The Biden administration has announced some of the biggest changes to US federal spending and taxation in peacetime in its first 100 days in office.
While some of the new spending measures will have a positive economic payoff, the tax measures proposed to finance them will be a long-term drag on US economic growth and dynamism, with potential implications for US investment in Australia.
The new administration has either legislated or proposed some $US6.4 trillion ($8.3 trillion) in new spending under the headings of the American Rescue Plan, Jobs Plan and Families Plan, with more spending still be announced.
While some of the new spending measures will have a positive economic payoff, the tax measures proposed to finance them will be a long-term drag on US economic growth and dynamism, with potential implications for US investment in Australia.
It is difficult to generalise about the economic effects of such far-reaching spending proposals, but it is possible to point to some measures that will have a positive economic payoff.
It would be almost impossible to overspend on the vaccine rollout given the benefits that will flow from greater resistance to COVID-19. The vaccination effort has been one of the few bright spots in America’s pandemic response.
Similarly, extensions to tax expenditures such as the Child Tax, Child and Dependent Care and Earned Income Tax credits will provide much-needed support for families and workers without qualifying children.
Other elements of the administration’s spending plans raise significant questions about design and implementation, as well as opportunity cost. While such far-reaching spending measures are necessarily a mixed bag in terms of their macro and microeconomic effects, the tax proposals for the most part will weigh on future investment and economic growth by increasing the tax burden on capital.
The Biden administration has reversed the centrepiece of the Trump administration’s 2017 Tax Cuts and Jobs Act, the reduction in the US corporate tax rate to 21 per cent.
The US will now re-join Australia in having one of the highest corporate tax rates among OECD countries, with a combined federal and state statutory rate over 32 per cent. The average rate for OECD countries not including the US is around 23 per cent.
The higher corporate tax will penalise US companies relative to foreign competitors and reduce investment and incentives to produce in the US relative to the rest of the world. This runs counter to the intent, if not the effect, of much of the Biden administration’s policy agenda aimed at re-shoring economic activity and preventing profit-shifting.
It is no surprise that both the US and Australian governments have supported a globally coordinated minimum tax. While this is sometimes portrayed as an effort to prevent a ‘race to the bottom’ on corporate taxation, the average OECD corporate tax rate is little changed over the last decade.
While the administration is also proposing to increase the tax burden on the foreign economic activity of US corporations, the net effect is likely to be a greater penalty on the US relative to foreign economic activity.
US multinationals can be expected to significantly restructure their global operations and ownership in response to this increased tax burden. Given that the US is Australia’s biggest foreign investor, this is also likely to affect the US corporate presence in Australia, even though Australia will now enjoy a small competitive edge over the US in terms of our statutory corporate tax rate of 30 per cent.
In this context, it is no surprise that both the US and Australian governments have supported a globally coordinated minimum tax. While this is sometimes portrayed as an effort to prevent a ‘race to the bottom’ on corporate taxation, the average OECD corporate tax rate is little changed over the last decade.
The bigger source of erosion in the US corporate tax base is growth in the share of US equity held by foreigners or by Americans in non-taxable retirement accounts.
The Biden tax proposals will also penalise investment through a higher capital gains tax rate. It has long been recognised, both in the US and Australia, that capital gains should be taxed at a lower rate than labour income.
Yet the new administration’s top capital gains tax rate above 43 per cent would exceed the tax rate on labour income when combining the top US income tax rate with other taxes. The proposed maximum tax rate on capital gains will be the highest since the 1920s.
Both historical and international experience suggests that higher rates of capital gains tax result in fewer realisations of assets, lowering the tax take. Capital gains tax is easy to avoid simply by not selling the assets subject to the tax. The increased capital gains tax rate incentivises such avoidance.
This creates a lock-in effect for existing investments, reducing the agility and efficiency of capital allocation, making capital gains tax a particularly inefficient revenue raiser.
The increased tax burden on capital, while notionally designed to pay for the Biden administration’s new spending proposals, will actually make it harder for the US to finance increased federal expenditures in the long run by slowing growth in the US tax base.
The Biden administration could have chosen other, more growth-friendly tax measures to finance its increased spending that would have raised more revenue.
Like Australia, the US will ultimately have to grow rather than spend its way out of its post-pandemic debt burden. Both countries will have to come to grips with fundamental tax reform, not least in respect of corporate taxation.