Corporate Tax Rates in The United States
Proponents of corporate income tax cuts claim that corporate income tax rates in the United States are the highest in the world and are a major reason companies make new investments in other countries with lower rates. Lower the rates in the U.S., they continue, and the economy will explode. But they’re wrong on all counts.
Let’s look first at current tax rates. To make their case, they cite the maximum statutory rates, which, in the United States, are higher than virtually every major country. But that is not the rate actually paid. Because of inadequate restrictions in current law, multinational companies earning millions or even billions of dollars can shelter profits in low tax countries so they pay little or no tax in the United States. And to make matters worse, they can defer their off-shore profits indefinitely. Otherwise, allowable deductions reduce the amount of taxes actually paid to about 50% of the statutory rate.
In March of this year the Congressional Budget Office estimated the effective tax rate in 2012 was 18.6%, which was the fourth highest in G20 countries. But even that rate does not tell the whole story.
Corporate Tax Rates in Other Countries
Most countries outside the United States have higher employer social costs which makes hiring employees an expensive proposition. In its Paying Taxes 2017 report, PriceWaterhouseCoopers analyzed tax data on 190 economies around the world,summarizing total, profit, labor and other taxes by region and country. While the United States at 44.0% total tax rate was still above the world average of 40.9%, it was quite competitive with other industrial countries with a range of 21.0% in Canada to 62.8% in France, and still lower than Germany and Japan, each at 48.9%.
China (68.0%), India (60.6%) and Mexico (52.0%) all have total tax rates significantly higher than most of the industrialized countries. Yet these countries have enjoyed the benefit of considerable foreign investment, almost always taking jobs away from workers in the industrialized world. How could this happen if investment decisions were based on corporate tax rates? The fact is, they were not and are not. No rational businessman would make a decision on that basis alone. One does not have to be sophisticated in the realm of business to know that the cost of labor was and is the driving force in these decisions.
The Bureau of Labor Statistics reported these average compensation costs (in dollars): China (2009) $1.74; India (2010) $1.46; Mexico (2012) $6.36 including $1.92 social insurance and related labor taxes; the United States (2012) $35.67 including $11.73 in directly paid benefits, social insurance and related labor taxes. Aside from specific reasons such as the need for a particularly skilled labor force or proximity to its marketplace, does anyone truly believe that lowering the corporate tax on profits will induce new investment in the United States?
Then there is the other specious argument that these corporate income tax cuts will produce wage increases for workers, create more jobs, explode the economy and eventually pay for the huge deficit it will create. The fact that this has never happened before is completely ignored by those promoting this baseless premise. [See TAXES, HYPOCRISY AND DISHONESTY, October 5, 2017, the Kansas experiment and the disastrous consequences of its similar attempt to usurp the rule of economics]
The Labor Force
By the way, in the unlikely event this great explosion of jobs occurs, where will the companies find the huge number of employees to fill them? The unemployment rate in October was 4.1%, which many economists consider well below the 5.0 – 5.5% when the economy is at full employment. And while there are still some 6 million people unemployed, there are some 6 million jobs available but unfilled. Not to mention the negative effect the Trump Administration’s immigration policy will have on the job market, reducing the number of immigrants coming into the country and deporting others, many of whom now fill jobs Americans don’t want. Look at the restaurant and construction industries. Remove the unskilled laborers there and what happens to the businesses that employ them?
Shifting Profits to Low Tax Countries
The proposed corporate tax reform is a conglomeration of corrections to conditions that no longer exist and the wrong prescription to correct those that do. Worst of all, the proposed corporate tax cuts are part of a package that will substantially increase the deficit with the fantasy of it eventually paying for itself. In reality, later years will see cuts in spending and/or huge tax increases, the burden for which will fall on the middle class.
Changes are required in the way corporations are taxed, but at the very least, they should be revenue neutral; that is changes that cause reductions in revenue should be offset by changes that increase revenue. While operating within the legal framework of the law, multinational corporations have been sticking it to the United States for years, and that should be the initial focus of attention.
In a report issued earlier this year, the Institute on Taxation and Economic Policy identified 100 individual companies that paid no taxes in at least one year from 2008 to 2015. In that list, 1 company paid no tax for 8 years, 4 companies for 7 years, 3 companies for 6 years, 7 companies for 5 years, and 8 companies for 4 years. Much, if not all, of these results are the consequence of shifting profits from the United States to low tax countries such as Ireland (perhaps about to change based on proposed European Union tax code requirements to take effect in 2018) and the Cayman Islands, where they can sit “offshore” untaxed until they are repatriated to the United States.
This process begins with an easy to manipulate accounting policy called “Transfer Pricing.” Very simply it means transferring ownership of income producing assets such as patents, trademarks, and licenses from a U.S. company to an affiliated subsidiary in a low tax country, which then receives the income they generate from fees charged other subsidiaries in high tax countries. Or it can be though judicious pricing of products as they move through the supply change from country of manufacture to the company of sale in the United States. Let’s take the example of widgets, which the U.S. parent, ABC Company, makes in China at a cost of $10, including the cost of shipping to the United States. These widgets are sold by the U.S. company for $100. If the Widgets were billed directly to the U.S. company, it would earn a gross profit of $90. But the billing goes to the ABC subsidiary in the Cayman Islands, which then rebills it to the ABC Company in the United States at a price of $85, thereby transferring $75 profit out of the clutches of the U.S. tax man. Or take the case of a company that does most of its research in the United States, which absorbs the entire cost as a deduction from its profits and never recoups that cost when the fruits of that research are translated into salable products in other countries.
A Better Way
For the most part, these transactions are legal tax avoidance schemes with no real economic rationale. It’s time to eliminate the effects of all such transactions and tax them based on their economic reality. It is also time to eliminate the deferral of tax on profits made in other countries until they are repatriated. Some might argue that such changes will cause more corporations to move their legal domicile from the United States to a lower tax country, despite maintaining their substantial operations in the United States. This process is known as a “Corporate Inversion,” and like the tax avoidance transactions described above, should be eliminated.
The European Union has proposed a new law requiring multinationals with global revenues in excess of €750 million to disclose staff numbers and activities at their EU subsidiaries and branches, as well as revenue, profits, taxes due, and taxes actually paid. Additionally, they will have to reveal the same details about their operations in a number of tax havens named on a new EU blacklist, and publish an aggregate figure for taxes paid outside the EU.
Perhaps the first step in transition is to follow the EU proposal with one similarly based on U.S. interests. With such information, we can more readily bring the corporate tax code back to economic reality; to base the tax on real economic profits earned in the United States, not those that that fall within a Potemkin Village structure; to make the code a tax on the substance of profits, not their form.