Obama’s Fruitcake and the Truth About Business Taxes

By :: February 8th, 2011

In his speech yesterday to the U.S. Chamber of Commerce, President Obama doubtless pleased many in his audience by repeating the business community’s favorite mantra about U.S. taxes:  “Another barrier government can remove,“ he said, “is a burdensome corporate tax code with one of the highest rates in the world.”

Now, what the president said is not wrong—the 35 percent top statutory U.S. corporate income tax rate (39 percent when you include average state rates) is among the highest in the world. And it is far above the 26 percent average among major developed countries. That’s no doubt a bad thing. But real story of business taxation in the U.S. is far more complicated than that one rate. 

The average effective U.S. corporate tax rate—the amount of tax corporations actually pay—is far lower than 35 percent, roughly 20 percent to 25 percent by some estimates. Thanks to the diligent and widespread use by many companies of hundreds of billions of dollars in tax breaks, and because the earnings of many firms are reported on individual, rather than corporate returns, the U.S. raises very little tax revenue from corporations.  And the variation of tax liability among corporations is huge.  GE pays a 3.6 percent rate. Disney pays 36.5 percent.

Th Tax Code is loaded with reasons why. For instance, multinationals shift income to low-tax countries. Firms are allowed to depreciate some investments for tax purposes much faster than the equipment needs to be replaced. Congress went even further in December when it agreed to let businesses immediately write off the entire cost of investments they make in 2011. Firms that finance this equipment with borrowed money may end up paying a negative tax rate on the deal.

But these breaks are only one reason why the statutory rate tells less than the whole corporate tax story. It turns out that more than half of taxable business income in the U.S. is earned by pass-through companies such as partnerships and S corporations. Their owners pay individual taxes on this income, but owe no corporate tax at all.

Because this happens far less frequently elsewhere, it is very difficult to compare U.S. business taxes (either rates or payments) with those in other countries. Peter Merrill, a principal at the accounting firm of PriceWaterhouseCoopers, argues that the shift to pass-through companies may be the single most important reason why U.S. corporate tax revenues are so low.  

Indeed, even though the U.S. corporate rate is the second highest in the world, corporate tax revenues amounted to only about 1.3 percent of Gross Domestic Product last year--less than half the average among major industrialized countries.

Because the corporate tax in only a piece of the U.S. revenue system, it is important to think more broadly about all taxes. And when you do, it is clear that Americans are hardly overtaxed, at least compared to the rest of the developed world. One reason is that the U.S.is about the only major industrialized nation that does not also have a Value-Added Tax or national sales tax. For instance, advocates for low corporate taxes love to talk about Ireland’s 12.5 percent combined corporate rate. But they usually don’t say much about Ireland’s VAT, which has a top rate of 21 percent. Indeed, those countries with the lowest corporate rates, such as the Slovak Republic and Poland, raise a big chunk of their tax revenue though a VAT, where their rates tend to be among the world’s highest. The money, they have learned, has to come from somewhere. 

Add it all up and the U.S. collects far less in taxes than most of our trading partners. In 2008, for instance, Americans paid about 26 percent of GDP in total taxes. The average among developed countries was 35 percent. Ireland collected 29 percent, Canada 32 percent, and Germany 37 percent. Only Turks and Mexicans paid less than Americans.

I don’t mean to suggest that having a high corporate rate is good. It isn’t. But Obama is doing all of us--including the business community--a disservice by talking about that statutory rate alone, as if it had nothing to do with other business taxes, individual income taxes, and even consumption taxes such as a VAT. That corporate rate does not exist in isolation.  

At the Chamber, Obama joked that perhaps he would have gotten off to a better start with the business lobby had he brought them a fruitcake when he first moved into the White House. I guess he felt that yesterday’s bit of tax pandering made up for the omission.

17Comments

  1. Michael Bindner  ::  7:11 pm on February 8th, 2011:

    Since some of your remarks on corporate tax rates mirror what Eric Toder wrote last week, I will repeat my comments to his article here:

    The reason to lower the corporate rate is the lowering of the top individual rate. Currently, the top individual rate and the corporate rate are 35%. The Fiscal Commission recommends both be 28%, while the Bipartisan Policy Center (BPC) recommend 27 percent.

