Thursday, February 25, 2016

Corporations should pay their fair share.

Corporations should pay their fair share.  This is a refrain often heard on the campaign trail.  Believe it or not, the US has the highest corporate tax rate (35% + state taxes, estimated to total about 39%) in the world. Here is a list of corporate tax rates, by country.  In addition to the high rate, the US is one of a few (and shrinking) number of countries who tax foreign income.  Most countries only tax corporate revenue that is earned within their borders.  Even this wouldn't be that big of a deal if the US didn't have extraordinarily high tax rates.  If the US taxed worldwide revenue at a reasonable rate, similar to other countries, then corporations wouldn't have to pay that much after deducting the taxes they have already paid to the foreign countries where the income was earned.

Before we get into the numbers, I just want to consider how weird the public debate on this is.  For instance, the Obama administration has been pushing for capital controls to prevent corporations from moving out of the country to lower tax jurisdictions (which, as noted above, is roughly the entire rest of the world).  Burger King was targeted because they merged with Tim Horton's and moved their headquarters to Canada.  Moving to Canada is now considered a tax dodge.  Literally any business any US corporation conducts abroad can be derided as a tax dodge, because there is nowhere else a corporation could conduct business under a more onerous tax regime.

The usual response to this is that the real rate is much lower because of all the corporate loopholes.  Think about this.  If real corporate tax rates were actually lower, then why would they be moving to Canada?  Either de facto tax rates are low, or there is an epidemic of corporations moving to other countries to avoid high taxes.  Both can't be true.

Here is the White House (pdf: corporate tax expenditures start on page 228) estimate of tax deductions.  In 2015, corporations will pay about $340 billion in taxes.  Corporate tax deductions ("tax expenditures") total about $130 billion.  Of this, about $65 billion (from the White House file) is "Deferral of Income from Controlled Foreign Corporations".  This is the net additional tax firms would pay to repatriate their earnings from foreign subsidiaries.  Note, this is only considered a tax deduction because (1) the US has the highest corporate tax rate and (2) we impose that tax on foreign earnings in a way that most of the developed world does not.  In other words, if we simply mimicked, say, Denmark (23.5% tax on domestic income), US corporations would pay lower taxes and this $65 million would not be considered a tax deduction, because Denmark would have never considered it to be taxable income in the first place.

The next four largest corporate tax deductions are: $11.4 billion on "Deduction for US Production Activities", $9 billion on municipal bond interest, $7.6 billion for low income housing credits, $6.6 billion for expensing R&D activities.  These four, together, account for about half of the remaining deductions, and I think only the $11.4 billion would contain some of what people might generally be imagining when they think about corporate tax loopholes.

As a comparison, the four big individual housing tax deductions (imputed rent, mortgage interest, capital gains, and property tax deductions) total about $218 billion.  The deduction for employer provided health insurance is about $206 billion.

There is support among economists on both the right and left to eliminate (not reduce - eliminate) the corporate income tax and to eliminate these individual deductions.  These changes would, on net, make the tax code more progressive without reducing total revenues significantly.  Some of the housing deductions are much like the supposed deduction on foreign corporate earnings.  They are only considered deductions because we presume to tax them to begin with.

The taxation of rental income from tenants, which is not imposed on homeowners, is a very large and regressive tax expenditure.  This regressive taxation would automatically go away if we stopped taxing capital income.  Some, or all, of any revenue shortfall, in aggregate terms (local, state, and federal) could be made up for with higher property taxes.  Lower income households tend to spend more on housing, so property taxes are still somewhat regressive, but they are less regressive than our current set of capital taxes, which include large tax benefits, like nontaxed imputed rent and deducted mortgage interest, that are aimed solely at high income, high wealth households.  Somewhat higher property taxes would also probably help to alleviate some of the volatility we have seen in housing markets.

Anyone having political debates where they presume that higher corporate taxes are a step toward fairness is simply not engaging with reality.  Our current tax regime compares unfavorably in this regard to every other country on the planet, and doing the exact opposite of that would actually better achieve the end result of creating a more fair tax regime.

