The U.S. has the highest corporate tax rate in the developed world with a 35% federal levy on profits. When various state taxes are included, the nominal rate is just over 39%. Is it time to consider lowering our corporate rates?
American corporations have argued for years that our tax rate should be lowered, because the high rates force companies to look for all the possible legal loopholes and tax manipulations. As a result, companies never pay the actual rate. In 2011, the effective tax rate ended up at 29.2% including state and local taxes. A recent study estimated that the average tax rate American companies pay on foreign income is approximately 16.7%.
Foreign income presents a greater challenge, since the U.S. is one of the few nations that taxes income of American companies that was earned overseas. Corporations pay the difference between the U.S. rate and the rate of the country in which it was earned. This volume is still enough to keep companies stashing money overseas in foreign subsidiaries, or effecting tax inversions and merging to become a foreign-owned corporation, thus avoiding U.S. taxes entirely.
Here are a few points to consider regarding lowering corporate tax rates:
- Stimulating Investment/Jobs – The general argument for lowering corporate taxes is to give businesses more money to use for investment and job creation. However, this correlation does not always hold. It did during Ronald Reagan’s presidency (1981 to 1988), when the top tax rate was lowered from 46% to 34% and unemployment fell to 5.9%. In recent years, corporate profits have been high but companies have tended to sit on the cash due to lower demand. Unemployment has fallen gradually from 10% in October 2009 to 5% today without a corresponding change in the corporate tax rate.
- Repatriating Funds – Theoretically, a lower tax rate will give companies greater incentive to bring foreign income back into the U.S. and reduce the rate of tax inversions and other tax avoidance criteria. There is an estimated $2 trillion in foreign earnings stacked up outside the U.S.. Would a lower tax rate or a partial repatriation holiday help to bring that money back into the American economy? The repatriation holiday in 2004 did bring more funds back into the U.S. — although some of the companies that benefitted the most subsequently cut jobs.
- Income – Lowering nominal tax rates could result in more income through greater economic growth. The famous Laffer Curve suggests that the corporate tax rate that maximizes both government and corporate revenue is around a nominal 30%.
- Tax "Fairness" – As with individual taxes, some think that the corporate tax rate is not progressive enough. Economist Herbert Stein's famous quote sums it up nicely, "... that's as if people think that if the government imposed a tax on cows, the tax will be paid by the cows." Higher taxes are not just taken off the top of corporate profits without any consequences. Costs are passed on to customers, shareholders, employees, vendors, and other stakeholders throughout the system.
- Loopholes and Structures – Lowering the nominal tax rate can result in a higher effective tax rate if loopholes and certain deductions are reformed to make taxation more uniform. However, in some cases, a company's structure renders the whole argument moot. For example, an Apple subsidiary in Ireland generated $44 billion in foreign income over a three-year period but filed no taxes in any country because while it is considered an Irish company by U.S. laws, it did not meet Irish residency requirements. Lowering the tax rate has no effect on such a structure.
The goal should be to maximize the income for both the government and corporations, as the Laffer Curve suggests. However, given the series of tax structures and loopholes available, it is not a given that the Laffer Curve rate of 30% will truly produce the maximum, or that companies will not simply take advantage of lower rates and sit on the profits. Expect this debate to sharpen this election year.