March 24, 2023

Today’s Economist: Laura D’Andrea Tyson: Income Inequality and Educational Opportunity


Laura D’Andrea Tyson is a professor at the Haas School of Business at the University of California, Berkeley, and served as chairwoman of the Council of Economic Advisers under President Clinton.

A core American value is that each individual should have the opportunity to realize his or her potential. Birth needn’t dictate destiny. Education has been the traditional American pathway to opportunity and upward mobility, but this pathway is closing for a growing number of Americans in low- and middle-income families.

Today’s Economist

Perspectives from expert contributors.

And the failure to provide all Americans with the educational opportunities to realize their potential not only harms them; it harms the nation.

Educational attainment levels rose rapidly throughout much of the 20th century, with the college completion rate quadrupling for those born between 1915 and 1975. But it has been largely stagnant since.

The slowdown in college attainment levels has been most pronounced for individuals from low-income families. At the same time, the economic benefits of higher education have risen. In 1979, the average college graduate made 38 percent more than the average high school graduate. The comparable figure today is more than 75 percent.

During the last three decades the gap between the educational attainments of children raised in rich and poor families has widened dramatically, and it reveals itself remarkably early in children’s lives.

According to the most recent census report, about one-quarter of children under the age of 6 live in poverty. Recent research shows that early childhood poverty has negative effects on brain development. At the age of 3, children in poverty have smaller vocabularies than their peers and a harder time sorting and organizing information and planning ahead.

Children in poor families are also less likely to have access to early-childhood education programs. Such programs have a proven record of raising future educational attainment levels, especially for poor children. Sadly, many states are slashing such programs, despite the fact that the funds dedicated to them earn an annual real rate of return of 10 percent or higher.

Disparities in educational achievement among children from different income groups increase with age. Such gaps are larger in fifth grade than they are in kindergarten, and they continue to grow as children move through primary and secondary school.

As a result of residential segregation, children from low-income families are more likely to have classmates with low achievement levels and behavioral problems than children from affluent families. Poor children are also disproportionately situated in schools that often find it difficult to attract and retain skilled teachers. And as the Chicago teachers’ strike reminds us, poor children are often hungry, depending on their schools rather than their homes for breakfast and lunch.

The United States is caught in a vicious cycle largely of its own making. Rising income inequality is breeding more inequality in educational opportunity, which results in greater inequality in educational attainment. That, in turn, undermines the intergenerational mobility upon which Americans have always prided themselves and perpetuates income inequality from generation to generation.

This dynamic all but guarantees a permanent underclass. Indeed, the process is already under way: An American child’s future income is already more dependent on his or her parents’ income than a child born in most other developed countries.

Demographic trends are aggravating this vicious cycle. More than half of all births in the United States now occur out of marriage, and incomes for single-parent families are lower than for married families. That’s one reason that family incomes have been declining for more than 50 percent of all children during the last 40 years.

Poverty rates are much higher in single-parent households than in married households. According to the most recent census numbers, 11.8 percent of all families, 6.2 percent of married families, 31.7 percent of single-parent families headed by a female and 15.8 percent of single-parent families headed by a male were living in poverty in 2011. About 48 percent of children in single-parent households headed by women were living in poverty, compared with about 11 percent of children in married households. And poverty claimed a staggering 57 percent of all children under the age of 6 in female-headed households.

Researchers at the Hamilton Project have found a strong correlation between earnings and marriage rates. While marriage rates have declined across the board, the drop has been larger for middle- and low-income groups, especially for men with a high school degree or less. This group has experienced a large secular decline in real earnings during the last 30 years. A provocative new book posits that women are increasingly dominant in work and education and celebrates the growth of female-headed households as a sign that patriarchy is giving way to matriarchy.

But there is another, less sanguine way to regard these trends. The rise of single-parent households headed by women may reflect the fact that women do not want to get married or stay married to such men or that men with weak earning prospects would rather drop out of the labor force altogether and avoid marital responsibilities. In either case, the news is not good for children and their educational opportunities and attainments.

