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Taxation and growth.

Traditionally, taxation has been the payment made to government for "servitude rendered," but in a global economy, capital and knowledge move to wherever they are treated best. Some in government are beginning to understand this.

The recession that's drawing to a close was prolonged by several factors, among them a 1992 deficit of $400 billion. But the government officials and business leaders assembled at The Ritz-Carlton hotel in Washington for this month's CE roundtable say another culprit was the US. tax system. Both the degree and method of taxation demonstrably penalizes growth and inhibits the international competitiveness of American companies.

On the surface, U.S. companies and citizens bear a smaller tax burden than their European or Asian counterparts, with the exception of those in Hong Kong and Singapore. Taxes here claim between 32 and 35 Percent of personal income, compared with an average 40 percent in Europe. Corporate rates also are higher in some foreign countries (see chart on page 50). But statutory rates are only one element of the total costs borne by ratepayers. While other nations tend to tax corporate profits once, the U.S. taxes them again when they are distributed as dividends. This raises capital costs and leads to a bias toward debt over equity.

The rising level of state and local corporate income and payroll taxes, usually not tracked in comparisons by the Organization for Economic Cooperation and Development, has become the largest part of the corporate tax burden. But one barometer is a comparison of corporate taxes and profits. A Tax Foundation study last year revealed that in 1980, profits made up 10.8 percent of national income. But that figure dropped to 6.3 percent by 1990. Total corporate taxes, however, did not experience a comparable decline. Relative to Profits, taxes increased 28.1 percentage points from 58.9 percent in 1980 to 87 percent in 1990. During the 1970s, this rate averaged only 60 percent.

Hidden in the U.S. system, observes James Q. Riordan, CEO of Bekaert and former Mobil vice chairman, is a heavy compliance burden. At Mobil, where be was CFO, hundreds of tax accountants, attorneys and other professionals maintained compliance with intricate U.S. law, Riordan says. At foreign subsidiaries, only a handful of such people were required. Nor does the foreign tax credit allow US. companies to capture full credit for taxes paid elsewhere. Steve Perry, Coopers & Lybrand international tax partner-in-charge, thinks the compliance cost differential between U.S. and EC internationals can be significant. "One EC company we do work for employs at its headquarters only 25 percent of the tax-related personnel which its U.S. subsidiary needs to maintain compliance," he says.

This is not an efficient way to collect revenue. A study by Washington University's Center for the Study of American Business estimates that it costs the federal government $1.52 for every $1 it collects from citizens. Roundtable attendees such as House Ways and Means Committee member Sam M. Gibbons and ranking Republican Bill Archer advocate replacing corporate and personal income taxes with a 25 percent value-added tax, structured not to shift the tax burden but to reduce the costs of collection and compliance.

All agree with The Heritage Foundation's Ed Feulner that before any VAT is considered, two issues must be resolved: Because VAT is a relentlessly efficient revenue raiser, government must set an absolute rate ceiling to deter spending excesses. Also, VAT should replace other taxes and not add to the national tax burden.

Jim Miller, co-chairman of the Tax Foundation and director of the Office of Management and Budget from 1985-88, believes tax reform should begin with a cut in the capital gains tax, which currently stands at 28 percent. Such a move, be says, would help to modify a system that penalizes capital and rewards consumption.

President Bush, too, favors trimming the capital gains tax, but he has given broader tax reform a low priority. Lack of leadership from the White House prompted Ways and Means Committee Chairman Dan Rostenkowski to lament in a recent interview with CE (see cover story), "You won't see any radical change in our tax laws - to a consumption tax-unless the president forcefully endorses it. "

MOTORING DOWN THE ROAD

James C. Miller III (Tax Foundation): Many economists and politicians say that we have to jump start the economy, but I don't think that's an appropriate metaphor. Our car doesn't need a jump start. It's moving, but sluggishly. It's not gaining speed, and it can't maneuver very well.

And this sluggishness is caused by excess baggage, labeled government spending, over-regulation and monetary policy. But another bag - as large as any - is labeled taxation. We need to get rid of our excess baggage to make our car lighter and more maneuverable.

