Corporate Competitiveness: Are Taxes Really the Problem?

Corporations and their think-tank supporters have been busy arguing for a zero rate of corporate income taxation.  Their argument goes something like this:  Corporations today have to compete in a world market.  Corporations organized in countries with lower taxes will have an advantage over corporations organized in countries with high taxes.  The US has high corporate income taxes.  Therefore, the US should eliminate its corporate income taxes to help the US corporations be competitive.

There are a number of significant flaws in the corporatist argument for zero corporate income taxation. 

1) Although the US statutory rate for taxation of corporations is modestly high (35% on corporations with about $18 million in annual income),  corporations do not typically pay anything like the statutory rate on their comprehensive income.  Instead, they pay effective tax at a much lower rate.  Due to various legal loopholes (for which corporations assiduously lobby) and various illegal tax shelter schemes and aggressive tax reporting that plays the audit lottery (fewer than 2% of returns get audited, and even if audited, risky positions are likely to pass under the radar screen), corporations operating in the US tend to pay an effective rate of taxes that is about one/third the statutory rate or less (depending on industry, type of corporation, and various other factors).

Richard Sims, at the NEA, sent along a piece he'd written about the Tax Foundation's misleading propaganada arguing that the corporate income tax is causing America's corporations to fail to be competitive in the world markets.  Richard notes another flaw in the Tax Foundation's propaganda about high US corporate income tax rates--it focuses on comparisons of direct taxes on profits, but ignores the fact that different countries slice the tax world up in different ways.  As a result, while corporations in one country might be subject, let's say, to a 50% income tax and no other taxes, corporations in another country might pay only a 25% income tax, but have to also pay a 30% social contributions tax and a 10% environmental cleanup tax.  Added together, it is clear that the aggregate tax in the second country would be substantially higher, but the Tax Foundation's methodology for looking at US taxes would claim (irrationally) that the first country's corporations cannot be competitive with the second country's because of the higher income tax rate.  Richard notes the World Bank study on taxes on this issue.  I've excerpted his discussion of that, below.

PricewaterhouseCoopers, along with several other international consultancies, recently partnered with the World Bank in an extensive study on international business taxation (Doing Business 2008: The Global Picture).  The World Bank, unlike the Tax Foundation and other mono-tax theists, takes into consideration the fact that businesses do, in fact, face a host of taxes in addition to the corporate profits tax.  Particularly, it takes into consideration that businesses in many nations incur employment and social contribution taxes in amounts that are much higher as a share of profits than are the direct profit taxes themselves. 

For example, looking at taxes on labor and social contributions, the U.S. is 3^rd lowest as a percent of profits, ahead of only Denmark and New Zealand.  In the U.S., taxes on labor and social contributions are mainly the employer’s share of social security taxes and state unemployment contributions and amount to 9.6% of profits.  The average for such taxes in the industrialized world is 22.8%, more than double the U.S. level.  In seven of those nations, labor and social service taxes are more than 30% of profits, and in two of those, France and Belgium, are over 50% of profits.

When the World Bank study adds up the total tax bill for businesses, they find that the rates vary from as low as 28.9% and 27.2% in Ireland and Iceland, respectively, to as high as 66.3% and 76.2% in France and Italy.  The World Bank data shows the U.S. total business tax rate to be 46.2%, which happens to be exactly the average rate for the industrial nations.  Eleven of the 24 nations have higher total tax rates than the U.S. while twelve have lower rates.  You don’t get much more average than that

2) Admittedly, taxes may distort decisions, but the corporatist lobbying position that the economic distortions introduced by taxes are deeply harmful to corporations is highly overstated.  Every developed nation has an array of taxes that corporations are required to pay, and thus it is highly unlikely that taxes form a primary focus for corporations in deciding how and where to compete.  Various industry figures have verified that this is true, including John  Snow as Secretary of the Treasury commenting on his life as a railroad CEO.

3) Although the US taxes worldwide income of corporations, it permits significant deferral of taxation until profits are repatriated.  In fact, the foreign tax credit rules have been loosened recently so that corporations can cross-credit taxes paid to other countries to reduce their US tax due on US income, resulting in lower US tax rates that essentially subsidize those other countries' taxes.