Meanwhile, college-educated men and women are more likely to marry – most often to people with similar education levels – less likely to divorce and less likely to have children outside of marriage. Marriage and stable two-parent households are becoming marks of prosperity. These trends spell even greater income inequality and even greater inequality of opportunity for children in the future.

What can the federal government do to mitigate these trends? First, the progressivity of the federal tax and transfer system should be strengthened. The United States has one of the most unequal income distributions in the developed world, but its tax and transfer system is among the least progressive.

Tax expenditures that disproportionately benefit high-income families should be limited, while the earned-income tax credit that benefits working families should be expanded. The tax rates on capital gains, dividends and carried interest, most of which go to top income earners, should be increased as part of a multiyear deficit reduction plan.

Such a plan should also include more means-testing of entitlement programs and adequate funds for programs like food stamps, Head Start and Medicaid that address the needs of low-income families.

Second, the investments championed by President Obama to enhance educational opportunities – the $4 billion Race to the Top program to reward states for school reforms; the increase in the number and size of Pell grants; the tuition tax credit; the reformed student loan program; federal support for partnerships with community colleges – must be sustained. Deficit reduction must not be at the expense of these investments. Because they are investments, not handouts, they will end up paying for themselves.

Providing all Americans with the opportunity to realize their potential, regardless of their origins, is a core value. It is also a wise down payment on the nation’s future prosperity. ”A mind is a terrible thing to waste” is more than a clever slogan.

Article source:

Economix Blog: Laura D’Andrea Tyson: Wyden-Ryan’s Unrealistic Assumptions


Laura D’Andrea Tyson is a professor at the Haas School of Business at the University of California, Berkeley, and served as chairwoman of the Council of Economic Advisers under President Clinton.

In a surprising year-end act of bipartisanship, Representative Paul D. Ryan, Republican of Wisconsin, and Senator Ron Wyden, Democrat of Oregon, offered a proposal to reduce the growth of Medicare spending, envisioning a fundamental transformation of Medicare to a “managed competition” or “premium support” system.

Today’s Economist

Perspectives from expert contributors.

In their plan, the government would provide a subsidy to Medicare beneficiaries to choose among competing insurance plans, including the traditional fee-for-service Medicare program.

Mr. Ryan and Mr. Wyden say their system would control the growth of Medicare spending better than the current system by encouraging more efficient cost-sensitive decision-making by both providers and consumers. This incentive argument has considerable analytical appeal, especially among economists – competition usually reduces costs in most markets.

But the markets for insurance and health services are not like most markets, and there is scant evidence to support the Ryan-Wyden assertion, as Uwe E. Reinhardt noted in Economix last week. The cost savings from managed competition are hypothetical and uncertain – in fact, there are reasons to fear that such a system could actually increase costs.

Despite competition and choice in the private insurance system, Medicare spending has grown more slowly than private insurance premiums for comparable coverage for more than 30 years.

From 1970 to 2009, Medicare spending per beneficiary grew by an average of 1 percentage point less each year than comparable private insurance premiums. Between 2000 and 2009, Medicare’s cost advantage was even larger – its spending per beneficiary grew at an average annual rate of 5.1 percent while per-capita premiums for private health insurance plans grew at 7.2 percent, according to the Center on Budget and Policy Priorities.

Center on Budget and Policy Priorities

In inflation-adjusted terms, Medicare spending per beneficiary increased more than 400 percent between 1969 and 2009 while private insurance premiums increased by more than 700 percent.

What explains Medicare’s sustained cost advantage over private insurance? Medicare has much lower administrative costs than private insurance (administrative costs account for about 14 percent of health care spending, or a whopping $360 billion a year).

And Medicare has considerable negotiating leverage with providers as a result of its huge enrollment. Private insurance plans are unable to negotiate payment rates with providers that are as low as Medicare’s rates, even though Medicare’s negotiating authority is tightly limited and often undermined by Congress.

