Corporate Tax Reform: The Winners and Losers Problem

By :: January 20th, 2011

Corporate tax reform is a good idea and long overdue. But it won’t take  much time before the concept crashes into a seemingly-immovable political barrier. The problem is that the current tax code creates so many winners and losers that any broad-based reform will inevitably do the same.

This would happen even with “revenue-neutral” corporate reform—that is, if the revised tax code raised the same amount of money as the current law.  But given the nation's $14 trillion debt and $1 trillion+ annual deficits, tax reform will eventually have to increase federal revenues. And in that environment, the losers could vastly outnumber the winners.

And that’s not exactly a prescription for widespread corporate support.

For evidence of the problem, just think about the top corporate executives who chatted about  reform with Treasury Secretary Tim Geithner the other day. They represented  a What’s What of multinational corporate giants—GE, Coca-Cola, Johnson & Johnson, Exxon-Mobil, Cisco, Wal-Mart, Disney, Bank of America, and Procter & Gamble, to name just a few.  In some ways, it is a pretty homogeneous group—huge megacap companies with a big international presence. Not a dry cleaner in the bunch.

But, still, these firms represent very different industries. Some make equipment. Others sell services. Some profit from patents and royalties, while others generate most of their earnings by lending money, and still others are retailers. Even though all make billions of dollars overseas, their foreign operations vary widely. It is no surprise that each is either punished or rewarded by a tax code that is elbow-deep in everything  they do.

As a result, U.S. tax law is very, very good to some of these companies and much less generous to others. Courtesy of Marty Sullivan over at Tax Notes, here are the average effective rates that some of the firms represented at Geithner’s meeting reported paying over the past three years. Keep in mind the statutory tax rate in the U.S. is 35 percent, but companies can often lower their bill thanks to dozens of deductions and credits. At one end were the winners:  Cisco reported an effective income tax rate of 19.8 percent, Johnson & Johnson 22 percent, and GE just 3.6 percent. At the other end:  Wal-Mart paid 33.6 percent, and Disney paid 36.5 percent--more than the statutory rate. 

This all happens mostly because some companies can shift nearly all of their profits to low-tax countries while others, due to the nature of their business, can’t. But whatever the cause, the effect is that the winners are very likely to fight like Tiger Moms to preserve their tax preferences even as they argue for lower rates. Those who get the short end of the tax stick today will use all of their influence to drive down rates and, if they can get away with it, convince Congress to add a beneficial tax break or two. 

It would be silly to expect anything different. No CEO who likes his corner office is going to advocate for changes that will reduce his firm’s after-tax income. Such a step would make for a somewhat awkward shareholder’s meeting.

You could see all these gears turning at the House Ways & Means Committee this morning. At the first of what chairman Dave Camp (R-MI) promises will be a series of hearings on tax reform, Procter & Gamble CEO Robert McDonald spoke for the Business Roundtable. The Roundtable represents the CEOs of large U.S. companies, some who attended the Geithner session. 

In his prepared testimony, McDonald embraced lower rates and a dramatic shift in the way the U.S. taxes worldwide income. He called for new tax incentives for research and development, but said not a word about eliminating corporate tax preferences.  Instead, he suggested that reform be coupled with an overall reduction in corporate taxes, according to the Financial Times.  

McDonald’s position was entirely predictable and, from his point of view, perfectly reasonable. But it is not the route to reform.

6Comments

  1. Sid F  ::  9:43 am on January 21st, 2011:

    Very good analysis of why Corporate (and Individual) Tax Reform will not take place.

    As I have said earlier, we have already seen this movie and we know how it ends. We need to go see another movie.

  2. Roberta Palmer  ::  1:27 pm on January 22nd, 2011:

    I believe we have reached a tipping point in tax reform with the wide-spread conviction that the present law is a drag on our economy, not only because of uncompetitive rates but because of the man-hours and expense involved in filing returns and avoiding taxes. The drive for the latter distorts business decisions. CEO’s understand that in order to get lower rates, loopholes will have to be filled. In addition, we will not attract badly needed foreign investment with the current rates.

    All other developed nations use a value-added tax so that income tax rates can be lowered. France derives twice the revenue from its VAT as from its income tax (which, incidentally, has a floor of about $40,000/household). But we are very exceptional.

  3. Michael Bindner  ::  11:38 pm on January 22nd, 2011:

    They used to call this the Corporate Profits Tax, which was a more apt description. It should be married into an expanded business income tax where wages are no longer deductible and where all businesses file according to the same rules, regardless of their type of ownership. Portions of the personal income tax and payroll tax could be reduced or eliminated in this reform, although payroll taxes for retirement savings and the widows of retirees should remain separate so that the can be privatized. Additionally, the premium rates on the wealthy should remain part of a separate tax so that the progressivity of the overall system can be maintained. The expanded business income tax should become the vehicle for an expanded Child Care Deduction, while the mortgage interst and state income and property tax deductions go away to fund that. The health insurance exclusion can remain part of this tax, which allows non-corporate firms to take better advantage of it.

    There should also be a separate VAT that consumers do see and which funds domestic military and civil discretionary spending. In this way, the consequences of a buildup of advanced weapons and the defense of military bases becomes obvious to taxpayers, giving Congress some reason to make cuts.

    Both of these taxes could be regionally based, with balance requirements, however differing rates would require an constitutional amendment for the VAT to be adjusted to spending levels. Such a regime would also encourage spending reductions. Note that the VAT amendment would not be because regional governments can’t be created, but because excises must be uniform.

  4. Carl  ::  10:07 am on January 23rd, 2011:

    A brute force technique to deal with the offshoring of profits: lower the corporate income tax to 20% and treat capital gains as ordinary income. The result is close to a wash for double-taxation.

    (1-35%) * (1-15%) = .65 * .85 = .5525 kept for a total tax of 44.75%.

    (1-20%) * (1-35%) = .80 * .65 = .52 kept for a total tax of 48% for those in the highest tax bracket. For those in the 28% bracket the total tax for founding and selling a C corporation would be 42.4%, a slight cut.

  5. Immelt as Job’s Czar, be afraid, be very afraid! | Clearing the Air | NCPA.org  ::  5:24 pm on January 28th, 2011:

    […] pay billions in taxes, royalties and fees to the federal government each year, GE’s effective corporate tax rate was 3.6 percent – you read that right, one of the biggest companies on earth pays just 3.6 […]

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