Spending and taxation are closely related. I think it would be a mistake to use tax cuts to stimulate aggregate demand. There are more appropriate ways of addressing shortcomings in demand. I also think it would be a mistake to formulate tax policy based on "fairness." I think if we aim to create "fair" tax policy, we're bound to get bad tax policy.

It seems to me that we need a tax policy that maximizes growth and makes our car - the U.S. economy - as fast and maneuverable as it can be. The question is: "How can that best be accomplished?" Rep. Sam M. Gibbons (Ways and Means Committee): I'll tell you how. We can abolish corporate income taxes and about 90 percent of personal income taxes. We should substitute instead a value-added tax. A VAT would be more compatible with the tax and economic system in most of the world. That has got to be one of our goals in making the economy run more efficiently.

Here's why: We are subsidizing our imports and penalizing our exports through our tax system. Under a VAT, when a country's exports reach its border, that country uses the VAT to shave off the costs of government. But when these exports are sent into this country, we add no VAT to it and the goods go on to consumers.

But if you manufacture a product or grow it for export in the U.S., when it passes our border on the way out, it carries with it the full cost of the government. That cost is very heavy-probably between 30 and 40 percent of the value of the product.

And then the product goes into a country with a value-added tax. That country adds its costs of government to the price of the product. So the price tag now includes costs from two governments.

That kind of a system is devastating U.S. competitiveness. We're exporting job opportunities daily, hourly, every minute. We've got to hustle to keep in step with the rest of the world.

The VAT is an option because our current tax system is a mess. The system is ill-conceived; it's simply irreparable. We should not be trying to steer economic decisions through tax policies, but we do. Tax policy ought to be neutral.

But a VAT ought to be a replacement for - not an addition to - those taxes we abolish. Miller: How do you ensure that's what happens, that a broad-based consumption tax isn't simply added on to the taxes already in place? Gibbons: In the legislation you write to adopt a VAT, you include a provision to abolish the others. J.P. Donlon (CE): Is the adoption of a value-added tax politically feasible? Rep. Bill Archer (Ways and Mouns Commitee): It would be very difficult. For a VAT to have any chance of being enacted, there's got to be a force that pushes the Congress. And it seems that force is not going to be the White House.

But moving back to the big picture, I think we've also got to stop thinking that we can rely on the U.S. consumer to bail us out of the recession by spending more.

We're spending 100 percent of our income: That's a retardant to capital savings. So we've got to figure out how we can export more. When we do that, we create more jobs without having an overdependence on consumer spending. Certainly, Sam's VAT idea would be a major plus for exports.

It's also important, however, to ease the tax burden on the tools of production. The VAT would do that. But there are other ways we can create incentives, for example, by lightening taxation on capital gains. We need to protect existing capital savings and encourage new capital savings. Because dollar for dollar, the loss of an existing dollar equals the loss of new capital.

Every tax dollar that comes from capital gains takes away from the nucleus of capital savings. It's like the government is a giant vacuum cleaner, sucking up pieces of the capital pie every time you have a transaction.

Not many people want to talk about that, but it is exceedingly important. Some studies indicate that when an investor sells a capital asset, well over 90 percent of proceeds from the sale are reinvested in another capital asset.

One other thing: I'd rather go to a broad-based consumption tax than mess with European versions of the value-added tax. I would also say that any consumption tax has got to totally replace an income tax. If we're left with a vestige of the income tax, you'd still have the giant IRS hierarchy and with it all of the problems that Sam says we can't fix.

Sam also proposes eliminating the corporate income tax. Out with the same bath water would go the minimum tax.

Some 80 percent of our corporations today are subject to the minimum tax. Here's the problem: On the one hand, the government says: "Invest in new equipment, and take the accelerated depreciation," because it really wants business to become more efficient. But on the other hand, it says: "Now that you've invested in it, and you've taken the accelerated depreciation, by the way, you've got to face a tax on that."

Businesses can't ever get out. The more they invest, the more efficient they become, the deeper their minimum-tax hole. Donlon: Sam, we spoke earlier about "fairness" in income taxes. Would a valueadded tax be progressive in the way our current system purports to be? Gibbons: A value-added tax would be regressive compared to the current tax system. I'm not trying to change the tax burden. That's a political problem.