    Most of the base broadening will come on the individual side, at least under each proposal, although BPC also includes a VAT (even though it does not use that term).

    I question using individual loophole closing to lower rates and increase revenue and I question why it is any easier or any more equitable to cut the number of tax brackets to two, since by and large filers use the provided tax tables anyway, so the number or rates does not add any burden at all – unless I am missing something, it sounds gimmicky to me.

    I agree with the BPC on the notion of a VAT, however I would double it to 13% and tie it to discretionary spending, with a requirement that the two balance with automatic spending cuts and rate increases kicking in when there is a shortfall and the reverse when there is an excess – provided that the economy is out of recession – in which case a deficit would be permitted.

    In order to make payment of the VAT politically palatable, withholding tables would be altered to increase net pay by enough for people to pay the tax.

    The middle range of personal income tax rates, as well as individually filed pass through taxes from Schedule C and F income, as well as partnership and Chapter S income, will be shifted to an expanded business income tax – along with payroll taxes funding surivor benefits for widows under age 60, Medicare Hospital Insurance and Disability Insurance (which will be decoupled from income), as well as revenue from the current corporate income tax.

    This tax will be set to collect 27.6% of value added to cover all social service entitlements – however it will not show up on receipts because the tax will also include a refundable child tax credit to be paid to workers and the preservation of the mortgage interest exclusion. In order to account for these payouts, the statutory rate will be 33.6% The child tax credit is fully paid for by ending the home mortgage deduction and the state property and income/sales tax deductions at all levels. These deductions and credits, as well as residual Social Security payroll taxes, will be factored out before the VAT induced net pay increase is calculated.

    Payroll taxes for Old age and older survivors insurance will continue to be withheld separately, with the income cap eliminated and the employer contibution credited equally regardless of income – although the employee contribution will remain tied to income. Bend points will be ended as a result, with benefit calculations in the future tied to contributions in each year. Bend points will be phased out over time. Note that these developments are necessary in order to pursue any kind of personal account scheme – however such accounts should be limited to investments in one’s own employer rather than the casino of Wall Street, with diversification provided by having a third of employee-owned shares (which are only provided from the employer contribution) held by an insurance fund of all such companies.

    Budget balance should come from the residual income surtax, which will range from 4% for joint filers and widows making over $100,000 (or singles making over $50,000) to 28% at the $550,000/$275,000 level, with rates going up in 4% increments for each $75,000. If fewer rates are politically expedient, the tax floor could occur at 12% of all income over $200,000 and 28% for income over $475,000. Dividend income, capital gains and distributions from estates would be taxed as normal income – with an ESOP sales exclusion for estate distributions and the retention of the charitable contribution deduction.

    The income surtax would fund any deficits in the VAT or BIT in time of economic downturn, net interest payments, repayment of trust funds, including the Social Security Trust Fund, overseas military, air and marine deployments and naval sea operations.

    If taxes are inadequate, this fund may go into deficit – with the understanding that only this fund will pay back all such borrowing and that only high income taxpayers and their children will be on the hook for this. In reality, they are anyway, since the ability to run a deficit is solely provided by the ability to tax incomes and that taxing lower incomes has a Laffer problem, not because of tax avoidance but because such taxes would retard consumer spending. When this fact is really understood, the resistence to raising adequate revenue will evaporate fairly quickly, if only to save on interest costs.

    UPDATE: On the issue of competitiveness, adoption of what I recommend would effectively make the corporate tax rate zero for income earned outside the country. While others would undoubtedly follow suit, it would likely have more revenue go to the shareholders, who would pay income taxes on them instead of having corporate income taxes paid in their name..

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  4. Scott  ::  11:42 am on February 9th, 2011:

    I have been pointing this out to people for years! Yet, listening to media and corporate voices, you’d think America was suffering the highest levels of taxation in the known universe. It just demonstrates once again that the truth is seldom heard in the loudest voice(s). There is no question that the tax code needs to be reformed. Not so much to reduce taxation overall, but to allow for a more simple and honest accounting.

