Corporate Tax Reform

(And Conversations We’ll Never Have)
January 2015

Warning. The following material contains political commentary that may be offensive.

If you pay individual U.S. income taxes, Big Business is not your friend.

An accelerating flurry of corporate tax inversions in the past few years has caught the attention of our Washington legislators. As described in a February 2014 report by the Citizens for Tax Justice (CTJ), the prevailing view inside the Washington, DC Beltway is that America’s corporate income tax is more burdensome than the corporate income taxes levied by other countries, and this excess burden makes the U.S. uncompetitive. (1)
For review, a corporate tax inversion occurs when a U.S. corporation—with the aid of various loopholes in our tax code—buys a foreign corporation and then uses the foreign company to reincorporate in a country with a lower corporate income tax rate. In the highest profile case of the past year, Pfizer, a U.S. company since its founding in 1849, attempted to takeover AstraZeneca and become located in Great Britain. Although Pfizer’s takeover attempt was unsuccessful, several others did succeed: Medtronic, a Minneapolis company since its founding in 1949, acquired Covidien and moved its headquarters to Ireland.(1)

Corporate tax inversions are a problem, but they are not the main problem.

The rhetoric surrounding tax inversions is diverting attention away from comprehensive tax reform. This is the main problem. On its current path, this rhetoric and Big Business will bully the U.S. Congress into passing “tax reform” that will highly favor U.S. corporations. Such an outcome will increase—yet again—the tax burden for individual and small-business taxpayers. In particular, baby boomers will suffer as their Individual Retirement Accounts (IRAs) become a soft target for a government in need of reducing its budget deficit. While shifting more of the country’s tax burden to individuals could be particularly onerous for retirees, it won’t be the first time U.S. citizens are called upon to provide a larger share of the nation’s taxes.

In fact, as shown in the following charts using data from the Bureau of Economic Analysis (BEA), individual taxpayers have, with few exceptions, paid the lion’s share of U.S. income taxes since 1929. And the individual’s portion has been increasing in both nominal and relative terms for most of this 85-year period. Estimates for 2014 imply that individuals will pay $1.38 trillion in income taxes versus $0.51 trillion paid by corporations, a ratio of 2.7 to 1.

Shame on Obama. Shame on Democrats. Shame on Republicans.

In February 2010, President Obama commissioned The National Commission On Fiscal Responsibility And Reform. A bipartisan effort, this commission became known as Simpson-Bowles, after co-chairs Alan Simpson (former Republican Senator) and Erskine Bowles (President Clinton’s Chief of Staff). With the mission of finding a solution to the nation’s fiscal crisis, the commission’s brave recommendations fell into six categories: Discretionary Spending Cuts, Tax Reform, Health Policies, Other Mandatory Policies, Social Security and Process Reform. In each of these categories, sacrifices were demanded from the American people to put the country on a sound fiscal path, both short and long term.

These sacrifices were so painful that the report was rejected by politicians and economists from both conservative and liberal views. Upon its December 2010 release, the report was immediately buried by the Obama administration with the blessings of most Democrats and Republicans. It is possible that this universal hatred of Simpson-Bowles could be an indication the report’s conclusions represent “true north.” In any event, adopting the report’s recommendations would need to be in total, since embracing the recommendations piecemeal, as many from both parties (and the Obama administration) have tried, would greatly exaggerate the benefits for some at the expense of others.

Tax reform is a case in point.

Yes. Simpson-Bowles recommended lowering the corporate income tax rate to 28.0 percent, down from its current 35.0 percent rate. (2) But only after eliminating corporate tax loopholes and incentives, described more specifically in the report as “…a patchwork of overly complex and inefficient provisions that creates perverse incentives for investment…Corporate tax reform should eliminate special subsidies for different industries.” Together with individual subsidies (individual income tax rates would also be lowered under the commission’s recommendations), Simpson-Bowles identified $1.1 trillion of loopholes, incentives and subsidies.

These loopholes, incentives and subsidies are being left out of the current media coverage of corporate tax reform. And from intellectual circles comes dialogue asserting that our corporate income taxes make us uncompetitive to the rest of the world based on tax receipts divided by gross domestic product (GDP), as well as other contrived statistics. (3) But one doesn’t need to be a rocket scientist to understand that lowering the corporate tax rate without eliminating special incentives for business will add to the individual tax burden. Just look at the charts and ask how much is business going to pay and how much will individuals pay? Do we really care about tax rates in Burmuda, or Ireland, or Panama, etc.?

Big Business does not pay 35.0 percent.

In fact, because of the aforementioned tax subsidies for business, Big Business does not pay 35.0 percent in very many cases. As revealed by CTJ, the 288 companies in the FORTUNE 500 earning a profit from 2008-2012 paid just 19.4 percent in federal income taxes. Twenty-six of these companies paid no federal income tax, and 93 of them paid federal income taxes of less than 10.0 percent. Noteworthy, two thirds paid higher corporate tax rates to foreign governments where they operate than they paid in the U.S. on their U.S. profits. (1)

Framing the corporate tax question in terms of being competitive with the rest of the world is disingenuous. The question should be who is going to pay what? Again, look at the charts. Clearly, tax reform needs to be comprehensive.

Elevating the conversation.

Who should pay what in income taxes, what are the benefits delivered by governments that collect them, and who gets them? Tax policies of some countries are obvious “beggar-they-neighbor” schemes, analogous to the policies of countries that depreciate their currencies to gain export advantages over their neighbors. A rational approach to global income tax rates might start with a standard of living analysis. A suggested guide for national tax rates could be constructed from such a study. This would be a herculean undertaking for sure, but think of the benefits resulting from a coordinated global tax system designed to increase the world’s middle-income population. Unfortunately, this is probably a conversation that will never occur, since we can’t even discuss the issue of tax reform domestically without the overbearing influences of special interests that corrupt our tax code and legislative process.

(1) “The Sorry State of Corporate Taxes: What Fortune 500 Firms Pay (or Don’t Pay) in the USA And What they Pay Abroad—2008-2012”
(2) Simpson-Bowles also recommended eliminating corporate tax on foreign income, subject to corresponding elimination of corporate tax subsidies as described.
(3) See “A Better Way to Tax U.S. Businesses,” by Mihir A Desai in the July 2012 issue of the Harvard Business Review.

By Sam Dreher
H.S. Dreher Capital Management, LLC