To remain equitable under a VAT, you'd have to have some vestiges of a corporate income tax. Also, you'd have to rebate to very poor families, as the Canadians do, or you'd end up with a tax system that really could be called a tax on the poor.

Perhaps the biggest advantage to a value-added tax is that it's very simple. Its proponents include the most advanced countries and the most backward countries. New Zealand uses a VAT. So does every member of the European Community. Canada recently moved to a value-added tax. The Japanese have a value-added tax. Even the Russian republics are adopting value-added taxes. It's the wave of the future.

And most of these countries employ the VAT with far fewer enforcement personnel than we've got. The U.S. has the most expensive tax system in the world and a vast tax bureaucracy - beginning with the 32 members of the Ways and Means Committee and their 50 staffers. The U.S. has 125,000 people in the IRS and God knows how many tax lawyers, accountants, theoreticians, writers, and economists. Donlon: Haven't other countries held on to their other taxes? Gibbons: That's the mistake they've made. The Canadians wish they'd done otherwise. They got rid of their manufacturers' excise tax. But they put in lots of exceptions and exemptions. I don't want to have any. Edwin Feulner (The Heritage Foundation): Before we all board Rep. Gibbons' VAT bandwagon, let's look at the other side of the coin. Certainly, the VAT is efficient, and it provides economic incentives. However, there are some problems. As we've discussed, one question is, "How do you ensure that VAT replaces, and doesn't simply add to, the present roster of taxes?"

But the other problem we haven't discussed is that a VAT can be so damn efficient, and it's hidden. The tax can be a veritable money-making machine, a lever Congress can pull to bring in tremendous amounts of revenue simply by jacking up the rates half a percent at a time. Gibbons (wryly): Politicians won't increase taxes. It's not politically popular to advocate a tax increase. Foulner: Look what's happened with the value-added tax in Austria. First they adopted a 4 percent VAT. By the end of 1990, it had increased to 26 percent. Gibbons: They tried to phase it in. That was a mistake. Foulner: But you advocate starting at 26 percent? Gibbons: You'd have to come in at around that figure. Our current tax system already is clumsily extracting that much money from the economy. To reduce taxes, you have to get into the budget side of the equation. I'm not trying to change the budget or the tax burden. I'm just trying to ensure that we don't penalize ourselves and that we stack up more evenly against our competitors.

As for a VAT being hidden, here's one solution: We could just require that the value-added tax be expressed in percent on every invoice of bills that you pay. Miller: What if you adopted a national sales tax? Given that our markets in the U.S. are pretty competitive, the tax would be nearly the same. The tax would be less hidden than a VAT. Gibbons: But there are other problems with such a sales tax. You can't tell when there's a final sale and when it goes to consumption. Elmer B. Staats (Committee for Economic Development): Sam mentions the budget side of the equation. The value-added tax is probably the only tax that would pull in enough revenue to balance the budget. So the question becomes: Unless we go to a consumption tax, how are we going to generate the savings needed to ensure new investment? Ven Doorn Ooms (Committee for Economic Development): I'm sensitive to fears that a value-added tax could become a money machine. But on my worry list, the notion that we are going to be politically insensitive to tax increases is just below the threat of being eaten alive by alligators.

Our real problem here is generating national savings. We are now using up almost all of our national savings on the federal budget deficit. Our first priority must be to reduce government spending as much as possible.

But with taxation, here's the point where the rubber meets the road: After we go after the spending side, are we prepared to raise any money needed to slash the budget deficit? We just can't do that under the current tax system. If we try, what will happen is that we'll simply ratchet up the income tax in ways that don't help savings, investment or growth. In essence, we'll end up shooting ourselves in the foot.

So whatever the objections to VAT, we have to think seriously about adopting some kind of tax that hits at the problem of trying to raise revenues in a way focused more on consumption than on savings. Congressman Gibbons said a value-added tax likely would be regressive, but that needn't necessarily be so. There are ways of structuring consumption taxes that make them politically acceptable. Archer: I share Ed Feulner's concerns about a VAT possibly being a hidden tax. But I haven't yet met a tax I liked. There are disadvantages to all kinds of taxes, and I think our income taxes also have become hidden.

