Direction of Tax Relief

Back in January, I wrote that the departure of Council of Economic Advisers Chairman Glenn Hubbard from the White House reduced the chances of getting a good tax bill this year. Unfortunately, my prediction is coming true.

Hubbard was the key person who convinced President Bush that elimination of the double taxation of corporate profits should be the centerpiece of his tax proposal. Hubbard is probably the leading expert on the subject in the United States among economists, and author of a definitive study on the subject that was published by the Treasury Department in 1992.

Hubbard’s reasoning is impeccable. Double taxation of corporate profits raises the cost of capital, reduces investment, slows growth and costs jobs. That is why almost every other major country offers some provision for redressing double taxation, according to a Cato Institute study.

Interestingly, one reason for Japan’s amazing postwar growth is that it adopted much lighter taxes on businesses at the behest of the U.S. In a 1949 report to General Douglas MacArthur, a group of American economists led by Carl Shoup recommended that Japan avoid double taxing corporate profits. Their analysis is still valid today:

"The corporation has always exerted a certain fatal fascination for the legislator looking for a source of additional revenue. Corporations are impersonal entities, often without the ability to voice as strong a political protest as other groups of taxpayers???. Thus it is that???heavy taxes are imposed on the corporation with hardly any semblance of economic justification or logic, merely because such taxes are found politically popular, easy to administer, and productive of substantial revenues???.

"Fundamentally, however, a corporation is but a particular kind of aggregation of individuals, formed for the purpose of carrying on a given business. Provided that the corporation does not become unduly large, and that it conducts itself with proper attention to the rules laid down by law, there is no reason, in principle, either to encourage individuals to use the corporate form or to deter them from using it. Ordinarily, therefore, it is not proper to impose a substantially heavier tax on business done in the corporate form than on business done through an unincorporated enterprise, or vice versa. Any such differential will, in fact, tend to impair the efficiency with which the economy is operated by inducing a movement away from that form or organization which is most efficient in production towards that form of organization that is given the lighter tax burden."

Fortunately for the Japanese, they followed this advice and implemented a tax reform based on the Shoup recommendations. Unfortunately for the United States, we never implemented anything similar. Although previous presidents, including Democrats like Jimmy Carter, talked about reducing double taxation, only George W. Bush actually made a serious effort to do so.

Still, it is important to keep in mind that reducing or eliminating the double taxation of corporate profits is only a means to an end, not an end in itself. The goal is to raise growth and incomes, and President Bush’s plan is just one way of doing so. House Ways and Means Committee Chairman Bill Thomas, Republican of California, also has a good proposal that would cut the top tax rate on dividends and capital gains to 15 percent. Economist Kevin Hassett of the American Enterprise Institute has calculated that the Thomas plan would reduce the cost of capital by as much as the Bush plan, and thus have a similar impact on growth.

Unfortunately, the Bush Administration still seems wedded to full elimination of double taxation, even though it costs more than the congressional budget resolution allows. To get even a semblance of the Bush plan will require economically unsound compromises such as phasing it in over a period of years, sunsetting the legislation after a short time, or capping the benefits at $500 per taxpayer, as the Senate Finance Committee has proposed. These measures would be far inferior to the Thomas plan, which has a much better chance of passage than the original Bush plan.

If Glenn Hubbard were still in the White House, I have no doubt that President Bush would understand that pride of authorship is unimportant; passing legislation that will boost growth by cutting the cost of capital-however it is done-should be the legislative goal. Unfortunately, his successor, economist Greg Mankiw, is still unconfirmed by the Senate, and thus in a weaker position to exercise influence. In fact, the whole Council of Economics Advisers has been physically banished from the White House.

All presidential initiatives necessarily require compromise to attain congressional passage. At the end of the day, it is important that administrations clearly understand what they are really trying to accomplish. Sometimes the same goal can be attained in different ways than the administration proposed. Presidents should not be afraid to follow a different path if it gets them to the same destination.