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Inversion, Investment and Economic Performance

By       Message Seymour Patterson       (Page 1 of 1 pages)     Permalink    (# of views)   2 comments

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Tax rate increases on the rich coupled with austerity--arguments for spending cuts--have led to investment stagnation in the US. Investment is needed for long-term economic growth. The blame for paltry economic growth, some argue, can be traced to high taxes on business that discourage investment. These high taxes, for example, are the reasons Apple's CEO is unwilling to pay billions of dollars in taxes owed the US government. (See Washington Examiner) But Apple's Tim Cook's sin is inversion, i.e. locating a company a lower tax country, then selling at cost (including expected profits) their product to the main branch in the US, and paying taxes (if any) on a sliver of profit. This way Apple avoids paying 35 percent to 40 percent tax on profits made abroad. Apple is not alone. In 2015, a number of profitable companies paid no taxes. According to USA Today, "27 giant profitable companies paid no taxes." This is not an aberration for in 2014 according CNBC, "20 big profitable US companies paid no taxes."

Since the countries listed by USA Today, including Apple in the Washington Examiner, paid no taxes, why should they care about tax reform? Why should they be expected to pay any taxes if the tax rate were lowered from 35 percent to say 15 percent or 8.75 percent? I would like to think that paying nothing as they are doing now trumps paying any positive rate. Logic would suggest the companies that have been successful at avoiding paying taxes would be happy with the status quo. If lower tax rates can be expected to increase investment, then where are all the investments from zero taxes?

Two points are worth making about investment. Point one: Investment depends on income and the interest rate. It is positively correlated with income, meaning that it moves in concert with the direction of income. When income rises, investment tends to rise, too. Inversely, when income falls investment falls. According to FRED (Federal Reserve Bank of St. Louis), has been trending upward for decades. In investment took a dip in Q3 2000 and bottomed out in Q4 2001. Then in Q2 2007 investment saw a steep plunge from roughly $2.7 billion to $1.8 billion in Q2 2009. (See FRED: Economic Research) The 2008 Great Recession explains this 33 percent retreat in gross private investment, implying a positive relationship between GDP and investment, alluded to earlier. For evidence, see the FRED chart below that shows the co-movement of investment and real GDP from 1947 to 2014. (Ibid.) One implication that flows from the positive correlation between investment and GDP at the macro level is that profit is income. Therefore, when a company earns growing profits, it is given thereby the wherewithal to invest in new plant and equipment and perhaps pay workers more. It does not matter that the government confiscates about half of profit is still income--half a loaf is better than no bread.


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Point two: The relationship between interest rates and investment is negative. Therefore, the current interest rate environment should be conducive to high levels of investment in the private sector. But that is not the case. Interest rates (1 year Treasury fell below one percent during the Q4 2008 to 0.49 percent. (See FRED) Since 2008 interest rates have remained below one percent--despite occasional rumblings by chairperson Janet Yellen promising higher rates. While low rates favor business that can borrow cheap money to meet their investment needs, they obviously hurt people who derive their income from interest earning assets. The expectation that low interest rates would increase investment have been frustrated because investment and income have been rising, the increases have not been as robust as might be expected. And it is possible interest rates have been so low they have no effect on investment.

The US reputedly has the highest corporate tax rate among industrialized countries. The US statutory corporate tax rate is 35 percent. However, its effective corporate tax rate, what corporations really pay, is about 27.7 percent. There were five countries (in a study of 59 countries from 2006-2009) with higher effective corporate tax rates: Japan (38.8 percent, Morocco (33.9 percent), Italy (29.1 percent), Indonesia (28.1 percent), and Germany (27.9 percent). (See Business Round Table: Global Effective Tax Rates) One might argue the US outperforms these countries because of its lower effective corporate tax rate. But that would ignore the fact that 54 other countries with lower effective corporate rates under perform the US. Among these countries are Greece (25.2 percent), the UK (23.6 percent), France (23.1 percent), Italy (21.8 percent), and Venezuela (-3.4 percent). To argue that the high corporate tax rate in the US explains inversion, it follows that were the US corporate tax rates lowered, off-shore companies would rush their operations back to the US. The irony is despite the outflow of businesses to low tax havens, the US economy is doing better than her competitors--the EU is falling apart at the seams. Consider the brouhaha over the Greek bailout, and Brexit is the latest installation in a series of missteps. The US recovery from the Great Recession, while not robust, has been steady and sustained. One must conclude a low or even a negative effective corporate tax rate (as an investment driver) is neither a necessary nor a sufficient condition for economic growth.

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Suppose the statutory corporate tax rate is reduced by 20 percentage points, from 35 percent to 15 percent and there is a failure of investments to blossom, who or what would be blamed? Chances are stifling regulations, Dodd-Frank, the debt, and a host of other evils. Remember: a tax is just a slice on income (or profit) that is returned to the economy as spending. It is the rise in income that spurs investment as the two are entangled in a positive way. A tax receipt does not change the level of income from which it came. It merely redistributes it from private hands to Uncle Sam.

 

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Seymour Patterson received a Ph.D. in economics from the University of Oklahoma in 1980. He has taught courses and done research in international economics and economic development. He has been the recipient of two Fulbright awards--the first in (more...)
 

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