Corporate taxes don't fall on the corporation.  After tax capital income has been a very stable proportion of total domestic income for many decades, with various levels of corporate income tax.  The distribution of incomes emerges from an infinitely complex set of inputs which are not significantly changed by a marginal change in corporate tax rates.  Corporate taxes are not particularly progressive or regressive because they don't particularly fall on shareholders.  In these two graphs we can see that total capital income (after tax corporate profit + interest income + proprietor income) is fairly stable over time, after tax profit is more stable than pre-tax profit, and most of the change in capital incomes come from changing shares of interest and proprietor income, not changing tax rates.  Capital income is such a stable portion of domestic income that its level is an insignificant factor in changing wage levels.  And, corporate tax rates have little discernable effect on the aggregate level of after tax capital income.  In short, corporate taxation would not be an important topic on a pragmatic platform for economic prosperity and fairness, and to the extent that it might be a topic, the elimination of corporate taxation would be the policy goal.

The effect of taxes on after tax profits can be seen clearly with municipal bonds, which are one of the larger corporate tax deductions.  The White House estimates this deduction at $9 billion, or a little less than 1% of domestic corporate profits.  So, the accounting for this appears to pull the effective tax rate down by a little less than 1%.  But, this tax deduction isn't a corporate tax deduction.  It is a municipal tax deduction.  Since municipal bonds are tax deductible, they pay lower interest rates, saving money for local governments and agencies.  So, if a municipal bond pays 3%, an equivalent corporate bond will typically pay something like 4%.  This is a well known issue.  So, this tax deduction reduced corporate taxes by $9 billion, but it also reduced corporate profits before tax by something close to $9 billion.  The existence of the municipal bond tax deduction has little effect on after tax corporate income.  Most taxes that are universally applied will have a similar effect.  Municipal bonds just happen to be publicly traded in liquid markets, so that we can see the effect easily.

Here is one more graph, measuring Compensation over time.  The upper and lower bands represent the maximum and minimum share of domestic income that has gone to compensation over this period.  Overwhelmingly, it is the growth rate of total domestic income that raises future Compensation levels, not the relative share, which is fairly stable over time.  And, of course, according to my recent research, both the decline in total growth of domestic income and the decline in relative compensation income to the bottom portion of its long-term range, are largely attributable to our destructive limitations on urban housing expansion.  This is why we don't see an unusual rise in capital incomes in the graphs above.  I didn't include income to homeowners in that graph, and that is the income category that has risen during our recent malaise.

We are the 100%.  Overwhelmingly, our well-being is a product of past growth rates.  Income shares between corporations and laborers are too stable to make much difference in aggregate income levels, and even if they weren't corporate taxes don't have much of an effect on after tax corporate income anyway.  The best tax regime, considering these issues, is the regime that encourages production and growth.  I will leave it as an exercise for the reader to decide if haranguing corporations as they move away to anywhere else in the world to avoid a tax that has little effect on income distribution is a sign of success.


  1. Egads, kill the corporate income tax already. By the way, a $3 a gallon gas tax would just about equal the lost corporate income tax revenues.

    But due to the fact that rural States get two senators, and rural states tend to have long drives, you will not see a serious gas tax in America.

    I guess we will just have to hope for prosperity despite bad policies.

  2. Not that it matters too much (as you point out), but my understanding is that the US effective corporate tax rate (which is what matters since no one actually pays the statutory rate except small businesses) is below the OECD average.

    1. Hard part is no one actually knows, because IRS data isn't public and GAAP taxes are useless for estimating actual taxes paid. If someone finds a study where researchers where given anonymized IRS data, I'd be really interested to see it. Post it in the comments if you know of one or find one.

    2. Well, it matters to the extent that it creates distortions, although probably local comparative advantages usually outweigh marginal tax differences.

      Here is a post where I used BEA data from Fred. It looks like, according to BEA aggregates, domestic corporate tax rates are generally above 30%.

      I suspect that the claim you have seen is mixing numerators and denominators. For instance, simply dividing US corporate taxes by US global corporate profits, the current tax rate appears to be under 25%, but it does this by including foreign profits in the denominator and not including foreign taxes in the numerator. This would be a very easy mistake to make, and it is the kind of mistake that would get forwarded on Twitter and Facebook with righteous indignation.

