I wanted to add some thoughts to Niklas’s post on the liberaltarian bargain of getting rid of corporate taxes in exchange for a carbon tax and a financial services tax. There are a couple of additional costs and benefits to consider here.

First, on one level this is the opposite of industrial policy. The U.S. has a demonstrated competitive advantage in financial services, and taxing that may cause many of those firms to go overseas. I know a lot of critics of the finance sector like to show charts about how large their profits have gotten over the year as evidence that it needs to get smaller, but I have never seen those numbers broken out by profits on domestic vs international customers and activities. I would bet that much of the banking sector growth has involved a growing dominance of the Wall Street as an international financial hub, and so those gigantic profits won’t somehow be magically transferred to other industries, but will instead simply go abroad. But maybe that’s a good thing, I don’t know.

Now, on the benefit side. I find myself increasingly thinking like Will Wilkinson that taxes which we usually consider value neutral like income taxes and corporate taxes are not value neutral, but are taxes on labor effort and business activity. And so we should consider if we have to discourage some activities, which ones do we want to discourage. Pollution is certainly better to discourage than business activity, and maybe financial services are too, I don’t know.

Another potential benefits depends on how elastic businesses location decisions are with respect to these taxes. Will lower corporate income taxes cause a large number of corporations to relocate to the U.S.? If so, then perhaps this can be a cudgel with which to encourage international adoption of the carbon tax and financial service tax. This is important because the effectiveness of both is largely dependent on international adoption. Other countries experiencing a large exodus of corporations to America may have little choice but to abolish their own corporate taxes, and thus may need to switch to carbon and financial service taxes to replace the lost revenue. If international adoption is a goal then we should think about choosing a bundle of taxes that will cause the largest economic drain from other countries unless they choose the same taxes. Of course, given the current potential for years of sluggish worldwide economic growth, these also need to be taxes that if we all adopted them would encourage growth, which means no protectionism. This proposed tax swap seems like the best option here.

Another benefit is that this will effectively remove the tax deductibility of  interest payments for businesses. (It has been awhile since I’ve taken corporate finance, so I might be mistaken here). The incentives created by this policy lead businesses to take on a greater level of debt, and while I have not seen it discussed much, it seems like not having that policy would have meant businesses were less vulnerable to the credit crunch. Here is Interfluidity on the wisdom of getting rid of this policy:

Eliminate the tax deductibility of interest payments by businesses. Debt financing externalizes the risks of business activity and magnifies social costs, while equity financing concentrates risk among stockholders who signed up to bear it. Yet under current rules, taxpayers literally pay firms to get rid of stockholders and take on ever more debt.

If I am correct that getting rid of corporate taxes would eliminate this problem, than that seems like a huge benefit.

In all there is much to consider with this proposal, and the potential upsides are really huge. I can’t express how much I would love the fact that, as Kevin Drum points out, it would “remove forever Congress’s ability to provide quiet subsidies and corporate welfare handouts for their buddies”. Nevertheless, it is a dramatic proposal in terms of its scope and impact, and I hope to see it fleshed out more in the blogosp-… wait, what am I saying? The un-populism of this idea ensures it will never be enacted, so it doesn’t really matter anyway.

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