Friday, November 21, 2014

The Corporate-Tax Conundrum

BERKELEY – The United States now has the highest statutory corporate-income tax rate among developed countries. Even after various deductions, credits, and other tax breaks, the effective marginal rate – the rate that corporations pay on new US investments – remains one of the highest in the world.

In a world of mobile capital, corporate-tax rates matter, and business decisions about how and where to invest are increasingly sensitive to national differences. America’s relatively high rate encourages US companies to locate their investment, production, and employment in foreign countries, and discourages foreign companies from locating in the US, which means slower growth, fewer jobs, smaller productivity gains, and lower real wages.

According to conventional wisdom, the corporate-tax burden is borne principally by the owners of capital in the form of lower returns. But, as capital becomes more mobile, relatively immobile workers are bearing more of the burden in the form of lower wages and fewer job opportunities. That is why countries around the world have been cutting their corporate-tax rates. The resulting “race to the bottom” reflects intensifying global competition for capital and technological knowhow to support local jobs and wages.

Moreover, a high corporate-tax rate is an ineffective and costly tool for producing revenues, owing to innovative financial transactions and legal tax-avoidance mechanisms. A company’s legal residence and geographic sources of income can be and are manipulated for such purposes, and the incentives and scope for such manipulation are especially large in sectors where competitive advantage depends on intangible capital and knowledge – sectors that play a major role in the US economy’s competitiveness.

In the absence of close and broad international cooperation, the US must join the race and lower its corporate-tax rate. A lower rate would strengthen incentives for investment and job creation in the US, and weaken incentives for tax avoidance. It would also reduce numerous efficiency-reducing distortions in the US tax code, including substantial tax advantages for debt financing over equity financing and for non-corporate businesses over corporate businesses.

But each percentage-point reduction in the corporate-tax rate would reduce federal revenues by about $12 billion per year. These revenue losses could be offset by curtailing so-called “corporate-tax expenditures” – deductions, credits, and other special tax provisions that subsidize some economic activities while penalizing others – and broadening the corporate-tax base. Both President Barack Obama’s plan for business-tax reform and the Simpson-Bowles deficit-reduction plan propose reducing such expenditures to pay for a reduction in the corporate-tax rate.

Corporate-tax expenditures narrow the base, raise the cost of tax compliance, and distort decisions about investment projects, how to finance them, what form of business organization to adopt, and where to produce. As Michael Greenstone and Adam Looney show in a just-released report, the resulting differences in effective tax rates for different kinds of business activity are substantial.

That said, if the goal of corporate-tax reform is to boost investment and job creation, broadening the tax base to pay for a lower rate could be counterproductive. Eliminating “special interest” loopholes, like tax breaks for oil and gas, or for corporate jets, would not yield enough revenue to pay for a meaningful rate cut. And curtailing accelerated depreciation, the manufacturing production deduction, and the R&D tax credit – which account for about 80% of corporate-tax expenditures – would involve significant tradeoffs.

Indeed, cutting these items to “pay for” a reduction in the corporate-tax rate could end up increasing the tax on corporate economic activity in the US. Eliminating accelerated depreciation for equipment would raise the effective tax rate on new investments; repealing the domestic-production deduction would increase the effective tax rate on US manufacturing; and rescinding the R&D tax credit would reduce investment in innovation.

Instead of cutting proven tax incentives for business investment, the US should offset at least some of the revenue losses from a lower corporate-tax rate by raising tax rates on corporate shareholders. Most countries that reduced their corporate-tax rates have followed this path, while the US has done the opposite.

At 15%, America’s tax rates on dividends and capital gains are at historic lows, while the profit share of national income is at an all-time high. Defenders of low rates for capital owners argue that it minimizes “double” taxation of corporate income – first of the corporation and then of its shareholders. A lower corporate-tax rate would weaken this justification. Moreover, pension funds, retirement plans, and non-profit organizations, which receive about 50% of all corporate dividends, do not pay tax on these earnings, and would benefit from a lower corporate-tax rate.

Although individual taxes on corporate income reduce the after-tax return to savings, they have less distorting effects on investment location than corporate taxes do, and they are more likely to fall on owners of capital than on workers. Moreover, it is far easier to collect taxes from individual citizens and resident shareholders than from multinational corporations. Apple can use sophisticated techniques to manipulate the location of its corporate income, but individual US citizens who own Apple stock have to report the dividends and capital gains that they earn from it in their worldwide income. 

