The Corporate Tax Myth
The only part of the 2018 tax cuts that made sense to me was the reduction in the corporate tax rates. At the time, I believed that in an increasingly interconnected and highly mobile world, the impact of taxes on businesses, and especially on their investment decisions, should not be ignored. Clearly, I thought, the previous federal statutory tax rate of 35%, when compared to an OECD average of 27%, was not conducive to economic growth or investment and should be reduced.
The data, however, does not support this conclusion. When looking at corporate taxes paid relative to GDP, U.S. corporations paid nearly a third less taxes than their OECD counterparts:2.0% for U.S. corporations versus an average of 2.9% amongst OECD countries (see Chart 1, 2016 data). It begs the question — how could companies that are subject to a higher tax rate contribute less to the GDP?
The answer, of course, is that companies rarely pay the statutory tax rate. With tax breaks, loopholes, off-shoring, and a vast range of legal and quasi-legal techniques, it is often a matter of employing the right tax lawyers to keep from paying the statutory rate. This can be so effective that many companies pay little to no taxes.
Over the past 60 years, the U.S. effective corporate tax rate that companies are subject to, including state and local taxes, has been in a sharp decline, from a high of 54% in 1951, to an astonishing 9.7% estimated for 2018 (see Chart 2). While the statutory federal corporate tax remained relatively constant for long periods between 1947–2018, (see Chart 2), the effective rate companies were paying maintained a consistent downward trend. In fact, the two appear unconnected.
Corporations and individuals seeking to pay less taxes is certainly nothing new, but it increasingly appears that U.S. corporations have absolved themselves from shouldering their share of the burden. A case in point is Amazon’s HQ 2 Survivor-like bidding process that pitted U.S. cities against each other, in an attempt to secure max tax benefits in the billions of dollars. It should come as no surprise that NYC decided it does not need the additional strain on its rundown subway system and struggling affordable housing.
The idea that American competitiveness is being hampered by taxes is ungrounded in reality. So why bother lowering the corporate tax rates? For one, it makes for good headlines. Second, it may lower effective corporate taxes even further, though until the data for 2018 is finalized it is still too early to say. A third reason has to do with repatriating offshore profits, though a slew of legislative initiatives have proposed alternative solutions that do not include a sweeping tax cut.[1]
A lower effective tax rate for corporations is all the more jarring in the face of the ballooning U.S. government debt. The U.S. fiscal deficit in 2018 was $779 billion, with the national debt rising to $22 trillion. This means that either we experience a generation of excessive inflation, or almost everybody, at some point, is going to have to pay more taxes. Since the top 10% of wealthiest households own a whopping 84% of all stocks, a lower corporate tax rate is simply another way of shifting the tax burden off wealthy Americans.
We need to change the perception that tax avoidance by all means is legitimate, as long as it is legal. Corporations, and by proxy, investors, need to pay a legitimate share of the burden. Investors and employees looking for values-aligned companies should ask corporations — are you bearing your share of the tax burden?
— AD
[1] See: Robert Puentes, Joseph Kane, and Patrick Sabol, ‘Establish a National Infrastructure Bank Capitalized by a Repatriation Tax Holiday’, Remaking Federalism, Renewing the Economy — The Brookings Institution (2013) & Shanske, Darien and Gamage, David, ‘Why (and How) States Should Tax the Repatriation’, State Tax Notes, Vol. 88, №4, (2018)
