The business establishment has reacted with dreary predictability to the Treasury's plan for tax simplification. The proposal, we're told, would clobber corporate profits, reduce investment and damage the economy. Phooey: half-truths at best.
The heavy-handed response illustrates why business doesn't command public respect on major political and economic issues. People believe, correctly, that businesses speak only for themselves -- what's good for Joe's Desktop Computers is good for the country -- and, therefore, aren't worth listening to. The result is a political power vacuum. With most industries plugging their own interests, no one speaks for policies that would promote a genuinely healthier business climate.
The tax plan is a case in point. It aims to increase the efficiency of business by reducing the huge discrepancies in tax rates that divert investment from its most productive uses. The proposal has aroused widespread business opposition because it threatens tax breaks cherished by industries as far-flung as commercial real estate and electronics. The plan would cut the top corporate tax rate from 46 to 33 percent; at the same time, it would raise the total corporate tax burden 25 percent by eliminating many preferential tax provisions. The central question is whether the rise in total taxes (discouraging investment) offsets the reduction in tax discrepancies (enhancing the efficiency of investment).
It's hard to know, but I'm skeptical of two economic studies -- one by Wharton Econometrics, the other by Data Resources Inc. -- that say investment will suffer. Neither study considered the possible benefits of more efficient investment; not surprisingly, both were underwritten by business groups. The rebuttal comes from Harvard economist Dale Jorgenson, whose computer model does examine efficiency gains. He figures the Treasury plan would raise the gross national product in 1990 by about 3 percent ($110 billion at today's prices) higher than would existing law. Jorgenson's analysis is buttressed by the fact that much of the tax increase would fall on a few industries now heavily favored -- oil, insurance, banking. Logically, these increases shouldn't cut investment elsewhere.
Strange as it may seem, the business opposition to the tax plan amounts to a campaign against the profit motive; most industries are more interested in their familiar tax breaks than in overall economic efficiency. People tend to see profits as a necessary evil of capitalism without fully appreciating their function. When the profit motive works properly, it directs investment funds and labor to their most productive uses. The easiest way to see this is a simple example. Consider a computer software firm that earns a pretax profit of 20 percent on its investment and a large manufacturing firm that earns 15 percent. The message is that society should devote more of its resources to the software company.
You can imagine dozens of reasons for this. More software might extend computers to dozens of new applications -- from manufacturing control to insurance claims -- with huge increases in efficiency. Or maybe there's too much manufacturing capacity. Who knows? The marvel of the profit mechanism is that it automatically signals where investment should go without detailed answers. But taxes can devastate this benevolent arithmetic. Assume that taxes take away half the computer software firm's profits but only a fifth of the manufacturer's. Now the profit signals are reversed. The software firm has an after-tax profit of 10 percent against the manufacturer's 12 percent. Investments are made on an after-tax basis, and now the incentives point to investing where it will do the least good.
In fact, the tax system bristles with discrepancies because all business income is not taxed in the same way. If you don't think the distortions matter, examine the national office-building glut. Since 1981, the vacancy rate has jumped from 4 to 14 percent. In part, the 1981 tax law encouraged an office-building boom by enhancing real estate write-offs that would cut investors' taxes on other income. There's a destructive logic of waste at work. Ultimately, overinvestment in tax-favored industries will so reduce profitability that even tax advantages will be offset. Perversely, though, many industries are so wedded to specific tax breaks that they can't imagine life without them.
This explains the apparent paradox of how the Treasury proposal could be good for business even if much of business is opposed to it. Either you believe in the profit motive or you don't. When we subsidize something, we get more of it than we need -- no matter how worthy it sounds. The venture-capital industry, for example, complains that one provision of the tax plan (eliminating preferential treatment of capital gains) would make starting new companies more difficult. But there's no special virtue in new firms. When a smart engineer leaves a job in a large firm to start a new company, it's terrific when it succeeds; when it flops, it's a waste -- not only for the individual, but also for the old firm that lost a key worker. Risk-taking is good, but many start-ups will fail. There's no more public interest in subsidizing a high failure rate than in subsidizing empty office buildings.
The efficiency or inefficiency of American business is a great national asset or liability. So the politics of tax reform matter immensely. The Treasury proposal isn't perfect and it surely can be improved, but the basic principle of reducing tax considerations in investment decisions is critical. Frankly, I wonder whether the corporate lobbyists know what they're doing. Along with everyone else who considers the Treasury proposal too radical, they may be able to kill it entirely. But that won't be the end of the story. To cut budget deficits, Congress will remain on the prowl for tax increases. Business will then be more vulnerable. It's easier to tax corporations, which don't vote, than people, who do. So Congress might enact some of the Treasury proposals piecemeal. Business might end up with the worst of both worlds: higher taxes without lower rates. And that would hurt us all. Copyright (c) 1984, Newsweek Inc. Reprinted by permission; all rights reserved