Time for Washington to Think Like a State

I often think that the best thing that could happen to Washington is if it started thinking and acting like a state, instead of the largest economy in the world. States understand that they are in competition and that unless they can export products and services that the rest of the world buys they won’t create jobs and prosperity. That’s why all states, regardless of whether they are led by Democrats or Republicans, have economic development strategies. In contrast, Washington still thinks like it did 50 years ago when the U.S. economy was not in competition with the rest of the world and when our companies were dominant in industry after industry.

We see this regularly. When ITIF released our report Effective Corporate Tax Reform for the Global, Innovation Economy, I briefed a group of prominent tax economists on the report. The group included leading tax economists for Congress, Treasury, OMB and other government agencies. The report laid out 6 key principles to guide corporate tax reform efforts. When I got to the principle number 4—“In a globally competitive economy nations need competitive corporate tax regimes”—several hands shot up. One economist reflected the group’s consensus when he said “the corporate tax code doesn’t have to reflect this because while Boeing may compete with Airbus, for example, the United States is not in competition with Europe. At this point most heads were nodding in agreement. I should reiterate that these were not academic economists, or junior GS 8’s. These were senior USG economists charged with advising policy makers on tax policy.

When I share this story with colleagues, they look at me with jaws agape, in disbelief. I actually think many don’t believe me. For such a view is so patently out of touch with the reality of the 21^st century global economy that most people just don’t believe that top government advisors actually believe this. But they really do. Just look at a recently op ed by Paul Krugman where he argued that countries don’t compete with one another, only companies, and therefore the entire enterprise of trying to make the U.S. more competitive in international markets is a fool’s errand.

And when the top advisors to USG fundamentally believe that we are not in competition with other nations, they are not likely to push for policies that would make us more competitive. We see this is the current craze over corporate tax reform. President Obama, presumably on the advice of these “we don’t really compete” economists reflected this view when he proposed in his State of the Union address to “Get rid of the loopholes. Level the playing field. And use the savings to lower the corporate tax rate for the first time in 25 years—without adding to our deficit.” Sound good?  Actually, it is not. This kind of corporate tax reform is exactly what the “we don’t really compete” economists want: a corporate tax code that taxes every industry the same because the government shouldn’t be picking winners.

This brings us back to the states. State tax codes pick winners all the time. By this I mean states try to lower taxes on companies that produce products and services, like manufacturing and software, which are “traded” outside the state. They know that lower taxes on barber shops and dry cleaners don’t matter. The barber shops and restaurants won't expand if their taxes are lower. But higher taxes on mobile establishments like a car factory or software firm can mean that that car factory or software firm will move to another state. It’s also why from 1970 to 2008, corporate taxes as a share of overall state tax revenues fell from 8.3 percent to 6.2 percent. States realize that a competitive corporate tax rate, particularly on “traded firms” are essential.

In Washington, corporate tax “reform” would actually make U.S. competitiveness worse for three key reasons. First, as long as corporate tax reform has to be revenue neutral, it means that U.S. companies overall will still pay high taxes, unlike our international competitors (oops, I mean “other nations”), most of which have lowered effective corporate tax rates over the last two decades. Second, corporate tax reform risks cutting rather than expanding tax incentives which are critical to growth and innovation, such as the R&D tax credit and expensing of capital equipment.

Third, reform would end up reducing taxes on industries that face virtually no international competition (e.g. electric utilities) and raising them on industries that are fighting every day for global market share (e.g. many technology-based industries). The end result would be further movement of U.S. jobs offshore. But again, if you believe that we are not in competition who cares. Indeed, some in power today appear to hold the view that since many U.S. firms in traded industries have moved some jobs offshore that we should instead lower taxes on “Main Street” barber shops and restaurants: after all these kinds of industries have remained loyal to the United States and created jobs. Amazing! They remained “loyal” because they had no choice. Supercuts and McDonalds aren’t going to move their barber shops and hamburger restaurants to India to take advantage of low-wage workers to serve American customers. But “traded” industries will because under with the current U.S. business and innovation climate they often have no choice.

The sooner Washington starts thinking like a state the better off we will be. States don’t blame companies that move out of state. They work to make their business climate more attractive. States don’t think they are entitled to jobs. They fight for jobs. States don’t want their tax code to be neutral. They want it to directly support their economic development goals.

Maybe it’s time for an exchange program. Let’s send the DC “we don’t compete” economists for 1 year stints in state government to see how the real world works. They probably wouldn’t do too much harm while there and when they return, maybe they’d finally understand that the U.S. economy actually competes with other economies.