A recent study found that taxing capital gains and dividends as ordinary income, subject to a maximum 28% rate on long-term capital gains (the pre-1997 rate), could finance a cut in the corporate-tax rate from 35% to 26%. Such a change would reduce corporations’ incentives to move investments abroad or shift profits to low-tax jurisdictions, while increasing the progressivity of tax outcomes by shifting more of the burden of corporate taxation from labor to capital owners.

An increase in the corporate-tax rate appeals to many US voters who believe that corporations are not paying their fair share of taxes and are worried about widening income inequality. But, in a world of mobile capital, raising the corporate tax rate – or simply leaving it at its current level – would be a bad way to generate revenue, a bad way to increase the tax system’s progressivity, and a bad way to help American workers.

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    1. Commentedjracforr jracforr

      In a world of mobile capital, corporate-tax rates matter, but it represent one of many factors that influence business investment. Cheap labor and lower infrastructure cost in less developed economies such as China and other S E Asian nation provided the incentive for American business to relocate to those areas, not the tax structure.
      While corporate taxes, workers pension and health insurance cost all need to be revised they were not factors in our economic disaster, because the world's economy with it's varied rules and regulations, was doing exceptionally well just before the banking crisis , a crisis caused by greed and dishonesty.
      It would be helpful to see someone of your statue focus for a while on the "greed and dishonesty" factor as the real cause of our economic problem. No disrespect intended you articles are informative and appreciated.

    2. CommentedMATTHEW M

      According to the World Factbook by the CIA, the United States collects through taxation 15% of GDP, making it 188 out of 210 countries: one of the lowest rates globally. Other sources have consistently noted that taxes both at the individual and corporate are at the lowest levels in 80 years.

      Additionally, the US investment back into the country is at a low level 12.4% of GDP, making it 174 out of 210 countries.

      This article is insightful but complex: is not the simple question, what kind of country do we want to have? With aging infrastructure and demographics, common sense dictates that more resources are needed.

      Common sense also should be apparent that there is an inverse relationship of taxing policy to earnings. As the tax rate moves to zero and one keeps more of their income, there is a disincentive to work harder or to make prudent investments.

      The often quoted Laffer curve has had much independent study or analysis with an optimal revenue point of around 60-70% tax rates. The Curve though has historically been used to justify lower tax rates, broadening the base, thereby increasing overall receipts.

      However, these analysis were during the most rapid expansion post Depression and WWII and have little relevance to the US now mature life cycle in growth: ie 2-3% nominal growth in GDP. And also does not take into account the new globally competitive business environment.

      Weak and bought politicians have perverted the tax code into a convoluted entangled mess that protects big monied interests from big oil to big finance to big agricultural. The real dreaded third rail in American politics since the 1980's at all levels, federal, state and local has been taxation.

      Reagan used Greenspan's advice to raise SS/Medicare contributions to hide deficits as one example.

      Again, ultimately, collecting too little receipts and not making investments in infrastructure, technology, education and research is what will really kill business competitiveness.

    3. CommentedFrank O'Callaghan

      The article and comments here are impressive. I apologise for lowering the level.

      Inequality has broadened and deepened over the past three decades. Much of this has coincided with a lower tax rate on capital and corporation profits. After almost a century of narrowing the gap between rich and poor this is not a welcome change.

      History tells us that the longest surviving systems are those that adapt quickly and intelligently. The system is losing the consent of the governed. It may be time for international concerted action to control the transnational entities that now threaten the existence of liberal democracy. Common rates of corporation tax may form a component of the mildest form of this.

    4. Commentedphilip meguire

      We very badly need base broadening and radical simplification. But cutting the corporate tax rate is not the best way to move us toward that goal.

      The relevant base for the corporate income tax is cash flow from operations. In 2009-10, the corporate income tax as a % of corporate cash flow was at its lowest level since 1939. The total amount of corporate income tax collected could rise 50-80% without significant harm. All this is consistent with David Doney's facts #2 a#3.

      Like so much discussion of tax policy, this article does not keep its eye on the ball, namely simplicity of administration and collection. I do not agree that " is far easier to collect taxes from individual citizens and resident shareholders than from multinational corporations." If it is true, it amounts to picking on the less mobile and less sophisticated among us.