    3. Whoops. Kevin, I didn't see your comment before I posted mine. I think my links might help. As far as I know the BEA data is reasonable. The problem with trying to use SEC filings, etc., is that in this day and age, the domestic vs. foreign distinction can really distort the numbers. Maybe the right IRS data would straighten that out. But, I think, viewed carefully, the BEA can be informative.

  3. Interesting looking at the countries that tax foreign income. I don't have a hypothesis for Chile or Greece, but I think it makes sense for the other non-US countries.

    Ireland - huge Pharma sector that they don't have a large enough population to benefit from just internal revenue taxes. They move their for the low taxes in the first place, so it still must be seen as a net benefit.

    Israel - A tiny country that's a huge tech exporter.

    Korea - See Isreal.

    Mexico - Big producer of goods for the rest of North America, trying to capture some of the value they create and send to their richer trading partners. Can't blame them, and Manufacturing still moves there because of the net benefit.

    Whether or not you think they should tax foreign income, I can see why they would want to. They are trying to account for the benefit those companies receive from domiciling there when most of their products' value goes elsewhere. Maybe not the most elegant system, but I get it.

    The US, besides just getting more money, doesn't seem to have a intuitive reason to tax foreign income like these other countries.

    1. Yeah. It would be interesting to see how large of an effect it would have on corporate cash holdings if we could get rid of that tax. It seems to me that tech firms, for a variety of reasons, seem to want to hold more cash anyway, but some portion of the large cash reserves seem to be from foreign holdings because of taxes.

      Hm. You know, I don't think I have thought of it until now. I wonder how much of the supposed global savings glut is related to this. I mean, there is a sort of tax arbitrage there, where US corporations invest excess foreign profits in cash equivalent securities. That cash goes to foreign investors, who can then reinvest it in US assets without the tax consequence. Wouldn't it be funny if the Chinese investors buying up San Francisco real estate are actually using Apple's cash to do it?

    2. Hm. I wonder about your list. They must allow corporations to deduct taxes paid to foreign jurisdictions, otherwise their de facto tax rates would be extremely high. So, for Ireland, I would think that they would collect little tax on foreign profits anyway. Mexico has relatively high taxes, but of course not as high as the US, so I have a similar question there.

  4. Kotlikoff, et al., say the gains from abolishing the corporate income tax would be significant;

    The U.S. Corporate Income Tax is a controversial element of the U.S. tax system. The tax produces remarkably little revenue- only 1.8 percent of GDP in 2013, but entails major compliance and collection costs. The IRS regulations detailing corporate tax provisions are tome length and occupy small armies of accountants and lawyers.

    As with many elements of our tax system, there is disagreement over what the corporate taxdoes and who ultimately bears its burden. The public’s general view of the corporate tax is
    that it’s paid by the owners of corporations, who are, when weighted by their ownership shares,disproportionately rich.
    But many economists, going back to the writings of David Bradford (1978) and Arnold Harberger (1982), have suggested that the tax may actually fall on workers, not capitalists. The reason is simple. Workers living in a country are generally immobile, i.e., they rarely seek employment abroad. On the other hand, capital that is invested domestically can be withdrawn and invested in other countries. When this capital flight occurs, the workers and their jobs are left behind leading to lower labor demand and real wages for those able to retain their positions.

  5. I'm confused by the last graph, specifically the red and green lines. What does it mean to say that the minimum share of national income going to CoE in 1948 is $18,000? What are you taking the maximum and minimum of at each year in this context? Thanks.

    1. The blue line is real Compensation per worker, in 2013 dollars. For the maximum compensation, I used the highest share of domestic income going to compensation for any year since 1948, which was around 1970. Likewise for the min. Then, I just multiplied those two constants (the max and the min) by each year's domestic income, divided by the labor force. The idea was to show the amount of compensation that could be gained from shifting income share to compensation, based on the historical range.

      Does that make sense?