  5. anon  ::  4:41 pm on February 9th, 2011:

    It’s more fascist than that. The favored companies pay 20%, new and unpopular companies end up paying much more.

  6. Ralph H  ::  8:59 am on February 10th, 2011:

    One of the things you notice as you look at the rolls of the high tax payers (Wallmart) vs low payers (Google, GE) is that those who employ low paid persons vs highly compensated persons pay the highest tax rate. This is counter to prevailing progressive personal tax logic. Maybe we should try to reverse this in our revised tax policy, since our overwhelming problem is unemployment in the lowest skilled segement, particularly in young minorities with less education. We are slowly turning to a society where 50% are highly educated and fund everything while the rest turn into wards of the state, since they cannot justify minimum compensation, and low cost products are produced by offshore enterprises.

  7. KG  ::  10:51 am on February 10th, 2011:

    I have said for many years that we should have a flat tax.

    It is the only thing that is fair. I understand that the fear is our government is out of control & would find a way to mess that up too (to THEIR benefit not the people they serve & that pay their checks – they bite the hand that feeds & they will find out in due time what the results will be), but the write offs, are problematic on many levels, they can be played with, & don’t include reward for keeping the business in America, so that is a gigantic problem that is causing us to implode.

    Not only do they not pay much, but give Americas jobs away – Good going, a runaway train with no Engineer!

  8. Michael Bindner  ::  9:47 am on February 12th, 2011:

    If Warren Buffett and David Koch pay more taxes becaue of this, I am all for it, however a flat tax would not be refundable at export, so it is a non-starter.

    Worse is the oft associated suggestion that Flat Taxes not be withheld, but paid by each taxpayer in a separate transaction. That proposal is a non-starter. One wonders if those who proffer such nonsense have ever taken even an undergraduate class in public finance.

  9. Items from Around the Web 2/9/11 | GLOW Democrats  ::  2:23 pm on February 12th, 2011:

    […] TaxVox » Blog Archive » Obama’s Fruitcake and the Truth About Business Taxes […]

  10. CLARENCE SWINNEY  ::  4:25 pm on February 17th, 2011:

    FLAT TAX?
    HOW MUCH?

    3600 bUDGET REQUIRES A 30% TAX ON ALL INCOME.

    12,000 INCOME 3600 BUDGET

    TOP 10% GET MOST OF THE INCOME AND MUST PAY HI PERCENT
    1% GET 24%

  11. CLARENCE SWINNEY  ::  4:30 pm on February 17th, 2011:

    S&P 500 lARGEST
    IN 2009
    OVER 200 PAID 0. ZERO. NONE. ZAP
    79 OF THOSE GOT A REFUND EVEN THO REVENUE WAS IN BILLIONS.

    TOP 400 INCOMES PAID 18%.

    BURN TAX BOOKS START OVER.
    REAGAN 1986 TAX REFORM WAS 1832 PAGES.

    EACH INDUSTRY HAS MANY MANY EXEMPTIONS. MANY.
    GE IS LEADER.

    2009 RECORD INCOME 4300 MILLION PAID 17%

  12. CLARENCE SWINNEY  ::  4:38 pm on February 17th, 2011:

    2009 We paid the Federal 17.5% of Total Income.
    Lowest amongst all rich nations.

    35% Corp tax Rate no one pays it . Scream eliminate it.

    They do not share in our budget. 7% of our budget versus as high as 30% in the past.
    Each adm. gave then exemptions.
    $$$$$$$$$$$$$$ BUYS INFLUENCE $$$$$$$$$$ EXEMPTIONS

    Lookie at Health Care Reform. Public Option. 70% polled We want it. Max Baucus one of my heroes. Chair Senate Finance. First act took it out of the bill.
    Shocked me. Till I read his campaign kitty had $1,900,000 from Health Care Providers.
    $$$$$$$$$$$ BUYS GOOD PEOPLE $$$$$$$$$$$$

  13. CLARENCE SWINNEY  ::  4:40 pm on February 17th, 2011:

    MICHAEL. VERY VERY GOOD. APPECIATE IT

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