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Friday, May 5, 2023

Weekly SSRN Tax Article Review And Roundup: Roberts Reviews Clausing’s Capital Taxation And Market Power

This week, Tracey Roberts (Cumberland; Google Scholar) reviews a new work by Kimberly Clausing (UCLA; Google Scholar), Capital Taxation and Market Power.

Roberts (2020)

On Tuesday the Wall Street Journal reported that Americans are facing continued price increases, not because of pandemic-related supply-chain disruptions or because of rising energy costs following the Russian invasion of Ukraine, but because corporations are simply padding their profits. How is this possible in a free market? Well, the market is not exactly free. Mergers and consolidations have given large corporations the ability to exercise market power. Because so few companies compete with one another for customers, they can set monopolistic prices. Likewise, when there are fewer companies competing for workers or resources, they can engage in monopsony, paying lower wages and lower prices than they would be able to claim in a competitive market. Scholars and journalists have reported that employers are forcing employees across many sectors to work longer, for less pay, and in more difficult conditions, and are effectively reducing employment opportunities.

Powerful, tax-favored entities have also been extracting economic rents by acquiring projects and products for which there is inelastic supply (energy supply, housing) or inelastic demand (life-saving drugs, life-flight services). Furthermore, the tax system has supported the systematic hoovering up of Americans’ equity in their professions, farms, and more recently, in pensions and other retirement vehicles. These activities have exacerbated inequality, supported race and sex discrimination, and undermined consumer welfare.

In her new article, Capital Taxation and Market Power, Kimberly Clausing has surveyed the recent economic scholarship on these trends, underscoring that declining competition has also undermined market fundamentals, reducing investment, quality, productivity, innovation, economic growth, and market dynamism. Furthermore, corporations enjoying market power redirect their profits toward government capture to ensure their continued extraction of economic rents. More importantly, she has also proposed a reform: modifying the corporate tax to apply progressive rates to the highest levels of corporate income. She argues that the corporate tax is a better instrument than antitrust regulation to address these ills because regulation has been slow to resolve issues and enforcement has been sporadic. In contrast, the corporate tax is direct, transparent and immediate. While other tax reforms have been proposed, she notes that entity-level taxation is really the only way to reach income from investment. Seventy percent of stock holdings are not subject to income tax at the individual level because they are held by foreigners, retirement plans, nonprofits, and insurance companies. The remaining investors who are subject to the income tax may easily avoid taxes on capital income by deferring sale of their assets until death, when they receive a step-up in basis under IRC §1014.  Therefore, individual taxation is not a good solution.

By imposing the higher rates on corporate income in excess of $100 million, the United States would be able to increase revenue while avoiding the adverse effects on entrepreneurship, useful risk-taking and workers’ wages. Numerous broad-based studies show that the corporate tax base is comprised primarily of above-normal returns to capital, excess profits. These profits are also concentrated in largest companies. By structuring the graduated rates system to apply higher rates to only the highest corporate incomes, Clausing leaves the vast majority of corporations (and normal returns to capital) unburdened. Most corporations would, in fact, likely benefit from a more competitive environment. Furthermore, higher rates would not undermine existing tax subsidies that support entrepreneurship, such as income averaging via net operating losses and preferential capital gains treatment for founders’ stock. She notes that other policies and institutions may be as, or more, important than taxation in spurring innovation: education, immigration, research, and legal, banking, telecommunications, and transportation infrastructure.

The most significant challenge to her proposal will be addressing the likely behavioral responses: corporate inversions, profit-shifting, corporate divisions, and change in entity form. She notes that implementation of the OECD / G20 / Inclusive Framework establishing a corporate minimum tax of 15% could be enforced by adopting countries against corporations headquartered in non-adopting countries by topping up the tax they owe through an Under-Taxed Profits Rule. Existing benefits of agglomeration, economies of scale and scope, and cost-beneficial synergies from internalization may also offset the pressure to avoid the higher rates through corporate de-mergers and splits. Nevertheless, the reforms may need to be expanded to encompass all U.S. business entities to be truly effective. Unfortunately, it may be an arduous task to enact these policies precisely because the business entities facing higher rates under the proposed reforms have already amassed such significant market power and influence in politics.

In 1944, Fredrick A. Hayek published The Road to Serfdom, arguing against central economic planning, and in favor decentralized markets and competition. Far from voicing strident anti-government rhetoric, Hayek stressed that some forms of regulation might be salubrious, such as those that create conditions in which competition would be as effective as possible, breaking up monopolies, and preventing fraud and deception. Undergirding Hayek’s arguments in favor of competitive markets was his insistence on the rule of law, granting the same legal rights to all, rather than reserving them to the few and powerful. Unfortunately, the tax system has been a key tool by which “aspiring monopolists have obtained the assistance of the state to make their control effective.” In Capital Taxation and Market Power, Clausing has identified key reforms that could reduce corporate consolidation of market power, restore economic competition, and bolster the rule of law. We can only hope that we have the political will and savvy to see them through and abandon this new road to serfdom.

Here’s the rest of this week’s SSRN Tax Roundup:

https://taxprof.typepad.com/taxprof_blog/2023/05/weekly-ssrn-tax-article-review-and-roundup-roberts-reviews-clausings-capital-taxation-and-market-power.html

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