Greg Mankiw's Blog: Is comparative advantage obsolete?

Greg Mankiw's Blog: Is comparative advantage obsolete?

Fair enough, but it remains the case that the United States is, through misguided tax policies, destroying its sources of natural advantage. For decades the United States was effectively the only country that really mattered. We had such a tremendous advantage in wealth, manufacturing power and technology that we could afford to toss away resources, whether it be on rebuilding Europe and Japan, on engaging in the expensive arms race that broke the Soviet economy, or on misguided policies that encouraged U.S. firms to locate their activities abroad. That time is gone. We now owe more than $9,000,000,000,000 to foreign countries because we no longer sell enough things that other countries want to be able to pay for the goods that we import. Our manufacturing operations have largely relocated to other countries – we became a net importer of high technology goods for the first time in 2002, and our deficit has increased each year since then. America’s dominance of technical publications and college degrees is fading quickly and surely.

Globalization was supposed to help our country by opening up foreign markets for our products, but that presupposes that the United States produces things that other people want to buy. As foreign nations with low wage rates have improved their infrastructure, though, companies have naturally moved their manufacturing operations to locations where the wage rates are a fraction of what they are in America. The economists tell us that fact should not worry us, because of the theory of “natural advantage”. Low value, labor intensive production will move to developing nations with low wage rates, but it will be replaced by the production of high value, high technology goods here in the U.S., which will benefit everyone.

If the U.S. had sensible tax policies, that might be true. But we don’t. In our system, a corporation that earns a dollar from manufacturing high technology goods in certain countries will keep the full dollar. If they manufacture the same goods in the United States, they will keep only about 60 cents after federal and state taxes. In other words, simply by locating their high value activities abroad, a company can earn more than 50% more than if they performed the same activities in the U.S. Corporate managers are not stupid. They respond to these incentives, and the rapidly increasing number of well educated foreign workers enables corporations to shift activities to the most tax efficient location. Our “natural advantage” thus dissolves. In direct consequence, the market power of middle class American workers has been fading, leading to nearly 30 years of stagnant real income growth for the bottom 99% of our population.

The responses proposed by Congress and the I.R.S. so far have just made matters worse. The I.R.S. has been attacking U.S. research operations in a way that just encourages corporations to move their R&D to other countries. Chairman Rangel has recently proposed a measure that would encourage multinationals to fire their U.S. administrative personnel and move those activities abroad. Some in Congress have proposed subjecting U.S. multinationals to current world-wide taxation of all of their income, a move that would decrease the value of many companies by 25% or more and cause them to be acquired by foreigners with large reserves of cash in strong currencies. We cannot afford such policies any more.

There is a simple solution. The Shared Economic Growth proposal, explained in detail at www.sharedeconomicgrowth.org , would instead provide a strong incentive for corporations to move their valuable operations back inside the U.S. borders, simply by allowing corporations a deduction for dividends that they pay out. At the same time, it would increase the earnings working people receive on their pension savings by over 50%. The proposal is largely self-funding (no voodoo economics here – the corporate tax savings are directly made up for by taxes on the shareholders receiving the dividends), with the balance of the revenue made up by eliminating a couple of unnecessary and unfair distortions in our tax code, and by an extra 7.5% tax on individual income in excess of $500,000 per year. This is a small price to pay for saving our economy, restoring our economic security, giving market power back to the middle class, and boosting pension savings. The problem with the proposal is that it does not fit neatly into either party’s usual set of canned speaking points. Enacting it would require politicians to care more about policy than about politics. Does anyone out there care enough about America’s future to stop bickering and do something useful for a change?