4) US multinational corporations often are competing against other US multinational corporations, even overseas.  Lowering US taxes in those cases has nothing to do with helping US corporations compete--it has to do with helping the managers and shareholders of those corporations make even more money, without paying their fair share to support governmental programs.

5) Even if the argument were correct (that US taxes restrain US corporations' ability to compete internationally),  it is not clear what the people of the US gains per se from the ability of US-based multinationals to compete better in overseas countries.   US corporations tend to take for granted that their gains redound to the benefit of the US.  But if they are not paying taxes, the government loses.  If they are conducting most of their business abroad, their ability to compete that way does nothing for this country and the people lose.  In other words, the only way competitive gains by US corporations abroad benefit this country is if those gains are translated into jobs at home and manufacturing at home.  The record seems clear that multinationals are generally taking more of their business assets  overseas, outsourcing more jobs, including even the financial sector jobs that had seemed "safe" in the US, and laying off US workers.  Helping them to "compete" doesn't provide any assurance of increased US based investment, operations, employees, or manufacturing.  In fact, if their recent investment patterns hold up, we can expect investment gains from reduced corporate income taxes to redound to the benefit of India, China, and other countries with expanding markets.

Comments

[andy]

"The record seems clear that multinationals are generally taking more of their business assets overseas, outsourcing more jobs, including even the financial sector jobs that had seemed "safe" in the US, and laying off US workers."

and increasing taxes would reduce this phenomenon??? I would think that any rational business owner would offshore even more if the cost of doing business in the US increase (via higher taxes).

[Darrell]

To conclude if corporate taxes needs changed, one would have to be smart enough to know how the change would ultimately effect people. All corporate taxes ultimately flow through to people. Corporations are a convenient legal structure to define the association of people as employees, consumers, stockholders and creditors. Who pays or benefits from a tax change is uncertain. One may think stockholders, executives or creditors earn to much but but an increase in taxes may ultimately be paid by consumers or non-executive employees.

[LindaMBeale]

Darrell, there are two major problems with your argument.

First, understanding the incidence of corporate tax is relevant. I've noted that numerous times on this blog. The problem is, of course, that many of those who are funding the campaign to eliminate corporate taxes use what little data we have misleadingly. No one has been able to conclude for sure the incidence--maybe shareholders and managers, maybe also workers and creidtors. maybe so diffuse that it really doesn't impact drastically on any one segment and becomes a kind of background noise. The huge concentration of share ownership in the hands of a few wealthy families makes the fairness issue extraordinarily important. Given the various assumptions that most economists make all the time, it is reasonable to assume that a considerable portion of the benefit of corporate tax reductions goes to those who already benefit enormously from tax expenditures and generally low rates on high income--the managers and the major shareholders.

Second, the incidence of the tax relates most to the efficiency arguments, and also to fairness arguments, for and against corporate taxation. But there are in addition important societal and institutional arguments that at this point may even transcend those particular efficiency and fairness arguments. Teddy Roosevelt recognized the problems of corporate titans of malfeasance--the incredible concentrated power of multinational corporations can be extraordinarily harmful. Yes, ultimately they are acting at the behest of men, but because they are legal entities that are given personhood under Supreme Court interpretations of the Constitutions, and consequently have free speech rights and other constitutionally protected rights, that concentration of power is enormously worrisome. It has certainly been used to the detriment of American society and American workers, as the pension and labor issues show. The current corporatist state approach, with "privatization and deregulation" as the mantras, have enhanced that power even more. So we have private corporations doing public jobs for many times what it would cost us to do as a public service, under the guise of achieving greater cost-savings and efficiency! This is the biggest problem of the decade and perhaps of the century, in my view.

[LindaMBeale]

Andy

the problem, of course, is that we have made it easier and easier for corporations to take assets overseas. We should treat corporations headquartered and managed here as US corporations and there should be a toll charge on exit--any corporation moving assets overseas should pay full tax on any appreciation in those assets. At this point, we actually encourage overseas development of assets, because of the deferral. So we should end the deferral, including the "active financing" exception to subpart F.

