Published in Standard Examiner, March 19, 2015, Ogden, Utah
By VIJAY K. MATHUR
It might be in the political interest of the GOP majority in Congress to implement federal corporate tax reform based upon facts and serious analysis. Some members of Congress from both sides of the aisle and lobbyists may want to gum-up the discussion with political rhetoric that feels good to the public at large. But political posturing may not be in the best interest of businesses, taxpayers and the country. Before discussing issues for tax reform let me present a brief history and other features of federal corporate tax.
According to Data Release (www.irs.gov), even though the Revenue Act of 1894 established the principle of taxing corporations separately from their owners, definitions of income and tax rates did not distinguish between them. The Supreme Court found the tax unconstitutional when it was challenged in 1895. President William Taft imposed corporate income tax in 1909 and also got ratification of 16th Amendment to the Constitution in 1913, thus establishing the principle of taxing income. Since then the basic structure of corporate tax remains the same.
A Congressional Research Service (CRS) paper, Dec. 1, 2014, states that a corporation pays taxes on income net of business expenses, such as labor compensation, capital depreciation, material cost, interest and advertising to produce that income. It also allows other deductions, credits and tax preferences. Corporate income tax is a progressive tax, imposing higher tax liability on corporations with higher incomes, since for most income brackets it varies from 15 percent to 35 percent.
Many who are critical of corporate tax rates in US only focus on all businesses and the maximum marginal tax rate of 35 percent. However, CRS reports that only 6 percent of businesses are subject to corporate tax. In 2013, corporate tax revenue was only 9.9 percent of federal tax revenue, as compared to 47.4 percent share of personal and payroll taxes. In addition, if one counts tax loopholes and tax breaks (tax expenditures, resulting in federal tax revenue losses of $154.4 billion in 2014), the average effective tax rate (actually paid) is 27.7 percent, same as other advanced countries. The Wall Street Journal, Jan. 6, 2015, reports that last year average profit margins at private companies with revenues of $1 million and higher were 6.6 percent, highest since 2003. These facts do not undermine competitive edge of corporations, as many claim.
My arguments are not against the reform and lowering of rates. My intention here is to emphasize that political discourse on reform should be based on facts, economic reasons and benefits to businesses and public at large.
Aside from a convoluted and patchy tax and rate structure, the following are some of the issues that must be considered in any corporate tax reform. First, corporate tax suffers from double taxation. Same income is taxed at the corporate level and also as dividends. It provides incentive to evade taxes by forming non-profit entities and S-corporations (that do not pay corporate tax since all income is distributed to shareholders). Second, interest rate deduction, favoring debt finance over equity finance, thus causing debt overload, should be eliminated. Professor John R. Graham (www.nber.org) finds that this bias creates net benefits of 3.5 percent of firm value, at the moderate end of estimates.
Third, even though most of the burden of the tax on many competitive businesses falls on capital, part of the burden also falls in the form of reduced real wages and higher consumer prices. The tax may also reduce capital expenditures, thereby decreasing productivity of labor. Real wages could decrease not only directly due to tax shifting, but also indirectly due to decline in productivity, since labor would have less capital to work with. Therefore, a case could be made for lowering tax rates within a narrow range, competitive with other advanced nations, and at the same time for closing tax loopholes and at least minimizing tax expenditures.
Fourth, reform should deal with tax deferrals where tax is deferred on incomes held abroad. Many proposals in Congress have been made over the years to fix this tax leakage. Lower rates would partly remedy this situation. In addition, as Thomas Hungerford of Economic Policy Institute suggests, tax should be on worldwide income of US companies with foreign profit tax credit. Fifth, as Professors Joel Slemrod and Jon Bakija argue, any corporate tax reform should be integrated with personal income tax, dividend tax and capital gains tax. With these changes no distinction should be made between different types of businesses, because one reform affects other tax sources of revenue. Finally, tax codes of all taxes mentioned above should be simplified, because complicated codes make it easier to devise loopholes.
I hope that Congress diligently and deliberately deals with reform for the long run to minimize uncertainties in the tax system. Uncertainty in tax policies imposes heavy cost on the nation’s economic activity.