A Bigger Slice of a Bigger Pie for Middle Class Americans

To all who care about our country, our economic security, and the future of our children:

Please consider the following issues:

The U.S. tax system, which has remained virtually unchanged for 20 years despite dramatic tax reforms abroad, strongly discourages companies from locating operations and jobs in the United States or otherwise investing here. It places U.S. companies at a significant competitive disadvantage in comparison to foreign rivals. For a given level of pre-tax profit, earnings from foreign-based operations may be 54% higher than from U.S. based operations - in other words, our tax laws create a situation in which a company can increase its profits by 54% simply by choosing to locate good jobs abroad, rather than here at home. The resulting lack of investment in the U.S. limits the bargaining power, productivity and wages of American workers. In fact, the real earnings of 80% of working Americans have remained stagnant over the past three decades.

Without drastic tax increases and benefit cuts or economic growth at a rate that has not been seen since World War II, the federal government predicts that increases in the cost of current retirement and healthcare benefits for our aging population will cause spending to exceed tax revenues as early as 2017, and the imbalance will only get worse in subsequent years. Yet the U.S. tax system effectively discourages working Americans from saving for college and retirement, making them even more reliant upon social safety nets that are not safe. The tax system imposes a hidden 35% tax on pension investments, investments that people think are protected from tax.

Our federal budget deficit and national trade deficit continue to grow, and the funding for this increasing debt comes, in significant part, from foreign governments that gain political leverage from our dependence on their money - over 9 trillion dollars ($9,000,000,000,000) worth that could be withdrawn at any time.

Intellectual capital and innovation are more important drivers of economic growth and prosperity than ever before, yet America's technical superiority over other nations is gradually but indisputably declining. Unlike many foreign tax systems, the U.S. tax system does not encourage the development of a knowledge-based economy that would make us less susceptible to competition from low-wage countries. The one advantage that has protected the strength of our economy is fading quickly.

The U.S. tax system is premised upon the concept of progressivity -- that is, through a graduated rate structure, the more an individual earns, the greater share of income taxes that individual pays. This principle ensures that the burden of maintaining our society is distributed based on ability to pay and on the relative benefit that persons have received from living and working here. However, progressivity is compromised all too often under our tax system. For example, recent news about "carried interests" revealed that individuals who are making fortunes investing cash for pension funds and the like pay tax at only a 15% rate, much less than what many middle class workers pay on their wages.

If any of these facts disturb you, please visit the additional pages here at www.sharedeconomicgrowth.org to learn more. This web site describes all of these issues in further detail and explains a simple tax reform proposal that would address them all. The proposal would greatly strengthen the U.S. economy, while ensuring that the benefits of that strength would flow to Americans from all walks of life. Briefly, the proposal would allow corporations to deduct all dividends they pay to shareholders. It would fund this benefit by raising the special favorable tax rates that individuals pay on capital gains and dividends received, eliminating a tax exception that allows permanent avoidance of tax on gains if individuals hold on to investments until death, and imposing an additional 7.5% tax on individual adjusted gross income of $500,000 or more per year. The proposal would raise the average effective tax rate of persons in the highest bracket to only 34% and the top marginal rate to 47%. (As the main paper explains, this actually raises and extra $36 billion per year more than is needed to offset the corporate tax revenue, and other sensible offsets are available, so there is room to address any real issues anyone may raise.) That's all there is to it, but the benefits Shared Economic Growth would provide to the U.S. economy would be extraordinary.

Why haven't you heard of such a proposal before? It would put corporate tax lobbyists out of business, it would require Democrat and Republican lawmakers alike to set aside the limitations of traditional party solutions, and it would impose some amount of additional tax on people who earn over $500,000 a year. But the benefits would flow preferentially to the quiet majority of working, saving Americans who tend not to have any group speaking up for their interests.

The proposal is valid. While the numbers included in the proposal involve certain conservative estimates, they are based on IRS and Federal Reserve data. They are fair and reasonable.

The proposal is viable, but it will not go anywhere unless citizens spread the word and contact their government representatives demanding action. The politicians do not believe that we are smart enough to understand these issues. We need to tell them that they are wrong. You, together with your family, friends, and neighbors, have the power to make this happen if you are willing to act.

Please take the time to review the additional information provided at www.sharedeconomicgrowth.org to find out more about the proposal and, if you agree that it is good for our country and you, to find out what you can do to make it happen.