs for about 16 months) has “an investment climate that has been described as one of world's worst” according to DOE.

Rising oil prices encourage companies to invest more in finding new reserves and to increase production from existing fields. Increasing taxes on oil company revenues will only reduce the desire and ability of firms to find and produce more oil. One of the axioms of public finance scholars is that if you tax something, you get less of it.

Hence, a windfall profits tax, by reducing capital available for investment in future energy production, will mean lower future energy production and hence lower government revenues into the foreseeable future.

Reinstituting the windfall profits tax on oil companies, changing the LIFO (last in-first out) inventory rules or limiting the foreign tax credit that companies can use to reduce the double taxation of foreign source earnings will only reduce the amount of money companies can plow back into finding more oil and reduce the return to shareholders. U.S. public and private pension funds hold approximately $267 billion in oil company stocks (or about 41 percent of the market value of these stocks).

According to a new report by former Clinton official Robert J. Shapiro, U.S. workers contributing to these pension funds and current retirees would bear 41 percent of the shareholders’ costs of a WPT.

A more useful approach for bringing down high energy prices would consist of several steps. Make more locations (both offshore and onshore) available for domestic exploration and development to help increase supply. Revise the U.S. federal tax code to increase the speed of capital cost recovery for new investment. Reduce the corporate tax rate to give companies more funds for capital expenditures. Fund the provisions in the 2005 Energy Policy Act aimed at increasing energy supplies, encouraging conservation, and promoting renewable energy sources.

Finally, work with developing and emerging economies to promote economic freedom, the rule of law, and the sanctity of contracts. In the long run, these steps would gradually enhance energy supplies, reduce demand for energy, and relieve the global pressure on energy prices.

ACCF in the Heartland
February 2006

“Déjà-vu on Windfall Profits Tax on Oil Industry,” an op-ed by Dr. Margo Thorning, ACCF senior vice
president and chief economst, appeared in many regional newspapers.
See the excerpts from the op-ed below.

ACCF Hosts 140th Economic Policy Evening

On February 7, the American Council for Capital Formation held its 140th ACCF Economic Policy Evening. The evening’s discussion focused on The Economic Challenges for the President and Congress in 2006. Guests included key economic policymakers from Congress and the Bush Administration, top journalists and private sector leaders. For more information on ACCF Economic Policy Evenings, see www.accf.org. Pictured left to right: 1) ACCF president and CEO Mark Bloomfield presents Senator Jim DeMint (R-SC) with a copy of the ACCF’s book, The Consumption Tax: A Better Alternative?; 2) Stephen Moore, senior economics writer, Editorial Page, The Wall Street Journal, and Gov. John Engler, president, National Association of Manufacturers; 3) Dr. Adrian Wooldridge, Washington bureau chief, The Economist, and Sebastian Mallaby, columnist and member of the Editorial Board, Washington Post; 4) Representatives Artur Davis (D-AL), Joseph Crowley (D-NY), Frank D. Lucas (R-OK), and Mr. Bloomfield; 5) Dr. Matthew J. Slaughter, member, President Bush’s Council of Economic Advisers, and Representative Michael C. Burgess, M.D., (R-TX); and 6) Dr. Margo Thorning, ACCF senior vice president and chief economist, Herschel L. Abbott, Jr., vice president, Government Affairs, BellSouth Corporation, and John S. Grace, co-chairman, Associated Asset Management, Inc., and chairman, Sterling Grace Corporation.