      The fundamental problem with income taxation is that it taxes recipients instead of payers. It is much much easier to locate income payers than ultimate recipients. Taxes should be levied at the source, and factor payments should be received having already paid tax. Such a tax is harsh on those with modest incomes; hence the need for demogrants. Maximising simplicity and minimising distortions requires that the demogrant be paid to all legal residents of a country. I have caculated that a tax on business value added, net of capital expenditure, at the flat rate of 35% (the current corporate income tax rate), with FICA/Medicare taxes credited in full against flat tax liabilities, and a demogrant of $350/person/month, would go a long towards balancing the budget and eliminating poverty.

      I would like to see the EU, Canada, Japan, and Australasia all adopt such a tax system. Nations could choose differing demogrant amounts. Nations and local authorities could still differ in the way they tax property and retail sales.

      If a firm creates a foreign sub to take advantages of cheaper wages, that will increase the parent's bottom line. That bottom line will remain fully taxable.

      The shift of taxation from capital to labour amounts to the exploitation of labour: exploiting the fact that language, culture, personal association, and family ties make labour less mobile than capital. All forms of value added should face the same marginal rate. This would put debt and equity, and corporates and noncorporates, on the same footing. It would eliminate the double taxation of dividends, a fact which makes the 15% tax rate on qualified dividends and capital gains grossly misleading. That rate is in truth 1-(1-0.35)(1-0.15) = 44.75%. I propose to lower that rate to 35%, but to apply that rate not only to value added but also capital gains realised by businesses.

      "pension funds, retirement plans, and non-profit organizations, which receive about 50% of all corporate dividends, do not pay tax [thereon]" Tax advantaged retirement plans exist mainly to correct drawbacks in the status quo. Abolish that status quo, treat all investors alike alike, and retirement plans cease to matter for tax law. If nothing changes, in 2050 something like 80% of dividends will be received by untaxed investors. We should accept this likelihood, increase the taxation of dividends at the corporate level, and abolish their taxation at the personal level.

      The wages and interest paid by nonprofits are fully taxable. The dividends nonprofits and retirement plans receive have paid corporate income tax. At present, the main advantage of nonprofits and retirement plans is that they don't have to pay taxes on interest, real estate income, and realised capital gains. I propose to tax interest and real estate income at the source, and to exempt from tax all realised capital gains on assets owned by households and nonprofits. Nonprofits would also not include donations received in their value added subject to tax.

      Taxing capital gains at realisation penalises desirable portfolio adjustments, and hugely advantages untaxed forms of investment. No one has come up with a practical way of correcting capital gains for inflation, or of exempting realised capital gains that are reinvested in short order. Finally there is the step-up in the tax basis at death.

      The effective average tax on the 400 largest returns filed in the USA is 26%. I propose to raise that to 35%. Mr Buffett would be pleased, I think.

      What I write above stems from 30 years' reflection on the Flat Tax of Hall and Rabushka.

    5. CommentedDavid Doney

      Good stuff from Ms. Tyson, as usual.

      1) Why don't we make the capital gains tax rate progressive like the income tax? Why only one rate? Make it higher for investors with more capital gains income. It is not a material number for retirees, who rely on pensions, social security, interest and dividends primarily.

      2) According to the CBO historical tables, corporate income taxes averaged 2.0% GDP over the past 40 years, but collections were 1.0% GDP in 2009, 1.3% in 2010 and 1.2% in 2011. They were 2.7% GDP in 2006 and 2007. So the burden isn't that high relative to GDP.

      3) CBO found in 2005 that the U.S. ranked 27th lowest of 30 OECD countries in its collection of corporate taxes relative to GDP, at 1.8% vs. the average 2.5%. I don't have a more recent analysis.

      What I would rather see is a tax on corporations that offshore for the wage differential or an outright banning of off-shoring jobs where the intent of the position is to export goods or services back to the U.S.

      This off-shoring has contributed to a $650 billion goods trade deficit and anemic job creation (just 2 million net new jobs 2000-2009 versus 15-21 million in each of the 3 preceding decades).

      If economies are built one job at a time, exporting them is probably a bad idea.