The 1986 Tax Reform Act was supposed to cure problems in the income tax, but it actually made things worse. If the act was our best shot at patching up the income tax, then what hope do we have that we can ever make it work? And how are we going to get away from political pressures that are always part of the income tax situation? I'm referring to the fact that the masses aren't going to pay because they'll just raise the rates on groups that are politically in the minority.

In short, neither the income tax or the value-added tax offers us an absolutely perfect solution. You have to put them on the scale and weigh the pros and cons.

SHRINKING NATIONAL SAVINGS

The Hon. Sidney L. Jones (Assistant Secretary for Economic Policy, Department of the Treusury): I have a sense of poignancy as I listen to this. When I came to Washington in 1969 with youthful notions about changing taxation and government, the federal debt was $367 billion and the interest on it was $12 billion. A decade later, it was over $900 billion, with interest payments of $45 billion.

In 1990, the gross national debt hit $3.7 trillion. We paid $184 billion of interest on it. And yet, whenever I get into a discussion about tax policy, within the first three or four minutes we're discussing exemptions and loopholes.

What I'm saying is that I've never lost an intellectual debate that we need more savings, investment or longer-term objectives. But I've never been involved in a tax policy decision in which three-quarters of the benefits didn't go to consumers and one quarter, at most, went to the business sector.

Part of the problem involves our savings rate, which is about half the rate of the Japanese. For a century, the gross national savings rate averaged 16.5 percent of the gross national product. The Japanese rate is about 31 percent, while European rates are in the mid-20s.

But in recent years, that savings rate has eroded an additional 4 percent. These lost savings should have been invested in plants and equipment, technology, human resources and development.

And yet we've never been able to sell the American people on the idea that we need more savings and investment. Because we're always talking about fair taxes. minimum taxes and income redistribution. We have to decide how much more investment we need and then decide how we're going to pay for it. Only when we've done that can we begin to sort out the details, such as how we make a particular type of tax work most efficiently.

America has some fundamental economic problems. Growth is slow. In the 1950s and 1960s, we grew 4 percent a year. In the 1970s, that figure dipped to 2.8 percent and a decade later to 2.6 percent. Yet, we have to remain competitive in an increasingly global economy. The only thing you can do about these problems is to boost productivity.

Economics isn't an exact science, but we do know that to increase productivity, you have to have savings and investment. And we know that you cannot invest more than you save. To fill the gap, the U.S. increasingly has turned to international investment. Everybody is despondent. And yet all we can talk about in terms of changing the tax system are tax credits for first-time home buyers.

YOU JUST DON'T UNDERSTAND

Donlon: You're alluding to a failure of political will. Is the problem that Congress and the administration don't understand the severity of the problem? Gibbons: Yes. But another problem is that the public doesn't understand the severity of the problem. Ooms: The public does not understand that the reason incomes and average wages have not been growing for nearly 20 years is a faulty approach to national savings and investment. Whether we're trying to improve education or boost R&D spending, the key is to save and invest more.

The public believes the current recession to be our sole economic malaise. That's not so.

The recession merely whacked us on the head with a two-by-four. It caught our attention. But I think that people are gradually understanding the broader reasons why income isn't growing for the first time in our 200-year history. The American dream has been shattered by the experience of the last 20 years. Archer: That sounds like something Dan Rather would say. But the reality is that in 1989, family incomes, in real constant dollars, were the highest in our history, except for the lowest quintile. And the lowest quintile was only slightly below its previous high. Ooms (sharply): I don't watch television or Dan Rather.

While it is true that real family incomes are higher, they are higher solely because we have more wage earners, and those earners are working longer hours. But average wages and productivity have not grown.

UNDERGROUND TAXES?

Walter R. Garrison (CDI Corp.): Under tax reform in 1986, we slashed income taxes $100 billion. But my perception is that we shifted individual taxes to the general public in a hidden way. And because of a group of additional taxes that business and industry had to bear, we may have reduced our standard of living by the same $100 billion.