Advocates of premium support point to the Federal Employees Health Insurance plan as an example of how competition would work in Medicare. But this plan has been no more successful than private-employer-provided insurance at controlling the growth of insurance premiums.

And traditional fee-for-service Medicare outperforms both, even though its elderly beneficiaries include a sizable share of the sickest individuals who are the largest consumers of expensive health-care services.

In the Ryan-Wyden version of premium support, the fee-for-service Medicare would compete with private insurance plans that offer a standard package of defined Medicare benefits or an actuarially equivalent one.

All participating plans would take part in an annual competitive bidding process, and the bid by the second-least expensive private plan or by traditional fee-for-service Medicare, whichever is lower, would set the benchmark for the federal subsidy granted to Medicare beneficiaries to purchase the plan of their choice.

A beneficiary who chooses a more expensive plan than the subsidy for which he or she was eligible would have to pay the difference; a beneficiary who chooses a less expensive plan would receive a rebate.

The Ryan-Wyden plan links the size of the Medicare subsidy to systemwide health care costs through the competitive bidding process and assumes that competition will slow the future growth of these costs.

But in an explicit acknowledgment that the resulting cost savings are speculative, the plan also contains a backup cap that would limit the growth of federal spending on Medicare per beneficiary to the rate of growth of nominal gross domestic product plus 1 percentage point. Historically, both private health-care costs and Medicare spending per capita have increased at faster rates.

The Ryan-Wyden proposal is ambiguous about what would happen if the cap became binding. The proposal says Congress “would be required” to intervene and “could” implement policies to change provider payments and premiums for beneficiaries.

Congressional intervention to control provider payments would shift the burden of higher-than-anticipated costs to providers from the federal government and would effectively signal the end of managed competition as the mechanism to control costs.

In lieu of such intervention, Mr. Ryan has indicated that the cap would apply to the growth of the subsidy itself, and this would shift the burden of higher-than-anticipated costs to beneficiaries from the federal government.

That would mean that the Ryan-Wyden system would devolve from a premium-support system in which the growth of the subsidy depended on actual health-care costs to a voucher system in which it was delinked from such costs.

The Affordable Care Act of 2010 sets the same target for the future growth of Medicare spending. But unlike the Ryan-Wyden proposal, the act does not undercut Medicare’s ability to control costs by weakening the negotiating influence derived from its national enrollment.

Instead, the act puts Medicare at the center of reforms to create accountable care organizations, reduce payments to hospitals with high admission rates, bundle payments to providers and carry out comparative effectiveness research. Such reforms are essential to controlling costs and improving care.

And only Medicare has the clout and responsibility to accomplish them.

Despite competition, private insurers have been unwilling or unable to spearhead such changes, opting instead to pass rising costs onto consumers through higher premiums and to rely on Medicare to foster efficiency-enhancing systemwide reforms.

That’s why the Congressional Budget Office has consistently refused to recognize large potential savings in health care costs from reforms to increase competition among private insurance plans. Indeed, the C.B.O. has concluded that replacing traditional Medicare with competition among such plans would drive up total health care spending per Medicare beneficiary.

The Affordable Care Act also creates an Independent Payment Advisory Board, composed of nonpartisan health-care experts responsible for producing proposals to keep Medicare spending within the target while shielding beneficiaries; increases in premiums and cost-sharing are precluded. These proposals would take effect automatically unless the president and Congress acted to overturn them.

In 1998, a National Bipartisan Commission on the Future of Medicare, chaired by Senator John Breaux, Democrat of Louisiana, and Representative Bill Thomas, Republican of Maryland, developed a premium-support proposal similar to Ryan-Wyden but without an enforceable backup cap on spending. The commission failed to achieve the supermajority required for a formal recommendation to Congress.

