A Conversation with Alex Brill
INTERVIEW CONDUCTED BY NAHUEL FEFER
Introduction:
Mr. Brill served as the Chief Economist of the House Committee on Ways and Means from 2002 to 2007. In this role he helped shape the Bush tax cuts, and worked on a variety of other issues related to economic policy. Since 2007 he has worked as a research fellow at the American Enterprise Institute. Mr. Brill visited Wash U on October 30th, 2014 to discuss tax inversions, a controversial tactic used by some companies to avoid US corporate taxes. Before his talk, WUPR had the chance to discuss a variety of economic policy issues with Mr. Brill.
Inequality and the Minimum Wage:
Fefer: Before we discuss tax inversions, I think it’s important to place that conversation within the context of your broader perspective on the challenges facing the US economy. Now, Arthur Brooks, the President of the American Enterprise Institute, recently explained that over the past decade, if you adjust for inflation, the bottom half of the American economy has stayed stagnant or has lost purchasing power. And the data backs this up, even though labor productivity is rising, median incomes in the United States have stagnated since the ‘80s. So, what’s behind this disturbing trend, and how can we reverse it?
Brill: So, Arthur’s absolutely right. The economy, in the aggregate, and when we measure it in the simplest terms, in terms of Gross Domestic Product, or real GDP, the US economy is growing, and it’s growing sort of at moderate pace, could be faster, could be worse. But when you peel back the onion and you look more closely at the components of the economy and you look at the economy from a household perspective, you see, just as Arthur has described, a wide variety of outcomes, and the ones that are most troubling are when you look at these statistics with regard to lower income households, or as is often cited, median incomes. So median incomes in the United States are fairly stagnant. It varies regionally, it varies depending on the data points you use and how you adjust for inflation, but there is no story one can tell that says that those right in the middle of the distribution are experiencing a lot of prosperity. So, how do you pull together those two facts, how can the economy be growing while those in the middle aren’t feeling any better. … It’s curious I think to a lot of economists why that is. It doesn’t surprise economists when the economy grows at a pace slightly different than income grows, but in general as we invest and as the economy grows, the benefits of that should be appreciated across the spectrum. Globalization is a factor, because we’re importing more, because a lot of US workers are competing with workers around the globe, they have less power to negotiate for higher wages, and some of it is simply not well understood.
Fefer: So if it is partially a bargaining power problem, one solution the Obama administration has proposed is a minimum wage, what impact do you think that would have?
Brill: I think that any concrete steps to change the federal minimum wage are unlikely. But the economics of that are an interesting one. It’s moving clearly and concretely away from basic free market principles where the wages would be set in a market place, and saying, it’s just not right for someone to make below a certain wage. … So as we artificially raise the wage rate we’re going to see a substitution towards capital in general terms, in practical terms, and we’re going to see more automation and things like that.
Fefer: The empirical data on its effects is mixed though, isn’t it?
Brill: I mean there certainly is a debate about what the market can bear. Obviously there’s sort of a principle issue here: should the government be setting a wage floor, and then there are practical questions about what the consequences are. As a practical matter it’s going to depend a lot on where you set the wage, where you set that floor. It’s going to depend a lot on what minimum wages states have. Many states … have their own minimum wage, either above or below the levels that are being debated by the Obama administration, and so the actual consequences are going to depend on the specifics.
Tax Inversions:
Fefer: Can we just begin by defining tax inversions, and explaining the objection that some politicians both in the democratic and republican parties seem to have with them?
Brill: Sure. A corporate tax inversion is a transaction by which a US … headquartered corporation merges with a foreign corporation, generally a smaller corporation, and at the end of that transaction, that … US based corporation has relocated its tax headquarters abroad, generally into a foreign tax jurisdiction that is more tax favorable. It doesn’t necessarily have anything to do with the location of physical assets for these corporations, the location of the president or CEO of these corporations, or the locations of its employees. … The reason why a US company would consider switching its tax headquarters, has to do with the difference between the US corporate tax system and virtually every other country’s tax system…. Now, just as we tax our income domestically, France or Brazil or Germany or Canada taxes income earned in those countries domestically as well, and so a US multinational pays tax on their US activity but also pays tax in France on their French activity to the French government. What’s unique about the US tax code is that the US tax code also taxes the income that’s earned in France, and taxed by the French authority. Now they only tax the excess, meaning if the French tax rate is lower than the US tax rate they tax the additional amount.
…
Fefer: Even if it’s rational, as you argue, for a company to want to headquarter in another country, aren’t they then, by keeping a lot of their operations in the United States, effectively free riding on the tax system, on the education and highways those taxes pay for?
Brill: That certainly is one of the arguments that’s being advanced: as a matter of fairness, they would suggest, these corporations should pay what they owe, and that they’re cheating the system by sneaking outside of the US, … [they] are breaking the rules, perhaps legally, but [they] are violating the intent of the rules by sneaking into Ireland or into Canada.
