Just outside the Senate Finance Committee hearing room where O’Neill made these remarks, however, is the famous “Gucci Gulch.” That otherwise drab hallway in the Dirksen Senate Office Building is where high-priced lobbyists, with their fancy footwear, lurk when senators negotiate tax bills. These fixtures of the Washington tax scene would tell you that O’Neill is dead wrong, that tax breaks — particularly tax breaks for their clients — create jobs and boost the economy.
So, who’s right? Do taxes affect behavior or not? This is a key question now that Congress is looking over the fiscal cliff and gearing up for what could be a major overhaul of the tax code.
Clearly, taxes do matter. Stiff state cigarette taxes, for example, cut smoking habits. Higher gasoline taxes encourage people to buy fuel-efficient cars.
In the business world, too, some effects are clear. Multinationals move big chunks of their profits into overseas tax havens to avoid the high U.S. corporate tax rate. Changes in the capital gains tax rate have enormous effects on the timing of stock sales. The research tax credit expands the scope of activities that companies call research. And right now, many corporations are speeding payouts so that their shareholders don’t face the higher taxes on dividends that will probably take effect after Dec. 31.
But the more important question is this: Do taxes affect the things that are critical to our economic well-being, such as employment, investment, innovation and worker productivity? Where companies book their profits doesn’t matter as much as where they build their factories. When investors sell stock may matter to brokers, but what shapes the economy is whether lower capital gains rates affect investment and entrepreneurship. We want to know if the research credit increases spending on science and technology, and not just on accountants coaxing more tax benefits out of existing activity.
These are much tougher questions to answer. Despite thousands of economic studies, we are left with a mass of confusing and contradictory results. Some studies report large effects. Some report small effects. Some report no effects at all.
Why? It’s partly because economists, being human, often let their political views influence their analyses. The spectrum of their findings mirrors their wide political differences about the virtues or vices of taxes.
But even after setting aside personal bias, much uncertainty remains. Even the most sophisticated research can provide only clues, not definitive answers. We cannot, for instance, isolate the effect of taxes on business investment because so many other variables, such as interest rates and optimism, matter too. And even if these studies were conclusive, the effect of taxes in the future is not likely to be the same as it was in the past, given the tremendous amount of structural change in the economy.