I was a commission member appointed by President Clinton, and at the time I thought premium support was worth trying. Ultimately, however, I could not recommend the commission’s proposal because it rested on unrealistic assumptions about the magnitude of the cost savings that would result from competition. I believed competition might ease Medicare’s future financing gap but would not eliminate it, and I was concerned that the commission offered no credible cost-containment measures to address this gap.

I have similar reservations about the Ryan-Wyden plan. No evidence supports the plan’s assumption that a premium-support system with competitive bidding would control Medicare spending more effectively than traditional Medicare.

Nor does the plan contain enforceable cost-containment measures like those in the Affordable Care Act. And the plan’s backup cap on the growth of Medicare delinked from the actual growth of health care costs could shift the burden onto Medicare beneficiaries in the form of higher premiums and reduced access and quality of care.

This post has been revised to reflect the following correction:

Correction: December 30, 2011

An earlier version of this post misstated the year in which the Affordable Care Act was signed into law. It was 2010, not 2011.

Article source:

Economix Blog: Laura D’Andrea Tyson: Tackling Income Inequality


Laura D’Andrea Tyson is a professor at the Haas School of Business at the University of California, Berkeley, and served as chairwoman of the Council of Economic Advisers under President Clinton.

The Occupy Wall Street protesters have focused attention on rising income inequality in the United States, and they are right to do so.

Today’s Economist

Perspectives from expert contributors.

Income and wealth disparities have reached levels not seen in the United States since the Roaring Twenties. And the concentration of income and wealth contributed to the speculative excesses that brought on the 2008 financial crisis (see Robert Reich’s “Aftershock” and Raghuram Rajan’s “Fault Lines”).

According to a recent report by the Congressional Budget Office, rising income inequality is a long-term trend that began in the late 1970s and strengthened during the last two decades. The report confirms the protesters’ belief that the rising gap between the income of the top 1 percent and the income of everyone else is a major factor behind escalating inequality.

In the last 20 years, inequality has been largely a story of a small elite – not just the top 1 percent, but the top 0.1 percent – pulling away from everyone else in every source of household income: labor income, capital income and business income.

The top 1 percent’s share of national income has also been rising in most other advanced industrial countries, but it is by far the largest and has grown the most in the United States (see Jacob Hacker and Paul Pierson’s “Winner-Take-All Politics”).

Why have incomes of those in the top 1 percent soared? Their occupations provide some clues. From 1979 to 2005, nonfinancial executives, managers and supervisors accounted for 31 percent of the top 1 percent, medical professionals for 16 percent, financial professionals for 14 percent and lawyers for 8 percent.

Together, executives, managers, supervisors and financial professionals accounted for 60 percent of the increase in the top 1 percent’s income, with a widening compensation differential between those in the financial sector and those in other sectors of the economy after 1990.

Superstar athletes, actors and musicians, often portrayed among the super-rich, accounted for about 3 percent of the top 1 percent from 1979 to 2005, far less than the less glamorous people (mostly men) who lead and advise America’s businesses.

Researchers have identified several reasons for the rapid growth in incomes for the occupations that make up most of the top 1 percent, including “winner take all” technical innovations that have changed the labor market for superstars in all fields; increases in business size and complexity; a growing premium for highly specialized skills; changes in the forms of executive compensation, including the rise of stock options and weaknesses in corporate governance; and the increasing size of the financial sector.

All of these factors have played a role, but there is no definitive evidence on their relative significance.

Growing inequality in labor compensation played a major role in increasing income inequality between the top 1 percent and the rest of the population from 1979 to 2007. Over the period, however, both the growing inequality in business income, including income from small firms, partnerships and S corporations, and in capital income in the form of dividends, interest and capital gains, as well as the rising share of these forms of income in household income, played a more significant role, especially after 2000.

According to the Congressional Budget Office, from 2002 to 2007 more than four-fifths of the increase in income inequality was the result of an increase in the share of household income from capital gains, with the remainder the result of an increase in other forms of capital income.