Another troubling part of the tax code is its inability to collect taxes from the underground economy. That's not fair to people whose taxes are calculated and automatically removed in the workplace. Feulner: We did a study of the underground economy a number of years ago. It was then costing us $100 billion a year in revenue. It's now probably costing us $200 billion or $300 billion. Gibbons: Right. A value-added tax would improve that situation, because it taxes turnover, not harder-to-define income. Donlon: Under a VAT, theoretically, the government could tax drug dealers? Garrison: It could tax all the inputs.

WHOSE SAVINGS ARE THESE ANYWAY?

Miller: Let me play devil's advocate for a moment. Why is there any reason to believe that if you increase our gross savings rate, the savings would be put to use to increase U.S. productivity? We have an increasingly global market, and a lot of the investment in the U.S., as you know, comes from abroad. On the flip side, a lot of U.S. savings ends up overseas. Jones: That's the evidence. The fact that in the 1980s you had to borrow $100 to $150 billion to support domestic investment. That meant you had a demand for investment that could not be supplied by savings. We had to go offshore, and this was a tragedy. You had to offer 7 or 8 percent real interest - in nominal rates, that's 11 to 12 percent-to attract $100 to $150 billion of income here.

If you remember your basic college economics, when the demand for cucumbers goes up, their price goes up. When the demand for dollars went up because people were buying dollar-denominated assets, the dollar doubled versus other currencies. That killed our manufacturers and our agricultural industry. Miller: The international dimension is one of the reasons we need to solve our taxation and savings problems: We need to make America an attractive place to invest. If we increase our savings, we will have a devoted following from abroad.

BALANCING ACT

Staats: I'd like to come back to the problem of the budget deficit. The idea of a balanced budget has been brought up repeatedly, but it has faded just as often. We've talked about balancing the budget by 1991, 1994, 1995. Unless we can address that problem, we'll never be able to come up with the savings needed for investment. All our funds will go toward paying interest on the debt. Ooms: In fact, we've regressed in terms of our approach toward the debt. At one time, government would not tolerate budget deficits of the magnitude we have today. it would not tolerate the public savings rate we have now. But nobody gives a damn about that anymore. Jones: But they may eventually have to care. There is a final arbiter of shoddy financial practices, and that's the financial markets. Take a look at what happened in New York City. They thought they could get away forever with free spending and high taxes. But they were eventually heeled by the reality of bond ratings.

Reality will also attack the national markets. If the IMF looks the other way as we go about our affairs, ultimately the financial markets are going to respond. Ooms: But the cure is very painful. It comes in the form of the destruction of domestic investment.

OPPORTUNITY KNOCKS, NO ONE HOME

Jones: Ultimately, what we're saying is that we need to make a decision about the allocation of resources. This year is an election year, and we have the chance to do just that. Donlon: Do you think the claim of the government on the commonweal should be a topic in the presidential debates? Jones: It should be the only topic in the presidential debates.

Let's cut this another way: We're in the process of cutting the defense budget between 25 and 50 percent. What an incredible opportunity! I think we should take at least half that reduction and apply it to the federal budget deficit. And we should take the other half and spend it under targeted programs to increase savings and investment. But instead, we're buried in a debate over whether the ideal rebate for first-time home buyers should be $2000 or $5000.

HORROR STORIES

Donlon: What should people urge chief executives to do to advance the kinds of proposals we've been talking about? Gibbons: CEOS should learn about the value-added tax. They should demand that such a tax be enacted, and allow government to only take so much of the pie.

And they should scream about the horror stories they and their business have been through because of the income tax. Particularly important is how it effects savings.

CEOS should also raise hell about the payroll tax. That's a horrible tax: It stifles the creation of business.

All my sons are small businessmen. All are self-employed. On the first $55,000 they earn, they pay 15 percent without any exemptions. When I first came to Capitol Hill, the payroll tax was 3 percent. The increase is insufferable. Garrison: Another problem is the constantly changing set of rules. Every time you adjust to the current system, somebody comes along and changes the damn tax code.

