Kevin Hassett, chair of President Trump’s Council of Economic Advisers, argued today that the corporate tax cuts in the Sept. 27 Republican Unified Framework would boost overall economic growth. How? In large part because its corporate tax rate reductions would encourage firms to shift jobs from overseas to the US. But the claim is unsupported by the evidence.
In a speech at the Tax Policy Center today, Hassett said that the GOP plan would not only increase domestic employment but also raise worker wages by an average of $7,000. That is quite a promise, but after unpacking his argument, it seems improbable at best.
His claim: Making statutory US corporate tax rates competitive with the rest of the developed world would encourage firms to stop inappropriate transfer pricing, corporate inversions, and other income-shifting practices. Half of the US trade deficit, he said, results from transfer pricing.
A flawed argument
It is true that bringing US corporate rates in line with our trading partners may reduce incentives for improper transfer pricing. But there is a flaw in Hassett’s argument: While these practices are aimed at reducing tax lability, they do not represent real economic activity. And limiting income shifting won’t significantly increase domestic employment.
Transfer pricing is primarily an accounting game that works this way: Imagine a pharmaceutical company that develops a new drug in the US, where the corporate rate is 35 percent. It transfers the patent along with European marketing rights to a subsidiary in Ireland, which has a 12.5 percent corporate tax rate. Then, the European subsidiaries of the US firm pay the Irish entity an inflated price for the right to sell the drug and its income is taxed at the low Irish rate. Had the sales been made by the US parent, the income would be subject to the higher US rate.
Income shifting
Transactions such as this occur all the time, but they exist almost entirely to lower taxes. They don’t create many new jobs in Ireland. And if firms scaled back the practice, they would not create many new jobs in the US.
It is the same with corporate inversions, where a US firm merges with a smaller foreign company to benefit from its partner’s low home-country tax rate. This requires a bit of legal work to change a corporate address but even after the transaction the US headquarters staff largely stays put. As with transfer pricing, there is no real economic activity produced by the deals. Thus, there is little evidence that US employment would rise if inversions stop in response to a corporate rate cut.
This isn’t to say that cutting corporate tax rates doesn’t have some benefits. Taking this step could attract more capital which, in turn, US firms could use to boost domestic production.
Two caveats
But even that comes with two caveats. As long as Congress is unwilling to pay for those rate cuts, some of that new capital would be used to finance higher US debt, not private investment. The other issue: There is no reason to assume US firms would use any influx of investment capital to increase production in the US. They could just as easily use it to invest in, say, China.
And, by the way, the territorial tax system that the Big Six outline contemplates could further encourage US firms to shift revenue to lower-tax jurisdictions since that model would exempt the income of foreign subsidiaries from US tax.
Hassett made some bold promises to US workers, but, based on what we know so far, the Unified Framework can’t deliver them.