Capital and business income are much more unevenly distributed than labor income and have become more so over time. Capital gains income is the most unevenly distributed — and volatile — source of household income.

Congressional Budget OfficeThe concentration index is a measure of the inequality of income from different sources among households. The index ranges in value from zero to one, with zero indicating complete equality in the distribution of an income source among households and 1 indicating complete inequality (for example, if one household received all of the income from that source).

The top 0.1 percent earns about half of all capital gains, and such gains account for about 60 percent of the income of the top 400 taxpayers.

Large cuts in federal tax rates on capital and business income have been very beneficial to the top 1 percent over time. In 1978, a Democratic Congress and a Democratic president reduced the top tax rate on most long-term capital gains to 28 percent from about 35 percent. It was reduced again to 20 percent in 1981 and then raised back to 28 percent in 1987, where it remained for a decade.

While serving as President Clinton’s national economic adviser, I led a study by his economic team of the likely effects of reducing the rate. We concluded that a cut would decrease future tax revenue, would contribute to rising inequality and would not increase saving and investment as its advocates asserted. Despite these warnings, in 1997 the president agreed to cut the rate to 20 percent, as part of a budget compromise with the Republican Congress.

Then, with Democratic support, President Bush reduced the tax rate on capital gains and other forms of capital income to a record low of 15 percent in 2003. Under the “carried interest” provisions of United States tax law, this rate also applied to fees earned by hedge fund and private equity managers, a rapidly rising cohort within the top 1 percent.

As a result of these changes, along with President Bush’s across-the-board cuts in income tax rates, federal taxes as a share of household income fell for the top 1 percent. Over all, the Bush tax cuts were the largest — not only in dollar terms but also as a percentage of income — for high-income households and increased the concentration of after-tax income at the top. Far from curbing escalating inequality, the Bush tax cuts exacerbated the problem.

While the federal tax code is still progressive, its progressivity has eroded, with a significant percentage of the richest now paying a much lower tax rate than the merely rich and the middle class. (Warren E. Buffett pays a lower tax rate than his secretary because most of her income comes in the form of wages that are subject to both federal income tax and the payroll tax while most of his income comes in the form of capital gains and dividends that are taxed at 15 percent and that are not subject to the payroll tax.)

A credible plan to reduce the long-run deficit requires a significant increase in revenue. Polls indicate that the majority of Americans, like the Wall Street protesters, believe that higher taxes on the rich are warranted both to reduce the deficit and to contain mounting inequality. I agree.

Restoring the top income tax rates and capital gains and dividends tax rates to their levels under President Clinton, as President Obama has repeatedly proposed, would be useful first steps. Taxing some carried interest as ordinary income would make the tax system more efficient and curtail outsize compensation in the financial sector. Adding a progressive consumption tax would augment revenue while encouraging saving and discouraging spending on luxury goods, both by the very rich and by those down the income ladder struggling to keep up.

The majority of Americans, like the Wall Street protesters, also believe the corporate tax rate should be raised. I disagree.

For reasons I discussed in an earlier Economix post, I believe that this rate should be reduced – a position advocated by both President Obama and former President Clinton in his new book. Raising tax rates on capital gains and dividends to the levels under President Clinton would curb the growth of income for the top 1 percent and could finance a substantial cut in the corporate tax rate that would bolster wages and job opportunities for American workers.

Article source:

Economix: Jobs Deficit, Investment Deficit, Fiscal Deficit


Laura D’Andrea Tyson is a professor at the Haas School of Business at the University of California, Berkeley, and served as chairwoman of the Council of Economic Advisers under President Clinton.

Like many economists, I believe that the immediate crisis facing the United States economy is the jobs deficit, not the budget deficit. The magnitude of the jobs crisis is clearly illustrated by the jobs gap – currently around 12.3 million jobs.

Today’s Economist

Perspectives from expert contributors.

