By Tom Pallow of Third Way Progressives, 3/29/11
Economists may disagree as to the value that tax incentives bring to generating economic efficiencies and prosperity. Some see great value in tax incentives and others do not. Regardless of these disagreements, there are some tax incentives that virtually all economists and policy makers like. Regarding tax incentives for businesses that bring private sector job growth to the US, in recent years the two most popular of these tax incentives seems to have been the R&D tax credit and the early depreciation of certain capital expenses. Given the popularity of these two tax incentives, if the superiority of the US Employee Tax Credit were to be demonstrated when compared to these two more known tax incentives, it would be safe to say that the US Employee Tax Credit should join these two more popular tax incentives as part of our country’s collection of tax tools that our federal and state governments use. This paper will demonstrate the superiority of the US Employee Tax Credit to these two effective tax incentives. Our US ETCs would affect C Corporations and businesses that are taxed as personal income.
Regarding businesses that are taxed as personal income, our US ETC would be awarded for all US W-2’d employee expenses up to the FICA tax cap. This credit would be worth $.15 for every dollar expensed. Our personal income tax plan would raise taxes on the top two brackets up to the same rates and income brackets as President Obama has proposed, or above that. However, businesses that hire employees in the US will be able to use these tax credits to lower their effective tax rate to no lower than if today’s top three rates stayed the same and the bottom three rates were dropped even further. Such a policy would create an effective tax cut for the employers of 98% of Americans who work for a non-C Corporation business. Yet statically scored, these tax credits would only cost about 21% of all the federal revenues that would be raised otherwise.
Very importantly, studies propose that President Obama’s tax plan would cause the loss of over 6 million private sector jobs between 2013 and 2020 (1). While using some of these same assumptions, our personal income tax plan would create or save over 7 million private sector jobs during the same period. Such a difference, if dynamically scored, would mean that our personal income tax plan would raise as much as 4 to 5 times the federal revenues as the President’s plan.
What our US ETCs would do is institutionalize in our tax code a reality that exists in our society but that is not yet institutionalized in our tax code. That reality is: All things being equal, someone who employs people in the US is more important to our nation than is someone who does not. Therefore, we should reward and incentivize private sector employment in our tax code in order to create more of it. Monetary incentives motivate!
The beauty of this tax policy is that the math always works for us. That is, even within the highest income stratums, those who employ people are always a relatively small percentage of each stratum. For example, within all of the income that is produced by all those within the top 2% of US income earners, the point where the President wants to raise personal income tax rates, only 19% of all that income is the profits of any business that is taxed as personal income that has one or more employees in the US. For the top 1% of US income earners this number is about 21%. For the top 5% this number is about 16%, and for the top 10% it is about 12%. Therefore, the math always works for us. The greater we make the effective tax rate difference between wealthy people who do not employ in the US, versus all entrepreneurs who do, the more private sector jobs and/or government tax revenues will be raised! If there is only one thing that all economists across the spectrum agree on, it is that incentives matter.
Our C Corporation tax plan would also use the same US ETCs, but use them in a slightly different way that is revenue neutral and that also provides more of an award for C Corporations that hire in more socially responsible ways. This is done by making the US ETCs worth only $.04 on the dollar, but allowing C Corps to exercise these tax credits to an even lowered effective tax rate than within our personal income tax plan. Plus, C Corps that have a higher mean wage than the prevailing wage of the geographic areas where they employ would be awarded a tax credit tax that is worth more than $.04 on the dollar and/or they could exercise the credit to an even lower tax rate.
While our C Corporation tax plan would appear to be revenue neutral if statically scored, the plan would incentivize the creation of enough new private sector jobs that a significant amount of new tax revenues would be raised. To read all about our personal income and C Corporation tax plans, along with our capital gains, FICA, and environmental tax plans, visit ThirdWayProgressives.org.
Now that our US ETCs have been explained, let us see why they would be even more efficient and would develop even more prosperity than would the rightfully popular R&D tax credits and early write offs of capital expenses. There are two primary questions to ask when it comes to comparing tax incentives and credits. The first is: In relation to the cost of the incentive, how well does the incentive achieve what it was enacted to achieve? The second is: How easy is it for the IRS to police the tax incentive?
Starting with policing, it is obvious that our US ETCs would be one of the easiest tax incentives of all to police. This is true primarily because nothing is more comprehensively documented in the area of tax policy than are W-2’d employee expenses. They are comprehensively documented, using multiple forms of documentation, from both the employer and employee, and on both the state and federal government levels.
