The Right Way to Cut Corporate Taxes

Nov 13, 2017 by

Photo

Members of the House Ways and Means Committee during a markup of the Republican tax reform plan. Credit Mark Wilson/Getty Images

Republicans are right about the corporate tax system being broken, but wrong about why it’s failing and how to fix it.

The basic proposition put forth by President Trump and congressional leaders is that the present tax rate, 35 percent, makes it hard for American corporations to compete with foreign companies and ends up driving American businesses overseas. They would address this by slashing the rate to 20 percent, claiming that this would not only help companies but would also raise household income by $3,000 to $7,000, mainly in the form of higher wages.

Much of this is absurd.

Start with the tax rate itself. American businesses theoretically pay 39 percent of their profits in taxes to the federal and state governments. That might seem shocking; it’s more than double the 19 percent Britain charges its businesses. But because of copious loopholes — not least the ability of large multinationals to shift profits to low-tax countries — few businesses pay the sticker price; in fact, American companies pay an average effective federal-state rate of 18.1 percent, according to a 2016 report by the Obama White House and Treasury Department, just shy of the 19.4 percent average effective rate for Britain, Canada, France, Germany, Italy and Japan — the other members of the Group of 7 nations. Far from being the highest taxed in the world, as Mr. Trump claims, United States corporations are taxed at roughly the same rates as those in other advanced nations.

Loopholes Aplenty

Although the combined federal and state corporate tax rate is 39 percent, loopholes effectively slash it to 18.1 percent.

EFFECTIVE CORPORATE

TAX RATES, 2015

STATUTORY

RATES, 2015

Japan

24.5%

32.1

France

24.0

34.4

Germany

21.2

30.2

G-7 average

(excluding U.S.)

19.4

29.6

Britain

19.0

20.0

United States

18.1

39.0

Canada

12.5

26.3

Italy

5.2

31.3

In fact, over several decades, the corporate tax rate has withered as a source of revenue for the government, partly because of tax cuts and partly because of deductions, credits and ingenious tax-avoidance schemes cooked up by expensive lawyers and accountants — including the offshore shenanigans revealed by the Panama Papers and Paradise Papers. In 1967, corporate tax revenue totaled more than 4 percent of the gross domestic product. Last year, it totaled just 1.6 percent. By contrast, individual taxpayers are contributing a larger share through income and payroll taxes.

Serious thinkers are well aware that the corporate tax isn’t generating the revenue it should. The Republican House and Senate plans, with their 20 percent rate, would do even worse. The proposals would close some loopholes but create new ones, like allowing the immediate expensing of new equipment. In addition, they would create a 25 percent tax rate for owners of pass-through businesses like partnerships and sole proprietorships.

Then there’s Mr. Trump’s warmed-over version of trickle-down economics. The White House asserts that businesses will take the money they save on taxes and use it to give workers raises and go on hiring binges. Sounds nice, but there’s little empirical evidence for this fairy tale. In fact, there was no such surge in income after Congress slashed the corporate tax rate in the 1980s; nor was there in Britain as it cut its corporate tax rate in recent years.

A Shrinking Burden

In 50 years, corporate taxes have dropped as a share of gross domestic product.

10

PERCENT OF G.D.P.

Income taxes

8.4

8

7.3%

6.1

6

Payroll taxes

4.1

4

3.9

Corporate taxes

2

1.6

1967

’70s

’80s

’90s

’00s

’10s

’16

So what would true reform look like? First, it would not blow a $1.7 trillion hole in the budget over the next decade, which is what the House plan would do, according to the Congressional Budget Office. Second, it would make the system fairer and more efficient. If Republicans worked with Democrats, they could reach a compromise to lower the top corporate tax rate to between 25 percent and 28 percent, eliminate loopholes and reduce the incentive businesses have to take on debt, rather than to use equity to expand. Under current law, interest is deductible for tax purposes while dividends are not.

Real reform would also include a minimum tax on profits earned abroad by American corporations in the year those profits are earned, minus a credit for taxes paid to other countries. Businesses can now defer taxes on such profits indefinitely, as long as they do not bring the money back to the United States. Big companies like Apple, General Electric and Microsoft have kept an astonishing $2.6 trillion in profits offshore, hoping Congress will lower the tax rate or give them a tax holiday to repatriate the money at ultralow rates. The House bill would let companies bring those profits home at 7 percent (for money invested in hard-to-sell assets) or 14 percent (for cash). A plausible compromise would let businesses repatriate all past profits accumulated overseas at a somewhat discounted rate, say 15 percent to 16 percent. All of this money could be used to rebuild America’s dilapidated infrastructure.

While the outlined changes would solve an immediate problem, Congress also needs to consider longer-term obstacles to tax avoidance by multinational companies. One smart idea that deserves more study is a proposal by economists like Kimberly Clausing, a professor at Reed College. She argues that the United States and other countries ought to tax profits that corporations earn from sales inside their borders, similar to the way American states now tax corporate profits. Each country would control its tax rates, deductions and credits. But companies would lose the ability to game the system by booking profits through subsidiaries registered in zero- or low-tax countries like Bermuda and Luxembourg, where they might be making few sales.

Eventually, Congress will need to do more than just patch the tax system. Even without the Republican tax cut plans, the Congressional Budget Office expects the federal deficit to grow to 5.2 percent of gross domestic product in 2027, up from 3.2 percent in 2016, thanks in part to the Bush tax cuts and the Iraq war. Lawmakers will need to consider new sources of revenue, including a value-added tax, a carbon tax and a financial transactions tax. Each would broaden the tax base and achieve important policy goals, like encouraging savings, reducing greenhouse gas emissions and reducing risks in the financial system.

The Republican proposals do none of these things. They do, however, reward the wealthy. Among the worst offenders is the proposed corporate tax cut, which is larger than needed and does nothing to make the system more efficient. The victims here are the economy as a whole and the workers and ordinary folk to whom Mr. Trump promised relief.

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