That is how many jobs the economy must add to return to its peak employment level before the 2008-9 recession and to absorb the 125,000 people who enter the labor force each month. At the current pace of recovery, the gap will be not closed until 2020 or later.

The Hamilton Project, the Brookings Institution

History suggests that recovery from a debt-fueled asset bubble and ensuing balance-sheet recession is long and painful, with significantly slower growth in gross domestic product and significantly higher unemployment for a least a decade. Right now it looks as though the United States is following this pattern.

The jobs gap is primarily the result of the dramatic collapse in aggregate demand that began with the financial crisis of 2008. Even with unprecedented amounts of monetary and fiscal stimulus, the recovery that began in June 2009 has remained anemic, because consumers, the major driver of private demand, have curbed their spending, increased their saving and started to deleverage and reduce their debt — and they still have a long way to go.

As I asserted in my last post (and many other economists, including Lawrence Summers, Alan Blinder, Christina Romer, Peter Orzsag and Robert Shiller, have made this point, too), the jobs gap warrants additional fiscal measures to increase private-sector demand and promote job creation.

Sadly, current signals from Washington indicate that such measures will not be taken.

Instead, the risk grows that large, premature cuts in government spending will reduce aggregate demand, will tip the economy back into recession and drive the unemployment rate back into double digits.

Even if no budget deal is reached and no major spending cuts are made in the near future, there is now a serious risk that the rating agencies will downgrade government debt because of the political stalemate over a long-run deficit reduction plan. That would almost surely produce higher interest rates that could sink the economy into recession again.

Although the jobs gap and the high unemployment rate are the immediate problems in the American labor market, they are not the only ones. And there is no sign that the budget negotiations in Washington are going to address these other problems, either.

Even before the onslaught of the Great Recession, the labor market was in serious trouble. Job growth between 2000 and 2007 was only half what it had been in the preceding three decades.

Bureau of Economic Analysis, Bureau of Labor Statistics, McKinsey Global Institute

Productivity growth was strong, but far outpaced compensation growth. Between 2002 and 2007, productivity grew by 11 percent, but the hourly compensation of both the median high-school-educated worker and the median college-educated worker fell.

Lawrence Mishel and Heidi Shierholz, Economic Policy Institute

During the same period, the real median income for working-age households declined by more than $2,000. The 2002-7 recovery was the only American recovery on record during which the income of the typical working family dropped.

Lawrence Mishel and Heid Sheirholz, Economic Policy Institute

And despite the recovery, job opportunities continued to polarize. Employment grew in high-education, high-wage professional technical and managerial occupations and in low-education, low-wage food-service, personal-care and protective-service occupations; employment fell in middle-skill, white-collar and blue-collar occupations. The drop in middle-income manufacturing jobs was especially precipitous.

Bureau of Labor Statistics, National Bureau of Economic Research, McKinsey Global Institute

To fashion the appropriate policy responses to these long-term structural problems in the labor market, it is first necessary to understand their causes. The key contributors are three:

    1. Skill-biased technological change that has automated routine work while increasing the demand for highly educated workers with at least a college education, preferably in science, engineering or math.

    2. Globalization or the integration of labor markets through trade and more recently through outsourcing.

    3. The declining competitiveness of the United States as a place to do business.

Recent studies by Michael Spence and Sandile Hlatschwayo (discussed last week in Economix by Uwe Reinhardt) and by David Autor describe how technological change and globalization are hollowing out job opportunities and depressing wage growth in the middle of the skill and occupational distributions.

A widely cited commentary by Andrew Grove, former chief executive of Intel, and a prize-winning article by Gary Pisano and Willy Shih make similar arguments.

Many of the workers and jobs adversely affected by technological change and globalization are in the tradable goods sector, primarily in manufacturing. Nor is the United States labor market the only one to be affected by these forces: the polarization of employment opportunities is also occurring in the other advanced industrial countries.

Many of them, like Germany, are doing something about it. The United States is not. According to a recent McKinsey study, the United States is becoming a less attractive place to locate production and employment compared with many other countries.