[LindaMBeale]

Andy,
Often these issues are discussed in isolation and that is not a reasonable context. I am trying to suggest a more nuanced approach, to looking at the overall role of corporations in the US economy and in the broader society, and to consider what role corporate taxes actually play in corporate decisions. Corporations have become quasi-sovereigns, and that is problematic. We need to take various actions to reverse that development. If corporate taxes are maintained AND enforcement is increased (the paltry audit rate has to change, for example) AND the lax rules about exporting assets to run businesses overseas are changed, we could actually provide incentives for corporations to remain in this country. There must be a legislative focus on this issue, including among other changes a revisiting of the relaxation of the foreign tax credit basketing rules that facilitated corporations' use of foreign tax credits to reduce their US taxes.

[andy]

1. The 9 basket regime was an absolute nightmare. The only group that regime was good for was the lawyers.

2. Agree that audit/enforcement is key. I don't understand why Congress consistently provides IRS with less funding than it requests. Increased funding pays for itself. Also, DOJ litigators are overburdened by the 000s of shelter cases and need more resources.

3. I am sure that we can provide an "incentive" for corporations to keep jobs at home, but I don't know whether that comports with neutrality principles. We could tax every corporation at 90% on foreign source income, in which case in the short run, we'll see massive domestic investment. In the long run, corporations will leave the U.S. altogether.

5. I find the argument that U.S. multinationsl are just competing against other multinationals extremely weak. Yes, e.g., Pepsi and Coke are everywhere, but every industrialized nation has its own assortment of cola manufacturers with whom Big Cola must compete.

I am much more in favor of rabid enforcement (e.g. offshore account scandals) than trying to convince ourselves that taxing multinational firms on their wholly multinational operations will not have adverse effects in the long run. Over time, doing so will just result in divestments or split-ups; no business will be able to compete in the long run with U.S. owners if those owners bring with them a taint. I

Insofar as companies that produce offshore for sale into US (as opposed to conducting wholly foreign operations) are concerned, those companies will likely be willing to continue to pay higher taxes in exchange for the low labor/capital costs abroad. Perhaps that group can be targeted with higher taxes. But blanket attacks on all foreign operations that are wholly or significantly owned by U.S. persons would not be good for us.

[LindaMBeale]

These are obviously arguments worth considering, Andy.
1) Corporations will of course argue that the nine-basket regime was a nightmare, but I have strong doubts about that. Basketing is doable, and spreadsheets today facilitate these kinds of tracking tasks. Most of the people that I spoke with at the time that eliminating the baskets was being pushed by the multinationals saw it as just one more way for corporations to lobby for favorable laws.

2) Enforcement is a major area of concern, and the failure to fund the IRS adequately is a problem we can all agree on.

3) The problem with competitiveness arguments is that it assumes there is some way that the US benefits from making corporations "more competitive" by reducing their tax burden. That assumes, of course, that US corporations' tax burden is in fact higher than other countries' corporations, whereas in fact it generally isn't, especially if you look at the overall tax picture.

furthermore, the issue about "neutrality" is somewhat of a red herring--there are various definitions of neutrality, as you know, and depending on the choice, arguments from neutrality differ. Further, it is arguable that "neutrality" is not a reasonable basis for making decisions about corporations' share of a country's tax burden. The language of neutrality comes from "free market" arguments, that simply haven't really held up to their promises. Free market arguments are strongest when profits are roaring, but discussion of bailouts inevitably starts when companies (and investors) are in danger are losing. We could debate both whether neutrality is a reasonable tax policy concept and, if so, what definition of neutrality is the "right" one, and I suspect we wouldn't agree there either.

Just as people are talking about localvore--eating foodstuff produced locally--we may need to start talking (and putting policies into place) about localfare--starting to produce more goods that are needed in the US in the US. How we do that is not easy, but it is a conversation that should begin. Assuming that furthering the race to the bottom in corporate taxation is the way to do it is a no-go: we need a much more analytical and in-depth discussion about incentives, disincentives, control, and privileges.
5) Again, your argument here assumes that the US needs to lower taxes to compete. But that basic fact isn't established--the US is really about average or less than average when all the government-funding costs are considered.

[Anders Chydenius]

Where is the link to the World Bank report?

[LindaMBeale]

Paying Taxes 2008: The Global Picture, the study by Pricewaterhousecoopers with the World Bank (which is part of the World Bank's Doing Business 2008 study) discussed by Richard Sims is available at this link: http://www.pwc.com/gx/eng/tax/paying_taxes_2008.pdf. It is described generally at this link: http://www.pwc.com/extweb/home.nsf/docid/E2A6B3ECC0594A728525737E005EF831.

