Yes, Virginia, tax rates matter

They matter a lot:

For those who still claim that tax rates don't matter to economic decisions or U.S. competitiveness, we present Exhibit A: the 2004 American Jobs Creation Act.

This law gave American companies a one-year window in 2005 to repatriate earnings from foreign subsidiaries to the United States at a 5.25% tax rate. Normally companies must pay the 35% U.S. corporate tax rate, minus a credit for whatever foreign taxes they paid on those earnings.

The IRS examined the results from this tax cutting experiment and found that the money came back in a flood. More than 800 U.S. corporations repatriated $362 billion from foreign operations. Congress's Joint Committee on Taxation had predicted closer to $200 billion. These dollars are now being invested in the U.S., rather than remaining in Europe or China. This capital infusion may be one reason that U.S. business investment rose 9.6% in 2005 – the highest rate in more than a decade.

Many Democrats, liberal groups and even some economists in the Bush Treasury opposed the measure four years ago, predicting it would lose revenue and merely be a tax holiday for profitable corporations. The Joint Tax Committee estimators also blundered again by predicting a mere $2.8 billion in revenue gains in the first year and then big losses after 2005. As always, they underestimated how tax reductions change behavior. The tax incentive raised $18 billion in 2005, and revenues have continued to exceed estimates. Instead of getting 35% of nothing, as U.S. companies kept their cash abroad, the Treasury took in 5.25% of the hundreds of billions the companies brought home.

One lesson here is how hypersensitive the trillions of dollars of annual global capital flows are to tax rates. It also underscores how damaging the U.S. corporate income tax is to American firms. Over the past decade the U.S. has gone from a below-the-average corporate tax nation to the second highest rate in the industrial world. (See table.) Many countries have slashed their corporate rates to as low as 10%. The economic impact is even worse because the U.S. is one of the few countries that taxes foreign subsidiary income when it is repatriated.

Those Americans who want to become more like Old Europe--as Europe becomes more like what America used to be--be careful for what you have wished. $7/gal gasoline, a fraction of the drugs currently covered under Medicare and private plans, and 6-month waits for critical care procedures, if not outright refusals of treatment

UPDATE: Monsieur Obama should pay more attention.