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.
