Playing Favorites in the Corporate Tax Code

By :: February 24th, 2012

The President’s new Framework for Business Tax Reform is two documents in one. The first diagnoses the many flaws in America’s business tax system, and the second offers a framework for fixing them.

Much of the resulting commentary has focused on the policy recommendations. But I’d like to give a shout out to the diagnosis. The White House and Treasury have done an outstanding job of documenting the problems in our business tax system.

As the Framework notes, our corporate tax system pairs a high statutory tax rate with numerous tax subsidies, loopholes, and tax planning opportunities. Our 39.2 percent corporate tax rate (including state and local taxes) is the second-highest in the developed world, and will take over the lead in April when Japan cuts its rate. But our tax breaks are more generous than the norm.

That leaves us with the worst possible system – one that maximizes the degree to which corporate managers have to worry about taxes when making business decisions but limits the revenue that the government actually collects. It’s a great system for tax lawyers, accountants, and creative financial engineers, and a lousy system for business leaders and ordinary Americans. Far better would be to fill in the Swiss cheese of the tax base and move to a lower statutory rate, just as the President proposes (albeit with much more clarity about the rate-cutting than the cheese-filling and with proposals that would make some of the holes bigger).

A related problem is that our corporate tax system plays favorites among different businesses and activities, often with no good reason. To illustrate, Treasury’s Office of Tax Analysis calculated the average tax rates faced by corporations in different industries. As you can see, the corporate tax really tilts the playing field:

The Corporate Income Tax Tilts the Playing Field

I am at a loss to understand why the tax system should favor utilities, mining (which includes energy extraction), and leasing, while hitting services, construction, and wholesale and retail trade so hard. Why should the average retailer pay 31%, while the average utility pays only 14%?

These disparities are unfair and economically costly. Investors recognize these differences and allocate their capital accordingly. More capital flows to industries on the left side of the chart and less to those on the right. Far better would be a system in which investors deployed their capital based on economic fundamentals, not the distortions of the tax system.

The chart highlights one of the key battlegrounds in corporate tax reform. Leveling the playing field (while maintaining revenues) will require that some companies pay more so others can pay less. The U.S. Chamber of Commerce announced yesterday that it “will be forced to vigorously oppose pay-fors that pit one industry against another.” But such pitting is exactly what will be necessary to enact comprehensive corporate tax reform.

P.S. The full names of the sector names I abbreviated in the chart are: Transportation and Warehousing; Agriculture, Forestry, Fishing, and Hunting; Finance and Holding Companies; and Wholesale and Retail Trade.

 

12Comments

  1. Michael Bindner  ::  8:03 am on February 24th, 2012:

    The unmentioned flaws in our tax code are the more glaring ones. The first is that we tax corporations one way and other employers another. All business should be taxed the same. The second is that the vast majority of employees are required to file their own taxes, even if they only have one job, instead of having employers pay the tax obligation on their wages as part of a consumption tax, leaving income tax filing for people with more complicated income streams. Reform will happen when we deal with these problems, which I believe will take someone running for President who promises to end the need to file personal income taxes. One would think this would be an attractive promise to make.

  2. M Leary  ::  9:34 am on February 25th, 2012:

    Mr. Marron is “at a loss to understand” why these differences should exist. Why not start with an analysis of what in the tax code causes these disparities (foreign tax credits, depreciation, interest deductions??)? That would permit a discussion of whether or not those items are reasonable and appropriate. Linking capital flows directly to tax rates seems to ignore a host of other factors that may contribute to those flows (seems I’ve noticed more retailers going bankrupt over the last five years than utility companies). And while we’re “leveling the playing field” is everything on the table such as the federal excise tax on gasoline? Issues like this cannot be dealt with in a vacuum.

  3. Roy J. Meidinger  ::  11:54 pm on February 25th, 2012:

    2/22/12
    Honorable President Obama
    My goal has always been to bring the health care industry in line with what it gives to society and what it costs society. To this end I have worked to reduce the overall costs of health care by a trillion dollars a year for both private and public expenditures and move these funds into the manufacturing sector of our country. Along the way I have uncovered many harmful financial practices.
    When the Medicare/Medicaid programs first started the health care costs represented 6.5% of our GDP; the health care costs have now moved to 18% of GDP. I find it completely unacceptable that one of the largest industries was able to grow this big because it has received special treatment by the Federal and State governments, by not enforcing our antitrust laws. To stop this in the future the McCarran-Ferguson Act must be repealed.
    When the Social Security System was first introduced the original policy was to keep all the trust funds separate from the general tax funds. This policy did not last long and the funds were co-mingled with other federal income taxes and utilized to pay for the government’s expenditures. We now owe over $3.6 trillion to this fund and the only way to make up this obligation is to tax the same financial groups which originally paid into the fund. Although these obligations are owed for future payments, we should write off this $3.6 trillion and only tax our citizens for what is need for immediate distribution. Over a long period of time, the tax has become a tremendous burden on the middle class, with the actual results of wiping out a great portion of the Middle class.
    This is completely unacceptable; the Social Security tax has to be converted from a regressive tax to at least a flat tax and have the higher income individuals pay their fair share; Keep in mind the higher income individuals benefited more when the Social Security funds were utilized to run our government, defend our country and secure our freedom. The benefits of such a tax are to lessen the burden on the middle class and lessen the burden on employees, place larger sums of money in the groups which will spend them.
    I have also found it incredible that in the private health care sector the premiums charged by the health insurance companies are determined by what the health care providers charge. The hospitals in this country are now writing off 85% of the patients’ billed amounts, but the insurance companies determine their premiums on what is billed rather than on the actual 15% paid. If the health care providers were to bill the actual amounts collected, the health insurance premiums would be lowered by 85%. This tremendous reduction would not lower the quality of care received by the individual but give businesses a tremendous reduction of employee costs.
    Respectfully yours,

  4. Michael Bindner  ::  4:05 pm on February 27th, 2012:

    Spending the trust fund is actually not unacceptable at all, because the alternative, subjecting this money to the speculative whims of the financial markets, is much worse, while allowing investment managers to profiteer using these funds. While the regressive nature of the tax is regretable, the way around this is to reduce the cap on the employer contribution, so that individual benefits go down for higher income retirees, while decoupling the employer and employee contributions, so that all workers are credited with the same contribution and it is funded with a consumption tax with no cap, with imports fully taxable and exports zero rated at the border.

    As far as expanding Medicare – it is entirely appropriate, as prior to Medicare, people had low quality insurance if they were insured at all, had to rely on charity and mostly simply died younger and without care that could have extended their lives by a decade or more.

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