Bridging the Red-Blue Divide: A Proposal for U.S. Regional Tax relief

Abstract

The United States is the only large federal country that does not have an explicit way to reduce the economic disparities among more and less developed regions. In Germany, for example, federal revenues are distributed by a formula that takes into account the relative level of wealth of each state (the so-called Finanzausgleich, or fiscal equalization). Similar mechanisms are found in Australia, Canada, India, and other large federal countries. The United States, on the other hand, has no such explicit redistribution. Each state is generally considered equal and sovereign and the federal government does not distribute revenues to equalize the states’ \nspending capacity. While the overall impact of the federal tax and transfer system may be to shift revenues from richer to poorer states, this is not openly acknowledged, and to the extent it is discussed in the literature, it is generally condemned as unfair to the states that send more revenues to Washington than they get back in federal transfer payments. Nor is it politically likely that the US will adopt a formal fiscal equalization mechanism, because unlike Germany or Canada it decisively settled the problem of secession in the Civil War and therefore does not fear a potential break-up along regional lines. \nThis Article proceeds from the normative position that the increasing gap between the richer and poorer areas of the United States is a problem that requires federal intervention, and that the federal tax system can play a role in that intervention. There is increasing evidence of a yawning economic gap between the eastern heartland (the region between the Mississippi and the eastern slope of the Appalachians) and the rest of the U.S., which translates into higher permanent unemployment and minimum wage employment, opioid abuse, imprisonment, and premature death. This gap contributed to the political division of the country \nrevealed in the 2016 presidential election, and needs to be addressed if we want to prevent ever further polarization. \nThe Article first assesses past and current attempts to enact tax provisions to help disadvantaged regions in the United States. On the federal level the prime example is Internal Revenue Code (IRC) section 936, which provided tax breaks for investments in Puerto Rico. This section was widely criticized and was ultimately repealed in 1996 with a ten-year phase-out. The Article will argue that in fact the evidence shows that 936 was quite successful in creating and maintaining jobs in the territory, and that its repeal led directly to Puerto Rico’s current economic problems, which began when section 936 was finally abolished in 2006. A contrary example was IRC section 199, the domestic manufacturing deduction, which was \nintended to stimulate manufacturing in low-growth areas like the rust belt, but was captured by coastal industries like software and entertainment and was ultimately repealed in 2017 because it was widely conceded to be ineffective. Its replacement, the Foreign Derived Intangible Income (FDII) provision in the Tax Cuts and Jobs Act of 2017 (IRC section 250), is geared toward aiding exports by intangible intensive industries and is therefore more likely to help the richer areas where these industries are located. On the state and local level, there exists a proliferation of tax incentives, but in many cases they do not result in successful development, and they \ntend to confer windfalls on multinationals who would have invested in the US anyway and to favor investment in already rich cities, such as the twenty finalists and the ultimate winner on Amazon’s list of candidates for its second headquarters. \nThe Article then takes a comparative perspective by surveying several more or less successful tax measures taken to encourage development of less developed regions, including in China and Israel. \nFinally, the Article develops a proposal for using federal taxes to influence multinationals to invest in poorer locations. It builds on an existing list of approved targets, namely the so-called “opportunity zones” created by the 2017 tax reform. Opportunity zones are limited to census tracts that have at least a 20% poverty rate \nor are below 80% of the state or city median income. An investor in an opportunity zone gets a tax break, although it is limited to gains that she has already made from other investments. The opportunity zone provisions have been widely criticized as only helping investors and not being limited to people and areas in need. We would limit our proposal to opportunity zones in the target area, i.e., between the Mississippi and the eastern slope of the Appalachians, and exclude major metropolitan zones in that area. We propose that the federal government should declare that a corporation that invests in an opportunity zone in the target area would pay no federal tax on profits from that zone. To define profits from the \nopportunity zone and segregate them from other profits, we suggest using a formula like the one the states use: take total corporate profit and multiply it by [(wages paid to employees in the opportunity zone divided by total wages) plus (number of employees in the opportunity zone divided by total employees)]/2. This type of formula should work to incentivize corporations to move jobs to the preferred areas. With jobs come homes, good schools and everything else the richer areas of the United States already have in abundance.