    6. CommentedRobert Ley

      Apparently Ms. Tyson doesn't do her own taxes! Her argument makes sense if the word "dividends" is omitted, as it should be. Dividends, unless they are 'capital gain distributions' from a mutual fund, are taxed as ordinary income, not the 15% for capital gains. They are truly taxed twice. Lowering the corporate rate would partially ameliorate the 'double taxation' complaint. Ordinary dividends are income in the same way that interest on your money market account is income. One is invested in a company which has elected to return some of its income to its shareholders, the other placed with an institution which can invest it and provide a return to the depositor. Same difference. Tax them the same.

        CommentedRobert Ley

        SORRY Dr. Tyson. Mea culpa.
        "Qualified dividends" are indeed taxed at 15%. And they should also be taxed at higher rates, just like capital gains, as she suggests.

    7. CommentedProcyon Mukherjee

      Trust that we are calculating the impact of these reforms on the government debt to Government revenue, and this ratio which has been growing would further lead to an abnormal number in the short run.

      We are looking at an elephant like many blind men would do and the trunk as in this case (the corporate tax reform), works in cross purpose to the body (the short run revenue) and in the long term in any case we are all dead.

      Procyon Mukherjee

    8. CommentedEmre Konukoglu

      Assuming that the activities for tax avoidance are costly (likely with a sizeable fixed cost component) the corporations have already accrued a significant portion of these costs. Therefore, I don't see why lowering the tax rate will necessarily result into lower incentives for tax avoidance.

    9. CommentedElizabeth Pula

      Now here’s the end summation, from the “report” (The Hamilton Project) linked in the article:

      Tax Reform Facts:
      1. America collects lower revenues than
      other industrialized countries
      2. Tax expenditures represent a large share
      of total government spending.
      3. The tax code subsidizes some activities
      and penalizes others.
      4. The tax system has become less
      progressive over time.
      5. Virtually all American families, even
      low‑income families, pay taxes.
      6.There is a limit to what tax reform can
      7.Individuals and the economy will feel
      every approach to tax reform.
      8.The benefits from tax expenditures are
      not equally shared.
      9.Cutting individual income tax rates would
      modestly increase the earnings of the
      typical American family while substantially
      increasing the federal budget deficit.
      10.Deficit-financed tax cuts do not spur
      economic growth in the long run.
      11.Corporate tax reform can improve U.S.
      competitiveness in several different ways—
      but not necessarily all at once.
      12. Addressing the deficit will require policy
      solutions equal to the size of the problem.

      Now here is a link and a quote:
      Here’s a quote (charts and tables eliminated) from page 6 of government projections for the US economy 2006-2016, dated 2007 from the link: “Over the long run, consumer spending is determined primarily by the growth of real permanent income, demo¬graphic influences, and changes in relative prices. Personal consumption as a share of nominal GDP is projected to be 70.1 percent in 2016. Real consumer de¬mand is projected to grow at an average annual rate of 2.9 percent from 2006 to 2016. The importance of the relationship between GDP and personal consump¬tion expenditures also can be viewed from the perspective of the contribution of real personal consumption to the change in real GDP; such change provides a measure of the composition of growth in GDP.”

      After reading the the article,The Hamilton report, and the .gov report, if GDP ain’t increasing by that 2.9% , real consumer demand, who is willing to give up, and what can give up to establish a better income and revenue balance, when, where, how and why? If real permanent income for the majority of American citizens has effectively flat-lined for about the last forty years, and is effectively decreasing, what are real options, or is this state just the predicted and expected normal state of the US economy, regardless of tax compliance and regulation?
      The US is an income based, geographically based, religious denomination based, and racially based, class structured society. In fact US citizens are not equals in many different ways, and especially not equal in the US legal, or tax systems. That’s just the way societies are, the US is no exception to any other nation. We just like to promote the illusion that we are the exceptional society, or nation. Job opportunities exist in any geographical location, depending on time, who you are, what you are and who your friends are, and/or are not. Corporations and certain individuals in certain corporations keep the profits/money flowing within their circle of friends. Any monies that trickle out from that circle are the left overs, that everyone else chases.

