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It's the taxes - Stupid! (but maybe not the way you think)

By
Real Estate Agent

With due apologies to James Carville's election assessment (It' the economy-stupid) we are constantly barraged (from every political perspective known to man) with how job growth is what is needed to help lift our economy (and certainly the real estate industry) out of this prolonged recession. However, in spite of all the talk about jobs, no one has put forth an actual plan to create jobs - and certainly no discussion of the types of jobs to be created (minimum wage jobs or high value jobs). So, knowing I don’t have any answers but at least some data to work from, I thought I would put forth an initial idea or two on possible policy changes which could help spur job growth.

Tax Rate ComparisonDuring discussions with friends and family regarding the issues facing our country invariably people talk wistfully about how good things were in the 50s and 60s in the "good old days". Granted the 1950s did represent significant growth for the US economy especially relative to the rest of the world (not surprising as the rest of the world had been destroyed by World War II). I've also read some articles discussing the differential in tax rates between individuals and corporations and various hypotheses that changes in these rates may have had unintended consequences over time.

So I went to the IRS and pulled their marginal tax rates since 1920 for both individuals and corporations. The graph to the left illustrates the differential between these marginal tax rates over time (click on the graph for a larger version)

Historically there has always been a large differential between the marginal tax rates of an individual versus the marginal tax rates of corporations with the individual marginal rates being substantially higher than corporate rates. In fact, in the 1950s, which we so pleasantly remember as a period of economic growth and vitality, the highest marginal tax rate on a personal level was approximately 90% versus the just over 50% marginal tax rate for corporations. This differential continued until approximately 1981-82 when tax code changes brought both corporate and individual marginal tax rates nearly in sync with one another. Perhaps coincidentally this is the same time frame we begin to see outsourcing of jobs away from the US. A process which accelerated in the late 80s and 90s.

One theory that appears to have some statistical justification is the significant differential between personal tax rates and corporate tax rates historically created a built in financial incentive for corporations to retain earnings and reinvest them into research and development, product expansion, wages and benefits enhancement, and other economic & labor market expansion behaviors. However, when the tax rate differential was eliminated there appears to be a nearly simultaneous increase in corporate executive compensation with a similar reduction in corporate reinvestment. Beginning in the 1980s corporate reinvestment appears in the form of job outsourcing to reduce production costs but not in terms of domestic product and manufacturing capacity expansion.

Another contributing factor exacerbating the outsourcing parade is a component of current US tax code which allows US corporations with overseas operations to defer paying US tax on profits produced overseas until such time those profits are repatriated (which may never occur). So not only have changes in the US tax code encouraged (or incentivized) a shift away from corporate reinvestment but the current tax code also encourages US based corporations to move profit making activities overseas and then leave those profits off shore so to avoid any US taxes. Now, part of the argument for maintaining this tax deferral is the current corporate tax rate of 35% on profits in excess of $18.3 million which is higher than the tax rates in many countries which are current beneficiaries of outsourced American jobs.

Now, brighter economic minds than mine will likely debate this topic until it is a thoroughly beaten dead horse. But given the economic vitality experienced in the 1950s, 60s and even 70s, perhaps a new fiscal strategy is warranted. So, here is a possible option to assist in our recovery. Reestablish the historic differential between the top marginal tax rates for individuals versus corporations (perhaps going back to the marginal levels in place in say 1980 while adjusting the income ranges for inflation). 

Change the current corporate tax rules which allow (actually encourage) corporations to move profit making operations offshore to close this jobs killer. In order to prevent some type of catastrophic rush to outsource and to spur reinvestment domestically, simultaneously reduce the marginal corporate tax rate to say 25% (this puts the US near the median for OECD countries). This also re-establishes the incentive for corporations to re-invest in their own operations. In fact, you could sweeten the pot to provide a further 1% tax break for every 1,000 jobs repatriated to the US.  We could even consider additional incentives for specific industries in which we would like to regain a global leadership position (e.g. alternative energy development, energy grid modernization, air transportation, diagnostic medicine, etc) much like what other countries are doing to spur their domestic economic growth.

Now, before people begin howling "what about government expenditures", yes, there needs to be a reconfiguring of the national budget to reflect the realities of today’s world (I sense another blog post coming along). However, that process will take time to unravel (especially as we consider the gridlock that the recent election results will likely create in Congress) whereas changes in the tax code to create incentives to invest in America can be done in a single legislative session (and it doesn't involve a direct payment of billions of dollars to corporations. As the free market responds to the tax "incentives" we could then target our budgetary process to maintain the momentum of the free market response.

So, right or wrong, there is my initial suggestion to begin the process of re-creating a vibrant American economy.

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Craig Frazer, Realtor, CRS, CDPE, GRI, CLHMS
RE/MAX Metro

Cell & Text: (801)699-6046
Email: cfrazer@remax.net

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Comments (2)

Jeanne Dufort
Coldwell Banker Lake Country - Madison, GA
Madison and Lake Oconee GA

Craig - very informative.  You've given me food for thought.  Thanks for sharing.

Nov 03, 2010 08:59 AM
Craig Frazer
Farmington, UT
Real Estate, RE/MAX Metro, Davis & Salt Lake County

@Jeanne - Thanks for giving it a read

@ Consumer - my intent was to succinctly (although apparently cryptically) suggest that budget slashing should occur in sync with the revenue changes the tax code modifications may generate.  If the revenue increase is sufficient enough we could take a more methodical approach to budget cuts as opposed to the more draconian measures that might be necessary (ala Greece or Great Britain) should tax revenues continue to decline.

Nov 03, 2010 10:00 AM