ANY SUGGESTIONS?

Donlon: What parts of the tax system most need to change if we are to compete effectively in the global arena? James Q. Riordan (Bekaert): The U.S. taxes the worldwide income of its companies; double taxation needs to be avoided. Many countries say: If you've earned income outside our borders we're not going to tax it. But because the U.S. doesn't do that, it provides a credit, which is supposed to protect U.S. companies from double taxation. The general theory of U.S. taxation of global operations is that companies get credit for income tax they pay to foreign governments, and they don't pay the U.S. government on foreign income until the money is repatriated.

The U.S. system now has become so complex that U.S. companies end up double paying taxes. More and more income is taxed before it is repatriated. Less and less foreign taxes are credited because of complicated sourcing rules. Foreign countries that use a credit system don't have those complicated rules. Their multinational companies have a competitive edge over U.S. companies trying to compete in the global arena. Donlon: What most needs to change here at home? Riordan: in 1986, the tax burden was shifted from individuals to corporations. Within the corporate sector, it was shifted toward capital intensive corporations and those with global operations. To improve the environment for savings and investment, we have to allow businesses to write off investments more rapidly.

Under the current accrual-accounting income tax system, you can't expense your investments, but taxes are collected in cash. The government is your self-appointed partner. It wants its share of your accrual income immediately in cash even though it doesn't put up any cash. That kills businesses. One improvement would permit you to have a lower current cash cost for investment.

You also need a lower tax cost for hiring the next employee. Lowering cash taxes will do that.

We now impose a marginal rate that's extremely high for two classes of people. First, let's look at those who have retired and want to return to work. If they do, they must again begin to pay social security and income taxes. We'll also take back from them the social security pension they've earned. The result? The incremental rate for a person between the ages of 62 and 70 is higher than it is for a billionaire.

The only higher marginal rate is imposed on a single mother who takes a job to get off welfare. We take away her welfare benefits, including medical insurance, when she begins to get a paycheck.

We need the talents of people like this in the workforce, but we impose a penalty when they come on board. Garrison: We'd like to take back into the workforce some of our retirees, but we can't make it worth their while to work. They tell us that they automatically lose $9,000 in benefits just by walking through the door.

AND THEN THERE'S THE PAPERWORK

Donlon: Any final thoughts on what you would like to see to change about the tax system? Garrison: I'd like to see a tax system that's simplified and stabilized. Daniel A. Witt (Tax Foundation): You're touching on bureaucracy and the procurement process. That's a good point. By its own reckoning, in 1984 it cost the IRS over $35 billion to raise $50 billion in corporate income taxes.

Talk about high expenses! At a company such as Mobil, where jim came from, it takes a staff of 300 to fill out corporate income tax returns. That doesn't add value to customers. Riordan: And that example doesn't tell you the whole story. Things can get particularly sticky when you're in business overseas and you have to ask foreign officials for data. They think you're crazy. In no way do they have to supply certain kinds of data.

When we went live with a computer system to perform financial analysis, we needed more separate items of data to comply with the tax code then we needed for public reporting or comptroller cash. Garrison: Maybe this sounds overly fundamental, but in order to effect any type of meaningful change in the tax system, we have to educate the American public.

A recent survey asked high-school graduates to estimate the after-tax profit margin at an average company. Typical responses ranged between 25 percent and 45 percent. They could not believe that a food company, for example, nets maybe 1.5 percent on fantastic revenues. Donlon: Dan, you have last crack at this. What needs to change? Witt: One thing we've failed to focus on today is state taxes. Of course, that topic probably could comprise another complete roundtable.

Last year, 28 states raised taxes a record $18 billion. This year, many of these same states are running into fiscal crises. Over the last 10 years, the average annual increase in federal taxes has been just over 4 percent. State taxes have been increasing an average annual rate of over 7 percent.

We're heading toward a time when state taxes may exceed those taken in by the federal government.

That's food for thought.

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Title Annotation:CE Roundtable
Publication:Chief Executive (U.S.)
Article Type:Panel Discussion
Date:Jun 1, 1992
Words:5244
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