    10. CommentedElizabeth Pula

      Could you clarify the first two sentences with specific statistical data? Is the"effective marginal rate" different than what most people generalize and think about in generalized terms as the: actual annual tax burden per IRS reports of amount of actual monies paid by significant and large multi-national corporations that are supposedly based and operating on US ground? Do corporate entities actually invest tax monies into new US investments? Isn't that more of a tax shelter to decrease annual actual tax monies paid that then affect public policy investment and public infrastructure development to better the public environment of all citizens? If the US public domestic policy is to in fact decrease revenues for internal domestic infrastructure then the US is headed to in fact establish a public infrastructure that will have the majority of citizens living a lifestyle similar to ??? Should the majority of US citizens live like the majority in Mubai and Rio de Janeiro?
      Effective tax rates on citizens earning less than $50,000 annually are higher than what most corporations today actually pay. Pensions funds and US citizens have been effectively required to pay higher taxes and assume losses because of corporate investments that are actually tax shields to allow profits to be assumed by individual human beings internationally. This transfer of monies to significant individuals (including subsequent corporate entities as individuals) rather than public infrastructure is what is hurting the US. The "subsequent corporate entities" even if they are supposedly "new US investments" are often times companies that are effectively sub-corporations that are used to skim profits as hedge funds and "private investors" repurchase spin-off businesses/corporations and then further shield profits, and sell the "shells" in re-packaged corporate entities to "delay" further tax payments, which then further delays any real revenues, so effectively there is NO revenue for public policy infrastructures. What you get is nothing for longterm public investment which is exactly what we are seeing now! You can only chase pieces on the monopoly board so long until none are left.

    11. CommentedZsolt Hermann

      I apologize for opening up this theme a bit further, but the reason we do not find any solution to our economical, financial, political or social problems is that we always only look at the superficial details, certain localized problems, but we never actually examine the main, true causes.
      All our present problems come from the same root, from our basic, inherent human nature.
      Each and every human being is operated by the "maximum profit/minimum investment" principle.
      Both nationally or individually we are only interested in the "inflow", in other words "how much can I get for myself". If I get it for free it is the best, but most of the time I have to do some work, still the only motivation is how much I end up with at the end.
      Thus all our life is based on this, and since at the same time we are lumped together in societies, since we cannot survive on our own, a struggle starts. The society has to maintain itself somehow, it needs to get taxes, and other forms of payments from the individual so it can function in general, and the citizens pay, grudgingly, but they always second guess why and how much they have to pay, at the same time those responsible for collecting the payment are not always transparent or "righteous" and sometimes (quite a few times) the publicly collected money disappears, thus there is a continuous distrust, and people try to evade their tax or other payment duties, and the higher the person or corporation is on the ladders the most skillful they get in evading.
      So there is this constant "war", policing going on, and somebody is always unhappy in this system.
      The solution is simple but very difficult.
      We would need to rise above our inherent introverted, subjective nature, and first examine how we can benefit the whole, in order to keep it running, keep it performing absolutely optimally, and only after this should we make our own self calculations.
      But how could we change our own inherent nature? How could we motivate people to do so, that they willingly contribute to the whole ahead of their own benefit?!
      Only through education, only by making them understand that this is actually in their favor, since we live in such a global, integral society today, we are so intricately interconnected and interdependent, that I can only succeed, prosper, get healthy or build a future for myself, if the whole system is successful, prospers, and healthy.
      In the meantime the global crisis is already providing us with a negative motivation, our present system, the present way of life is gradually collapsing in front of our eyes, and there is no solution for pulling it back from the brink, since it is excessive, unnatural and unsustainable.
      Only through understanding based on objective, factual, and respected knowledge can we build a system which people choose willingly, by their free choice.

    12. CommentedTim Colgan

      Here is an idea for discussion. Instead of distinct taxation for capital gains - don’t tax it at all as long as it remains invested. When withdrawn for consumption, tax it at normal rates. This would sustain the incentive to keep investments in productive enterprises and generate tax income from those who consume.

      I’ve yet to hear this idea discussed. Why?

    13. CommentedA. T.

      Alternatively, charge taxes on goods sold within the jurisdiction, with the countries with the most valuable consumers (due to legal protections, infrastructure, etc.) being in a position to levy the highest tax rates. Same way that taxes on labour are charged according to where one sells one's labour, and on the revenues therefrom (rather than net of such 'operating expenses' as food, clothes, housing, transportation, etc.).