Sure it is all too common for undocumented workers to use phony forms of documentation to work in the US. However, if an employer were to exercise a US ETC for employee expenses given to an undocumented worker in the US, at least these employee expenses would be going to someone working in the US and therefore most of this wage would be spent in the US. This is not true for many tax incentives that can be taken for expenses that are actually spent in a foreign nation. Further, it would be very easy to require, as a prerequisite for exercising a US ETC, that employers use the IRS’s E-Verify System. Also, in a very important way the US ETC would actually create an incentive for employers to pay higher taxes. This is because all those employers in the US who are currently paying employees under the table and not paying FICA taxes would have an incentive to claim all of their employee expenses and pay FICA taxes in order to exercise the US ETC. This is because a US ETC could not be exercised without an almost equivalent FICA tax being paid; the US ETC being worth more to the employer than the existing FICA tax expense. Avoidance of FICA taxes by employers has been a growing problem, and it will become even more so the higher we raise FICA tax rates.
Secondly, R&D and capital expenses are much harder to pin down and define, and are therefore much harder to police as tax incentives. It is much harder to determine whether a business expense is an R&D expense or simply a general businesses expense. This is both true for employee expenses that are said to be used for R&D and capital expenses that are said to be used for R&D. Capital expenses can also be problematic in this regard. With every capital expense the IRS must ask, are these expenses actually legitimate business expenses or personal expenses used by those running or owning a business? Further, many hands on investigations are needed by the IRS to determine whether a capital expense is being used in the US or in a foreign country. Whereas again, nothing in tax policy is more clearly cut than W-2’d employee expenses up to the FICA tax cap.
Regarding the effectiveness of US ETCs, R&D tax credits, and early capital expense write offs, all three have the primary goal of increasing private sector jobs in the US, yet once again it can be shown that the US ETC is superior. For one, because as is shown above that it is easier to make certain that more of the US ETC is spent in the US, more of the federal expense of the US ETC will be spent in the US than would the federal expenses for the other two tax incentives. This will mean that the US economy will grow more with US ETCs. Also, and very importantly, there is nothing to mandate in law that R&D expenses that are spent in the US will mean that whatever new technologies and ideas that are generated by this R&D will lead to jobs in the US rather than jobs in a foreign nation. The same is true for capital expenses that are used in a foreign country but written off as though they were spent in the US. The US ETC does not have this problem.
One of the great aspects of R&D tax credits and early capital expense write offs is that they primarily help manufacturing businesses, and manufacturing businesses typically pay on average a higher wage than do most other business sectors of the economy. Yet our US ETCs also accomplish the same thing. For one, within our current C Corporation tax plan, a tax credit could be worth more than $.04 on the dollar and/or a lower possible tax rate could be achieved if the mean wage of a business is above the prevailing wage of the geographic area where they are employing in the US. The same could be true with our personal income tax plan if desired. Secondly, more and more evidence shows that manufacturers find it more efficient and productive to conduct their R&D and make their capital expenses where they do their manufacturing. Therefore, if we were to enact US ETCs and therefore create more of an incentive to manufacture in the US, more R&D and capital expenses would follow this manufacturing into the US, even without an R&D tax credit and early capital expense write offs!
Our overall tax plan also contains a capital gains and FICA tax plan, together raising $558 billion in new federal revenues in the first 10 years. Our capital gains tax plan alone, and statically scored, would raise over 63% more federal revenues than President Obama’s capital gains tax plan. Statically scored, our overall tax plan would raise $1.25 trillion over 10 years versus the President’s tax plan and the Deficit Commission’s tax plan that would raise $700 billion and $925 billion over 10 years respectively. Our overall tax plan would create or save over 11,553,000 private sector jobs between 2013 and 2020, while studies propose that the President’s overall tax plan would create the loss of over 6,243,000 jobs through that same period (1). It is safe to say that the Deficit Commission’s tax plan would create the loss of even more jobs. If this jobs data were then dynamically scored into these federal revenue projections, our tax plan would raise as much as four to five times the federal revenues as the other two tax plans! For much more information on all components of our tax plan, visit ThirdWayProgressives.org.
The last reason why the US Employee Tax Credit is the best tax incentive is that it is one of the few, if not the only, tax incentive that could set the political stage for a grand compromise between Republicans and Democrats. The US ETC, along with our overall tax plan, would lead to the best case scenario for income taxes going up after the 2012 election! For more information on why this is so, read our paper, “A Compromise Where America Wins”, that can be found at the Weekly Blog section of our website, ThirdWayProgressives.org.
1. Obama Tax Hikes: The Economic and Fiscal Effects, Published on September 20, 2010 by William Beach , Rea Hederman, Jr. ,John Ligon , Guinevere Nell and Karen Campbell, Ph.D. Center for Data Analysis Report #10-07