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How will US and Indonesia's tax cut affect inequality?

Jakarta | Wed, December 13, 2017 | 02:14 pm
How will US and Indonesia's tax cut affect inequality? Beggars in Indonesian capital city Jakarta. (Shutterstock.com/Daxiao Productions)

On Dec 2, US Senate passed the tax bill proposed by  President Donald Trump’s administration. One highlight is statutory corporate tax rate (CTR) cut from 35 percent to 20 percent.

Cutting tax rate is not a new phenomenon. Data from auditory company KPMG shows that in the last 15 years the global average of the statutory CTR declined from 29.42 percent in 2003 to 24.25 percent in 2017. Among them, the Asian countries had the largest decrease from 30.19 percent to 21.28 percent. Trump’s tax cut proposal seems plausible if we look at the statutory CTR in North American countries that are historically among the highest worldwide;  in the last 15 years the rate in this region decreases only by 2 percent in average.

The decreasing rate is largely contributed by high-income countries where its current rate is 21 percent lower than its 2003 position. Middle-income countries also contributed to this phenomenon with smaller amount. The low-income countries, however, increased their statutory tax rate in the last 15 years possibly due to the needs to increase their tax revenue.

The race to the bottom phenomenon also can be seen by economic group. Tax rate sharp declining was not only happened in European Union but also in OECD   and G20 countries. Interestingly, the tax haven countries also tend to decrease their tax rates even though only in a very small portion. In short, almost every country joins the race which is still pushing the rate down until now.

The proponents of the tax cut policy usually based their argument on the notion that the policy will spur competitiveness and economic growth. In the US case, the advocates of the tax cut plan argue that the policy would use the money saved from the cut to boost investment, increase workers' salary, produce more jobs and eventually accelerate economic growth. They usually take former president Ronald Reagan’s 1981 tax cut as an example of how the policy gives a positive impact on economic growth and employment.

Answering whether the tax cut will affect growth is not an easy job;  economists find mixed results from the research. However, the moderate answer is that there is little evidence that corporate tax cut boosts economic activity unless implemented during recession, when they lead to significant increases in employment and income, according to economists Alexander Ljungqvist and Michael Smolyansky in a 2016 paper.   

Taxes, undoubtedly, is one of the most effective tools to combat inequality. Thomas Piketty, in his phenomenal book Capital in the 21stCentury, concludes that progressive tax on capital is the answer to inequality. The tax cut race could loosen the tax progressivity and eventually increase wealth accumulation in only a fraction of population.

Pikkety argues that the income share for the top 1 percent is relatively low when the tax rate was considerably highly progressive. The low progressivity of tax since Reagan’s tax cut policy led to the increase of wealth accumulation for the top 1 percent earners. Therefore, tax rate competition could negatively impact the distribution of income among societies which would widen inequality.

The US is not the only country proposing a tax cut.

The administration of President Joko “Jokowi” Widodo, through the Income Tax Act amendment proposal, plans to decrease the corporate tax rate from the current 25 percent to keep our investment attractiveness and competitiveness.

If tax cuts promote economic activity, the policy could induce wealthy people to work more productively and accumulate more income. The economic pie would get bigger but there is a risk that the pie will be concentrated only in a handful of people. Therefore, this tax cut policy must be followed by other policies to compensate the possible negative impact on inequality.

Whatever the government does to counter the possible negative impact of the tax cut policy, it has to make sure that the economic pie is distributed fairly through, for instance,  better access to jobs, education and health. More importantly, closing the loophole of profit shifting should also become one of the countermeasures to assure that the wealthy, after the tax cut policy, pay their tax correctly since they still tend to use various schemes to shift their profit to lower tax jurisdiction.

Jokowi puts inequality as one of his top priorities for good reason. Nobel Prize-winning economist Joseph E. Stiglitz wrote that inequality causes economic instability and inefficiency. Worse, since inequality is also a product of a political system, citizens could see this condition as not only a failure of the economic system but also as an erosion of our confidence in democracy. As a result, citizens would see no more opportunity in our country.

This is not a hypothetical statement anymore; the Occupy Movement in 2011 showed us how inequality divides our society into the 1 percent and the 99 percent. And when inequality divides us, our democracy is not the government of the people, by the people, for the people anymore but government of the 1 percent, by the 1 percent and for the 1 percent.

Finally, we should start to rethink development. In this case, what former US President FD Roosevelt said is highly relevant. “The test of our progress is not whether we add more to the abundance of those who have much; it is whether we provide enough for those who have little”.

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The writer holds a Master Degree in Public Finance from the  National Graduate Institute for Policy Studies (GRIPS), Japan. He is a Tax Objection Analyst at the Directorate General of Taxes,   Finance Ministry. The views expressed are personal. Website: http://iwayanaguseka.com/ Twitter: @iwayanaguseka

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