Fixed-Pie Fallacies and Tax Loopholes

Closing tax “loopholes” has been a major talking point of both presidential candidates as of late. But this kind of language distorts the conversation from the get go. As columnist David Harsanyi explains,

Basically, all of life is a giant loophole until [politicians] come up with a way to regulate or tax it. In its economic usage, “loophole”—probably more of a dysphemism—creates the false impression that people are getting away with breaking the law. It’s a way to skip the entire debate portion of the conversation and get right to the accusation.

So when Hillary Clinton promises to close the loophole of corporate inversion, what she means to say is that Democrats disapprove of this completely legal thing that corporations do to shield their money from the highest corporate tax rate in the developed world. Loopholes are like giveaways, monies that D.C. has yet to double and triple tax.

…But Bernie Sanders, bless him, just skips the entire perception game and just comes out with it by tweeting: “The offshore tax haven network isn’t something that we need to reform or refine. It’s a form of legalized tax fraud that must end.”

“Legalized tax fraud” is a revealing statement about the progressive belief system. For progressives, taxation is moral. So when you fail to pay an imaginary tax that doesn’t exist but Democrats think should, you are by default engaged in fraud. The law has just to catch up with sin.

Megan McArdle has lamented the “regrettable tendency” of legislators “to view their citizens, and particularly their corporate citizens, as a species of tax cattle.” She points out that the first-time-homebuyer tax credit is morally no different than tax-exempt municipal bonds or your 401(k). She points out that if we were to, say, get rid of tax-free bonds, “[i]t would be more expensive for local governments to borrow money. Rich people are paying for that tax benefit by accepting a lower interest rate on municipal bonds than they would if they had to pay taxes on that money. The net effect is a federal subsidy for local spending. If we remove the deduction, local governments will find their budgets pinched[.]” She also points to charitable deductions and corporate tax rate shopping at the local and international level. “Unless,” she writes, “you want the kind of government enjoyed by the majority of the people of the world — and to ship most of your money to those places, while getting little in return — then stop complaining that other countries exist, and that their existence makes it hard to keep the local tax cattle properly penned in.”

When groups like Americans for Tax Fairness complain about tax “loopholes” and demand that we should “end tax breaks for corporations that ship jobs and profits offshore,” they are ignoring the points above as well as the following evidence. Harvard’s Mihir Desai has done extensive work on this subject. “When American firms grow abroad,” he writes in The Wall Street Journal,

Image result for fixed pie economicsthey also grow domestically, as demonstrated by research I conducted with C. Fritz Foley of Harvard and James R. Hines Jr. of the University of Michigan (published in the American Economic Journal: Economic Policy, 2009).

The data do not support the crude, fixed-pie intuition that firms either invest abroad or at home. Ten percent growth in American firms’ foreign investment is associated with 3% growth in their domestic investment. And when firms grow abroad, their domestic exports and R&D activities grow especially…Vilifying or penalizing American businesses for their global operations will only lead them to consider leaving the U.S.—or consider being bought by foreign companies. Such moves would hurt America by removing valuable headquarter jobs.

The fixed-pie fallacy breeds protectionism. And protectionism manifests itself in many forms.