The Case against the Biden Tax Hikes

Having noticed that the government budget is running obscene deficits, that the national debt is expanding beyond our ability to pay, and that spending money on infrastructure is very popular, the Biden administration has proposed new tax levies-- on rich corporations.

It is part of the administration plan for a flood of new infrastructure spending-- almost as a way to pretend that we are going to be able to pay for it.

Other states and municipalities are also going into the tax raising business, though with slightly less fervor.

Taxing the rich, especially rich corporations, plays well politically. It is better than taxing the average Joe or Jane. And yet, how effective is it? How much will it really forestall the need to increase taxes on transactions that involve the middle class.

In principle, Republicans oppose tax hikes, because they are ineffective. And yet, the GOP seems barely to be capable of explaining why they are against tax hikes.

Since I posses no expertise in this area, I turn to David Rosenberg, Canadian market strategist extraordinaire. I posted about some of his views of the markets and readers seemed to be happy to read them. No one said that he or anyone else is always right, or always wrong, but he presents a more cogent argument against tax hikes than your average Republican has. And, of course, he is highly respected by Wall Street bankers-- for what that's worth.

Rosenberg begins with a comment on the Trump tax cuts, especially about where we were before the Tax Cuts and Jobs Act was passed. In short, we were not in a good place:

It helps to understand where things were before the 2017 Tax Cuts and Jobs Act (TCJA) was passed. At 35 per cent, the headline U.S. corporate tax rate was much higher than the Organisation for Economic Co-operation and Development average of 24.2 per cent. Just as important was the unique absence of an exemption for repatriated foreign business income: U.S. multinationals were keeping billions of foreign profits offshore.

You will recall that this was an important argument for lowering corporate taxes. Billions of dollars would be repatriated. You will note that Biden proposes to tax overseas funds, regardless of whether they are repatriated.

We know that following the Trump tax cuts year-over-year capital spending rose eight per cent in 2018, one of the best years of the past cycle for capital deepening. A reversal of the cuts could have the opposite effect.

Get it-- reversing the Trump tax cuts would diminish capital spending and investment.

And yet, the investment boom soon petered out. Some companies chose not to increase capital investment, but preferred to buy back their shares:

However, the impact of the TCJA was temporary (many tax planners knew even at the time that the 21-per-cent corporate rate was unsustainable), with capex fading the following year even before the onset of the pandemic, to just two per cent in 2019. Some of the windfall also went to share buybacks, which skyrocketed temporarily to a high of US$223 billion for the S&P 500 in Q4 2018 from US$137 billion in Q4 2017.

As for Biden plan, Rosenberg continues, raising corporate taxes will surely have an unwelcome side effect-- lower corporate investment. Businesses hate uncertainty and they are less likely to invest when they do not know what their future taxes will look like:

However, the problem with tinkering with corporate taxes is that it creates uncertainty for businesses embarking on multi-year projects. What business is going to embark on a major multi-year spending project without knowing what the after-tax rate of return on the capital invested is going to look like?

What would happen if the Biden plan goes into action. Not much that is very good. America would become the highest taxed country in the OECD, and this would decrease our competitiveness:

As well, the proposal, as it stands, would raise the U.S.’s combined corporate income tax rate to 32.3 per cent from 25.8 per cent, positioning the country as the highest tax jurisdiction among OECD countries and decreasing U.S. competitiveness. The impact could be a short-term freeze in capital expenditures, particularly as companies hold off during the months of negotiations that will no doubt ensue as G-20 countries work towards a harmonized tax plan.

Rosenberg explains that raising corporate taxes will not have much of an effect on the budget deficit. After all, corporate taxes contribute very little to the government’s budget:

There is still quite a bit of negotiating to be done on this file, even within the Democratic party, but the Treasury’s estimate of raising US$2 trillion from the final package of reforms seems far fetched and, of course, will be affected by unknown behavioral effects. It’s also important to remember that corporate income tax contributes a relatively tiny amount to governments’ bottom line — maybe five to 10 per cent at best. History shows that to be very stable whatever the rate and whatever the base. There is no way the corporate tax changes will pay for much in the way of infrastructure.

So, it’s a grand illusion. The Biden tax plan will not even come close to paying for the infrastructure spending it is proposing. In the end, Rosenberg concludes, America is going to be faced with the prospect of a new consumption tax or a value added tax-- tax that disproportionately hurts those of low and middle income. 

Of course, we can also deal with the debt by inflating the currency or simply by defaulting.