Corporate Tax Reform: The Winners and Losers Problem
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.