To get a good tax system we must: (1) know the cost and effects of each tax, (2) know who pays which taxes, and (3) decide which groups will contribute how much of the total.
We first explored estate taxes. They turned out to be cheap to collect, hard to evade and have low impact on economic activity Now corporate income taxes. They are costly to collect, quite easy to avoid or evade, and fraught with competitive issues. We noted earlier that estate taxes paid by the heirs of those who built the asset are the most unpopular of all. That suggests we hold the peculiar belief that those who earn money should be taxed while those who inherit what others earned should not. The Walmart heirs, for example, own more than the bottom 40% of America. Is that what we want?
In general, we want corporations to pay more income taxes while we pay less. Taxes are taken directly out of what we earn, so they are highly noticeable. It feels unfair that a significant amount of our earnings is taken away but corporate income taxes do not feel unfair because we feel corporations could afford more. When we hear that some pay none at all, it feels outrageously unfair. It also feels unfair that while we are taxed on gross income, businesses are taxed only on profits.
Who in fact does pay corporate income taxes; customers, workers or owners,? It can’t be customers because prices are set by the market and the market is supplied not just by corporations but also sole proprietorships, partnerships and S-corporations that pay individual income tax. That means corporations can’t raise prices to cover their taxes. So, is it workers or owners? When corporate income tax was introduced in 1909 it reduced profits, i.e. was paid by shareholders. Later, it was paid in part by workers getting lower wages. Treasury Department economists reckon 82% now falls on owners and 18% on labor.
Note that tax on the income of non-incorporated businesses is paid entirely by the owners and, as I noted in Business Tax, around two thirds of US businesses reporting profits of $1 million or more are not incorporated.
How much tax do corporations pay? The top rate in the US at 39.1% (35% at the federal level) is the highest in the world. The effective rate, what they actually pay, is less clear. The Tax Foundation summarizing 13 studies reports rates ranging from 23% to 34.9%. The US rates are among the five highest for all countries analyzed. Another analysis found 30 Fortune 500 companies had paid no federal corporate income taxes at all for the 2008-2010 period and there was recent outrage that, by accounting for them overseas, Apple avoided taxes on $74 billion in profits over the last four years. Less noticed is that Apple’s 14% effective tax rate is much higher than Ford’s 3%, Amazon’s 6%, Boeing’s 7% and Verizon’s 9%, and is in the same range as IBM 15% and Google 17%. That is half the 29.1% average rate for 2007-2012. This magnificent chart shows all the numbers.
Why such different rates? Chiefly because US corporations can delay paying income taxes on overseas profits until they are brought back into the US. $1.7T of profits is currently estimated to be offshore. Corporations like Apple locate intellectual property and/or manufacturing in countries with low tax rates. When an Apple product is sold in the US, Apple pays its patent-holding Irish subsidiary a royalty that reduces the profit Apple shows in the US and transfers it to low-tax Ireland. Apple borrows in the US, deducts the interest here, and uses the funds to pay dividends to shareholders and establish manufacturing overseas. PepsiCo relocated concentrate manufacturing from New York to Ireland. Over half their soda sold worldwide is now based on concentrate manufactured there. Coca-Cola opened a plant in Singapore to produce concentrate for 18B cans of soda a year. The soda industry as a result paid not the 29% average tax rate but 19%. But retailers, who among other things sell soda, cannot relocate offshore so most of them paid between 35% and 40%. Even Wal-Mart paid 31%.
The closer you look, the more complicated corporate taxes become. Large multinational corporations have great flexibility in where they locate production, incur costs and realize profits. They can borrow in one country and take the interest deduction there, locate production facilities and employ workers in another country, and realize profits in a third country. A change in taxes on overseas profits impacts only multinationals, a change in depreciation allowances mainly affects manufacturing companies, but many multinationals are manufacturers. The existing tax code encourages moving jobs overseas.
How important is this? The Joint Committee on Taxation estimates a bill introduced this February by Senator Sanders (I-Vt.), a member of the Senate Budget Committee, would yield more than $590B over the next decade. US corporations would pay US taxes on all profits when and wherever earned. “At a time when we have a $16.5 trillion national debt and an unsustainable federal deficit; at a time when roughly one-quarter of the largest corporations in America are paying no federal income taxes; and at a time when corporate profits are at an all-time high, it is past time for corporate America to contribute significantly to deficit reduction”, Sanders said.
By closing the gap between companies that now pay different rates, the bill would also result in the market, not the tax code, playing a bigger role in determining companies’ success and failure.
Is that the only alternative? Wouldn’t it price our corporations out of the global market or commit us to cut our corporate tax rate in a global race to the bottom where all countries keep cutting? Taxes based on where customers are located is another option. The state of California moved to a sales-based system last year because the States already are in a race to the bottom. Maine, where I live, is considering a substantial cut in business taxes for this reason. In California’s scheme, a company that gets 20% of its sales in California pays California taxes on 20% of its worldwide profits at the state’s corporate tax rate. It makes no difference where the firm has offices or where its employees work.
The US could move to a similar system, though if we were the only nation that did, companies could be taxed twice. Presumably, there would be changes to our existing tax treaties with countries that require non-US companies to pay tax here while US companies pay tax there.
But could it be there is no system in a global economy that’s fair for multinational vs domestic corporations, small vs large ones, corporations vs non-incorporated, advanced vs developing economies, and so on. Should we just end corporate income tax? As I noted in Business Tax, it has long been falling as a % of GDP and as we saw above, it is paid mostly by shareholders. Since they tend to be wealthier than average, that results in greater income inequality. It would at least be clearer if we simply decided what rates of tax those with higher and lower incomes should pay.
What to do about corporate income tax? Eliminate deferral of the tax on profits held overseas and other exemptions while cutting our tax rate? Switch to taxing worldwide profits based on the US percentage of worldwide sales? Eliminate corporate income tax? Or what? That decision must be made along with decisions about personal income and other taxes, each forming part of a better overall tax system.
The research for this series of posts is proving a lot more interesting than I expected. We value working for success but want to abolish estate taxes. What we call “payroll taxes” are not taxes but savings and insurance. Corporate income tax is paid chiefly by wealthy people, distorts competition and cuts personal income by encouraging jobs to be moved overseas. What will we discover next?