    2. Yes, thanks. Multiplying the max/min by each year's income was what I missed.

      Btw, when I read an excerpt from Paul Krugman's column today I thought of your post here (in addition to putting my face in my palm):

      "You probably know that Mr. Rubio is proposing big tax cuts, and may know that among other things he proposes completely eliminating taxes on investment income — which would mean, for example, that Mitt Romney would end up owing precisely zero in federal taxes."

      In other words, Nobel laureate Krugman doesn't understand that decline in investment income tax rate is mostly cancelled out (for the investor at least; passed on to consumers I guess) by decline in interest earned on investment. If only he read your blog.

  6. Of course, if you want to get serious about tax reform you would go all the way to consumption taxes only, and perhaps Pigou taxes, and maybe heavy fossil-fuel taxes depending on whether the Global Warming story is true...

    I favor heavy gasoline taxes as pollution is not free, and using the public air as a toilet is not good classic economics. The right to pollute air other people breath strikes me as tenuous at best.

    For dense cities, I would keep raising gasoline taxes and subsidizing mass transit fares until the streets were not congested. This might reduce the NIMBYism we see (which is related to horrible traffic), though I concede that is a longshot....

    But there is this: How much is a half-hour of your time worth? If you could pay heavier gasoline taxes, yet get to work and back in 30 minutes less every day, would that be worth it?

    I find the ideologues do not have the answers.

    1. Good points. I find that it is a full time job just describing things where it would help if people stopped acting like the state of the world was precisely the opposite of what it is. Saying we need to raise taxes on corporations more so they pay their fair share, in the U.S., in 2016, is bizzarro, like saying we may be in a new housing bubble is bizzarro. There is a long distance between this post and optimization.

      It's like I'm saying, "Hey, you ought to stop poking yourself in the eye with a stick." and you say, "While your at it, can you cure my bursitis?" Baby steps, Benjamin.


    2. I once opined to myself that the best tax policy on gasoline (both environmentally and economically) would be to find a way to tax it 'progressively.' By that, I mean to tax 'overconsumption.' A flat tax on gasoline would be regressive and might not do much to deter consumption since gasoline consumption is (I expect) inelastic. The goal, I think, should be to tax the act of driving to nearby movie theater instead of walking, but not tax driving to work in a city with horrible public transit, since the latter would only hurt the person driving to work, but won't reduce consumption because the person has to drive to work almost no matter what the price of gasoline is.

      The one easy way I can think of doing this (to tax 'gratuitous' gasoline consumption but not 'necessary' consumption) is to tax the sale of auto-mobiles according to how fuel efficient they are. But taxing individuals according to how much gasoline they use might be trickier.

      I agree that Pigouvian taxes are the best solution to such problems. I never understood why Deirdre McCloskey dislikes them so much.

      Also, Uber and Lyft must do a great deal to help; Uber is how I survive without a car and I use it more than public transit. Any city (or state, or country) that purports to be environmentally friendly should deregulate such enterprises.

  7. is this such a big problem? companies can invert and escape the dumb policy, no? do higher corporate taxes discourage US investment that can't be plausibly represented as foreign operations?

    1. I think the main distortion is that this is a tax on savings, in effect, so, like a financial transactions tax, it's a tax on something that produces a large amount of positive externalities. There is the distortion of causing corporate assets to move abroad, but the larger distortion may be the incentive to consume instead of investing. I admit I haven't thoroughly reviewed the literature on the subject.

      I think, in terms of the scale of distortions, the most significant issue is probably the effect on shelter related taxes. Because of imputed rent, capital taxation will inevitably favor owners over renters, and will increase relative demand for housing, which creates economic stress in cities where there are sharp limits on housing expansion. Since there is basically no cost to eliminating capital taxation, these are changes that can be made to tax policy that would be nearly revenue neutral and would have equalizing distributional effects. The housing tie-in may be more important than the issue regarding international flows.

  8. while you comments of the statutory tax rate is legally correct,
    hardly anyone pays anywhere near this rate.

    The effective tax rate is about half the statutory rate and as far as international comparisons are concerned it is int middle of the pack.

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