Tax incentives: Boeing 707 edition
I’m going to a book party at a bar in Newton, Mass. tonight (yes, life here in metropolitan Boston is unspeakably glamorous) for Sam Howe Verhovek’s Jet Age: The Comet, the 707, and the Race to Shrink the World. It’s a great little book—and I don’t think the fact that Verhovek’s brother is a friend of one my wife’s best friends from high school (the reason I was invited to the book party) invalidates my positive opinion. I brought a galley along on a flight West a couple months ago and, despite being alarmed by Verhovek’s accounts of exploding jet airplanes, couldn’t stop reading. I had finished it by the time I landed in Reno.
The reason I’m bringing all this up (other than to impress you with the facts that I know Sam Howe Verhovek’s brother and have been to the Biggest Little City in the World), is because there’s a really fascinating tale in the book involving tax incentives. During the Korean War, Congress enacted an excess profits tax meant to keep military contractors from, well, profiteering. In its infinite wisdom, Congress defined excess profits as anything above what a company had been making during the peacetime years 1946-1949.
Boeing was mostly a military contractor in those days (Lockheed and Douglas dominated the passenger-plane business), and had made hardly any money at all from 1946 to 1949. So pretty much any profits it earned during the Korean conflict were by definition excess, and its effective tax rate in 1951 was going to be 82%. This was unfair and anti-business. If similar legislation were enacted today, you could expect U.S. Chamber of Commerce members to march on Washington and overturn cars on the streets.
It being 1951, Boeing instead sucked it up and let the tax incentives inadvertently devised by Congress steer it toward a bold and fateful decision. CEO Bill Allen decided, and was able to persuade Boeing’s board, to plow all those profits and more into developing what became the 707, a company-defining and world-changing innovation. Writes Verhovek:
Yes, it was a huge gamble, but for every dollar of the dice roll, only eighteen cents of it would have been Boeing’s to keep anyway. For Douglas and Lockheed, both in a much lower tax bracket, that was not so easy a call.
So that’s it! High tax rates—confiscatory tax rates—spur innovation! Well, at least once in a blue moon they do. Which is an indication that there might be some important stuff missing from the classic economists’ view of taxation, as summed up by Greg Mankiw a few weeks ago:
Economists understand that, absent externalities, the undistorted situation reflects an optimal allocation of resources. It is crucial to know how far we are from that optimum. To be somewhat nerdy about it, the deadweight loss of a tax rises with the square of the tax rate.
Somehow I don’t think that formula held true in Boeing’s case.