McKinsey Global Institute

A newly published study by the Information Technology and Innovation Foundation reaches a similar conclusion. The United States is underinvesting in three major areas that help a country create and retain high-wage jobs: skills and training of the work force, infrastructure, and research and development.

Spending in these areas currently accounts for less than 10 percent of all federal government spending, and this share has been declining over time. And that’s despite the fact that the borrowing costs of the federal government have been near historic lows and much lower than the returns on economically justifiable investments in these areas.

Such investments fall into the “non-security discretionary spending” category of the federal budget, the category in line to be cut to historic lows to reduce the government deficit over the next decade.

In my previous Economix post, I said a budget deal should pair fiscal measures aimed at job creation now with a credible plan to reduce the deficit gradually and that both should be passed at once as a package. I also urged that the plan include an unemployment rate target that would postpone serious deficit-reduction measures until the target had been achieved.

I also think the plan should include a separate capital budget that distinguishes government spending on education, infrastructure and research as investments with committed revenues over several years. A capital budget would close the investment deficit in those areas that strengthen American competitiveness and promote high-wage job creation. None of the budget plans currently under debate include a separate capital budget.

The labor market is suffering from two problems: an immediate jobs gap, primarily the result of inadequate demand, and a long-term shortfall in rewarding employment opportunities for American workers, primarily the result of structural forces.

As a result of these forces, even when demand has recovered, many of the good jobs lost during the last decade will not be replaced by new good jobs without significant public investments to strengthen the attractiveness of the United States as a production location.

So far, the deficit-reduction proposals attracting attention do not address the labor market’s dual problems and leave many American workers and their families to face another lost decade.

Article source:

Economix: The Logic of Cutting Corporate Taxes

Today's Economist

Laura D’Andrea Tyson is a professor at the Haas School of Business at the University of California, Berkeley, and served as chairwoman of the Council of Economic Advisers under President Clinton.

Corporate taxes –- or rather their absence –- have jumped to the top of the news in recent weeks, even drawing humorous commentary from Jon Stewart and Bill Maher. Many Americans are outraged to learn that some profitable American corporations pay little or no taxes in the United States, especially when corporate profits enjoyed their fastest growth ever in 2010.

Shouldn’t the government raise the corporate tax rate to require corporations to contribute their “fair share” to deficit reduction and to enhance the progressivity of the tax system? The answer is no.

In today’s world of mobile capital, increasing the corporate tax rate would be a bad way to generate revenues for deficit reduction, a bad way to increase the progressivity of the tax code and a bad way to help American workers and their families.

After the 1986 tax overhaul, the United States had one of the lowest corporate tax rates among the advanced industrial countries. Since then, these countries have been slashing their rates both to attract investment by American and other foreign companies and to discourage their own companies from shifting operations and profits to foreign locations offering even lower tax rates.

KPMG Corporate and Indirect Tax Rate Survey, 2008, published in “Growth and Competitiveness in the United States: The Role of Its Multinational Companies,” McKinsey Global Institute, June 2010.

The resulting “race to the bottom” in corporate tax rates has made the United States a less attractive place for both domestic and foreign investments, and that has encouraged American multinational companies to shift more of their income abroad, in ways permitted by the United States tax code.

The United States now has the highest corporate tax rate of all developed countries –- and is alone in its attempt to impose taxes on the worldwide income of its resident corporations. All other developed countries and most major emerging countries have adopted a territorial system that exempts most foreign income of their resident corporations from taxes.

Some critics, like Jeffrey Sachs, say the United States should resist participating in the race to the bottom and should champion a multilateral agreement that increases taxes on corporate income. My fellow Economix blogger Nancy Folbre made that same point on Monday.

But there is no sign that other countries are interested. The European Union can’t even agree on harmonizing the corporate tax rates of its member nations. In continuing negotiations over an European Union bailout package, Ireland has steadfastly rejected French and German demands to increase its low corporate tax rate (12.5 percent, the lowest rate in the European Union and one of the lowest in the world).