[Larry]

I realize I'm very late to this party, but a few reactions:

"Corporations and their think-tank supporters have been busy arguing for a zero rate of corporate income taxation. Their argument goes something like this: Corporations today have to compete in a world market. Corporations organized in countries with lower taxes will have an advantage over corporations organized in countries with high taxes. The US has high corporate income taxes. Therefore, the US should eliminate its corporate income taxes to help the US corporations be competitive."

But that is only one of the arguments. Others:

- Corporations spend vast sums on lobbying to get all the exemptions that you decry below. Getting rid of the tax would eliminate this deadweight expense (and the deadweight compliance expense), but more importantly would eliminate a big incentive to lobby/corrupt politicians.

- The incidence of the profits tax may be hard to decipher, but it is clearly not explicitly progressive. Wouldn't it be better to replace the profits tax by getting rid of the special treatment of dividends and cap gains? That focuses incidence on the rich, and unambiguously increases incomes of pension funds, endowments and other untaxed entities. It also simplifies the personal income tax.

The following is hardly convicing:

"For example, looking at taxes on labor and social contributions, the U.S. is 3rd lowest as a percent of profits, ahead of only Denmark and New Zealand. In the U.S., taxes on labor and social contributions are mainly the employer’s share of social security taxes and state unemployment contributions and amount to 9.6% of profits."

Ummm...US corporations pay 9.6% on revenues, not profits, no? FICA is based on salaries, which are typically a multiple of profits...US average profits are 5-10% of sales....

Isn't it also true that EU countries have been reducing their corporate taxes since the end of the cold war with no end in sight?

"Admittedly, taxes may distort decisions, but the corporatist lobbying position that the economic distortions introduced by taxes are deeply harmful to corporations is highly overstated. Every developed nation has an array of taxes that corporations are required to pay, and thus it is highly unlikely that taxes form a primary focus for corporations in deciding how and where to compete. Various industry figures have verified that this is true, including John Snow as Secretary of the Treasury commenting on his life as a railroad CEO."

Snow isn't the best example is he? Would his company invest in railroads in Denmark?

"Although the US taxes worldwide income of corporations, it permits significant deferral of taxation until profits are repatriated. In fact, the foreign tax credit rules have been loosened recently so that corporations can cross-credit taxes paid to other countries to reduce their US tax due on US income, resulting in lower US tax rates that essentially subsidize those other countries' taxes."

More deadweight losses. Simple is better.

"US multinational corporations often are competing against other US multinational corporations, even overseas.

GM is a lot more worried about Toyota than about Ford. Boeing watches Airbus, not Lockheed. Oracle watches SAP...

"Lowering US taxes in those cases has nothing to do with helping US corporations compete--it has to do with helping the managers and shareholders of those corporations make even more money, without paying their fair share to support governmental programs."

If the profits tax were replaced by neutral treatment of income, the money would be there...

"Even if the argument were correct (that US taxes restrain US corporations' ability to compete internationally), it is not clear what the people of the US gains per se from the ability of US-based multinationals to compete better in overseas countries. US corporations tend to take for granted that their gains redound to the benefit of the US. But if they are not paying taxes, the government loses."

Not if their investors are paying those taxes.

"If they are conducting most of their business abroad, their ability to compete that way does nothing for this country and the people lose. In other words, the only way competitive gains by US corporations abroad benefit this country is if those gains are translated into jobs at home and manufacturing at home."

This isn't the comparison. The comparison is with what would happen with jobs at home if those corporations weren't competitive. Don't we know that pay, benefits, and job growth are higher in multinationals than in non-tradable industries? When such firms lose jobs, it's to non-US multinationals, not to the ether.

"The huge concentration of share ownership in the hands of a few wealthy families makes the fairness issue extraordinarily important."

That's a bit 19th century isn't it? The big holders now aren't wealthy families; they're pension and mutual funds.

"the incredible concentrated power of multinational corporations can be extraordinarily harmful...This is the biggest problem of the decade and perhaps of the century, in my view."

This is an argument about corporations in general, not about taxation. If you're upset about the US' current economic system, is keeping a dumb tax regime the right lever?