Senator Byron Dorgan (D-ND) has had enough. "It's time for the big corporations to pay their fair share," Dorgan said. The focus of his frustration is the fact, confirmed by a Government Accountability Office (GAO) study, that in the US, 66% of US corporations and 68% of the foreign companies doing business in the US avoided paying federal income taxes. The GAO’s study, which was requested by Dorgan and his colleague, Senator Carl Levin (D-MI), covered a period from 1998 to 2005. It developed the statistics, but did not delve into why this was happening.
Corporate Taxes in the US
It shouldn’t be a surprise to anyone—that is, anyone outside of the democratic party—that the two main reasons for this are the sheer, mind-numbing complexity of the tax code and the fact that with an average combined federal and state corporate tax rate in the U.S. of 39.3%, the US corporate income tax is the second highest on the planet (second only to Japan’s 39.5%). The first provides all the loopholes needed and the second provides the motivation.
The fact is that US companies are at a serious disadvantage, not from foreign competition but from their own government. According to The Tax Foundation, “A growing body of academic research indicates that foreign direct investment (FDI) can be quite sensitive to the corporate tax rates imposed by a state or country. One recent study of the effects of corporate income taxes on the location of foreign direct investment (FDI) in the United States found a strong relationship between state corporate tax rates and FDI—for every 1 percent increase in a state's corporate tax rate FDI can be expected to fall by 1 percent.
A new study of income tax rates in 85 countries by economists at the World Bank and HarvardUniversity found a strong effect of both statutory and effective corporate tax rates on FDI as well as entrepreneurship. For example, the average rate of FDI as a share of GDP is 3.36 percent. But a 10 percentage point increase in the statutory corporate rate can be expected to reduce FDI by nearly 2 percentage points.”
In other words, the higher the taxes, the lower the investment. This is hardly a surprise. Punitive taxation punishes success by taking a huge portion of a company’s income, income that could be used to reinvest in the company, hire new workers, expand or just compete. How are US companies supposed to compete with each other, let alone in the world market, when their so-called “fair share” is nearly 40% of their income? Is it any wonder these companies are using the tax code to protect themselves?
The US Tax Code to the Rescue
It is always amusing when the federal government gets caught in its own nets. It gives us a chance to watch senators and congressmen flopping around like fish on a pier as they express their outrage at, or try to explain their complicity in, the latest national gaff. Here we have Dorgan and Levin on the pier, a pair of oily cod, twisting and flipping in their outrage over a problem that each of them had a hand in creating.
At roughly 3.4 million words or about 7500 pages in length, the US Tax Code is truly mind-numbingly complex, and within that lovecraftian mass of text can be found the dodges and loopholes that these corporations use to skirt their tax liabilities. For example, with the rise of the S-corporation and the limited liability corporation, a major portion of corporate income is now flowing through the far less expensive individual income tax system and not through the corporate tax system. That is legitimate, but through the 1990s and into the 2000s, tax dodges that held a veneer of legality—since they conformed to the esoteric rules of the tax code—were created by major accounting firms, leading to a situation where companies like PepsiCo, J.P. Morgan and General Motors paid no federal taxes and, in some cases, were actually due a tax refund.
Did these companies do anything that was actually illegal? No, they didn’t. What they did do was take the language of the tax code and turn it to their own advantage, an act that has earned more outrage in the halls of government than the current energy crisis. It was the principal of the thing. The tax code is both the carrot and the stick that the government uses on both people and business, and they don’t like having that stick taken away or the carrot stolen. According to former IRS commissioner Charles Rossotti, “Congress needs to act. They need to outlaw tax shelters, period."
From a Washington point of view, that may be right. Then, the only tax breaks you could get would be the ones that the government wants you to have. Then they could freely enforce that near-40% corporate tax and essentially gut American free-enterprise. If that is the objective, this is a good way to go about it. On the other hand, if the objective is to create a thriving economy where everyone actually does pay a real fair share of the tax burden, this kind of thinking is suicidal.
The Bottom Line: A Sensible Tax Code with Sensible Tax Rates
On the issue of state taxes, Chris Atkins and Curtis Dubay, two analysts for The Tax Foundation, wrote of the issue of state tax shelters:
Lawmakers create these deals under the banner of job creation and economic development, but the truth is that if a state needs to offer such packages, it is most likely covering for a woeful business climate plagued by bad tax policy. A far more effective approach is to systematically improve the business tax climate for the long term. When assessing which changes to make, lawmakers need to remember these two rules:
1. Taxes matter to business. Taxes affect business decisions, job creation and retention, plant location, competitiveness, and the long-term health of a state's economy. Most importantly, taxes diminish profits. If taxes take a larger portion of profits, that cost is passed along to either consumers (through higher prices), workers (through lower wages or fewer jobs), or shareholders (through lower dividends or share value). Thus a state with lower tax costs will be more attractive to business investment, and more likely to experience economic growth.
2. States do not enact tax changes (increases or cuts) in a vacuum. Every tax law will in some way change a state's competitive position relative to its immediate neighbors, its geographic region, and even globally. Ultimately it will affect the state's national standing as a place to live and to do business. Entrepreneurial states can take advantage of the tax increases of their neighbors to lure businesses out of high-tax states.
If that is true for business at the state level, it is also true for businesses at the national level. There is a reason so many US jobs have gone overseas—a better business climate. Our own leaders seem to be deaf to the argument that we have to improve the business climate in this country rather than increase taxes, criminalize and regulate. What American business needs is a loosening of the governmental hand, not a tighter squeeze, and that starts with a better tax rate—Sen. John McCain and Rep. Eric Cantor have proposed cutting the rate to 25%—and a tax code that is very simple and easily understood by everyone.
I wonder if all this is possible. The concept of a low tax rate and a tax code that is so simple and straightforward that politicians can no longer use it to reward and punish flies in the face of Washington political tradition, but if we want our nation to compete and prosper, they are necessary. What is not necessary is the whining “they’re not paying their fair share” demagoguery. If we, as a people, buy into that sort of class warfare, us-vs.-them mentality, then we, as a people, will suffer.