Fefer: And deriving a competitive advantage from it against … companies that remain domiciled in the United States.
Brill: Sure, the argument back has a couple of pieces. One, sort of on the competitive advantage, these firms argue, and I think persuasively, that the competition that they’re facing are foreign competitors who have a more advantageous system. … On the sort of, fairness, we need this money to pay for the roads to pay for the roads, to pay for the schools, to pay for national defense…to put the issue in budget context, the legislation that’s been suggested that would make these deals either impossible or virtually impossible,… the best guess is that they’ll raise about $20 billion over the next decade. $20 billion is a lot of money, but …over the next decade there’ll be about $4.5 trillion paid by the corporate sector. So that this is, one could almost argue, a rounding error relative to the amount of tax payments that are being made.
Bush Tax Cuts:
Fefer: Let’s talk briefly about the Bush Tax Cuts. Now you’re on the record as saying that they made sense at the time, that the goal was to reduce surpluses and that they did so, they did so extraordinarily effectively. … But my question isn’t about whether they made sense at the time, it is, knowing what you do now about how that decade went, if you were at the table again, would you recommend implementing a series of tax cuts? Would you change the policy? If so how?
Brill: So, we’ve had this debate, obviously, again, because those tax cuts that were enacted in 2001, and extended a few times, periodically do expire, and so lawmakers have had to face this question: should we make the Bush tax cuts permanent. We faced that choice first in 2010 and then again in December 2012. Lawmakers said the first time, yes, we should keep all these tax cuts just as they are, and the second time they said no, we should keep almost all of them the same, but we should raise the top rate. …No one has been arguing to truly repeal the Bush tax cuts. The Bush tax cuts, you know, at the time they were enacted… included significant policy changes that certainly did not affect only those at the top of the income spectrum. Things like doubling the child tax credit from $500 to $1000, creating a 10% bracket when one previously didn’t exist spanning the Earned Income Tax Credit, those issues have actually never been debated. …
Fefer: …Most people agree that reducing marginal tax rates, particularly for middle income Americans, does have a stimulating effect on the economy, because they have larger marginal propensities to consume, and that means they spend a lot of their tax savings, and that helps the economy. But the question that a lot of people are asking is how do the lower marginal tax rates on the wealthiest individuals, how does that stimulating effect work?
Brill:…In terms of the impact of marginal rates at different spectrums, at the higher rates, and I don’t want to get hyper technical, but the higher the rate is to start, the bigger the impact is of a one point reduction, in terms of the deadweight loss associated with the cut. …And so the distortions caused by having the rate be 39% vs. 35%, are larger than when one would examine the consequences of having the rate be 19% versus 15%.
Fefer: Well the question is where are those savings, there’s no question that the savings are larger, but where are those savings going, how are they used?
Brill: So, those who are paying the highest marginal rates are some of the largest savers and investors in our economy.
Fefer: And outside of our economy.
Brill: Right, and so it’s less about marginal propensity to consume, and more about sort of fundamental drivers of long term growth, which is savings and investment.
Fefer: But in a demand deficient economy the question of how this will stimulate the economy remains, doesn’t it? Because, if we have a demand constrained economy, then all that saving can’t be used, or not effectively, to improve the short term economic output, and that explains why so much saving flows out of the country.
Brill: Yeah, and so for that reason I’ve argued that we shouldn’t try to craft our tax policy relative to the business cycle. That these are actually not great tools for moderating or accelerating demand, obviously they’re tools that are often used, we often think about tax policy as a means for a stimulus, but it would be more efficient to think about it as a tool for driving long term economic growth.
Capital Gains Tax
Fefer: Last policy question … and it’s about the capital gains tax. Why is it that capital income, returns to capital, are taxed at a much lower, and in a less progressive manner, than returns to labor?
Brill: That’s a great question, my answer in short is that … I believe it to be the case that investment decisions are more sensitive to tax policy than labor market decisions. Both are affected, when marginal rates go up, people may work less, and when marginal rates go up people may save or invest less, but those responses are different. One could argue on a number of grounds that we shouldn’t have this two-tiered structure. In particular, recently people have started to talk about raising the capital gains rates in exchange for lowering the corporate tax, maybe it’s easier to tax the shareholders instead of the corporation itself, and I think it’s an interesting idea in the context of broader tax reform…
The context of why it was reduced in 2003 was in part policy and in part politics. The issue that was brought forward to Congress by the administration at that time was in essence a dividends reduction, a cut in the dividends tax rate. That received a certain amount of political interest, but perhaps not a sufficient amount to get it over the finish line, so congress, the ways and means committee added in a lower capital gains rate. Now, that’s the politics of it, the policy of it, the underlying policy is that lower capital gains rates will lead to increases in capital investment because of the sensitivity of investors to taxes and the after tax rate of return.
Fefer: Again, assuming that we don’t have demand constraints in place.
Brill: Correct, these are long term impacts.