And Ireland has been wise to do so: its corporate tax incentives are credited with attracting significant amounts of foreign direct investment by European and American companies that fostered the Irish development miracle of the last decade.

The race to the bottom in corporate tax rates reflects intensifying competition among countries for mobile capital and technological know-how to support jobs and wages for immobile workers.

For many years, the conventional wisdom was that the corporate income tax was principally borne by the owners of capital in the form of lower returns. Now, with more mobile capital, workers are bearing more of the burden in the form of lower wages and productivity as investments move around the world in search of better tax treatment and higher returns.

In this environment, a high corporate tax rate not only undermines the growth and competitiveness of American companies; it is also increasingly ineffective as a tool to achieve more progressive outcomes in the taxation of capital and labor income.

The Obama administration and many members of Congress are calling for a significant reduction in the corporate tax rate to promote jobs and competitiveness, as well as a move to a territorial tax system.

At the same time, they are searching for ways to broaden the corporate tax base so that corporate tax revenues will either increase or remain unchanged, even with a lower tax rate. This search is proving difficult and may well produce an undesirable result.

A significant “revenue neutral” reduction in the corporate tax rate would require a significant broadening of the corporate tax base, and that in turn would require scaling back or eliminating three large corporate tax expenditures that reduce the cost of capital and encourage new investment and job creation in the United States: accelerated depreciation, the domestic manufacturing production deduction and the research and development tax credit.

Cutting these items to “pay for” a reduction in the corporate tax rate would increase the cost of new investments in the United States and could impose higher burdens on American workers, in the form of forgone productivity and wage growth. (For a discussion of the pros and cons of different options to reform the corporate tax system, see the President’s Economic Recovery Advisory Board’s Report on Tax Reform Options: Simplification, Compliance and Corporate Taxation, published in August 2010.)

More promising ways to pay for a significant reduction in the corporate tax rate have been proposed.

Prof. Michael Graetz of Columbia Law School told the Senate Finance Committee that the shortfall in corporate tax revenues resulting from a cut in the corporate tax rate could be offset by the imposition of a corporate withholding tax on dividend and interest payments to shareholders and bondholders.

Many countries that have reduced their corporate tax rates have raised taxes on these groups; the United States has been going in the opposite direction.

According to a recent study by Rosanne Altshuler, Benjamin H. Harris and Eric Toder, restoring tax rates on dividends and capital gains to their pre-1997 level of 28 percent could finance a reduction in the federal corporate tax rate to 26 percent from 35 percent.

Such a change would both reduce the incentive for corporations to move investments abroad and increase the progressivity of tax outcomes by shifting more of the burden of corporate taxation from labor to capital owners.

Professor Graetz, and more recently, William G. Gale and Mr. Harris have proposed introducing a value-added tax to reduce the deficit and to finance a reduction in the corporate tax rate.

Most countries that have reduced their corporate tax rates have a value added tax that accounts for a significant share of their tax revenues. To offset the regressive effects of a value added tax, countries have used lower value-added-tax rates on items like food, health care and education, as well as cash subsidies for poor households.

I believe that a federal value added tax with such offsets should be considered as part of a balanced multiyear deficit-reduction package that includes a sizeable reduction in the corporate tax rate.

Many Americans who are outraged that American corporations pay little or no corporate tax would be equally outraged to learn that more than 50 percent of all business income is earned by partnerships, sole proprietorships and S corporations, many of which are very large and profitable and enjoy the same legal benefits as regular corporations and do not pay corporate taxes.

Broadening the corporate tax base to include more business organizations with corporate characteristics would allow for a revenue-neutral reduction in the corporate tax rate that would make the United States a more attractive location for both foreign and domestic investments, with benefits for American workers.

The United States needs a significantly lower tax rate on corporate income, not a higher one.

Article source: