Corporate taxation is emerging as an important political issue. Although partisan talking points abound, unfortunately much of what is being said is hyperbole. In order to reach an informed point of view, one needs to consider information lurking below the waterline.
Corporate income taxes have been around since 1894, but really did not take hold until after the 16th Amendment was ratified. In the early 20th century, American businesses became increasingly concerned about liability protection, and the most cost-effective way of addressing those concerns was for those enterprises to incorporate.
In 1952, corporate income tax amounted to almost a third of all tax revenue collected. However, since 1980, a combination of corporate and tax law changes have allowed businesses to operate in pass-through form, where the owner, rather than the business entity, pays tax. Today, the overwhelming majority of corporate taxes are paid by large corporations who spend considerable sums lobbying for tax breaks. By 2017, corporate income tax collections were less than 10% of total federal tax revenue.
When a corporation computes its tax liability, it does so by applying a rate of tax to its taxable income. Thus, there are two variables affecting the amount of tax a corporation pays — the tax rate and the amount of income subject to tax. Over the past 50 years, rates have dropped from 48% to 21%, while changes to the accounting methods used to compute taxable income have not offset the rate reductions.
This is clearly demonstrated by public companies that report increased income to shareholders and other regulatory bodies while legitimately reporting a smaller amount of taxable income to the IRS. Many large profitable corporations pay no tax. Furthermore, as business has become more multinational and technologically based, corporations are able to move taxable income into low-tax jurisdictions. Global tax systems are based on a 20th century industrial model that does not work very well in an age dominated by technology.
Many nations have sought to entice businesses with exceptionally low tax rates. Consequently, there has been a race to the bottom among European and North American nations. After massive bailouts from the Great Recession and the pandemic, many Organization for Economic Cooperation and Development nations are working together to create a centralized regime applying minimum tax rates and standardized tax accounting principles.
There also is a global movement to change how technology is taxed. Under current rules, to be taxed in a jurisdiction, you generally must have a physical presence (e.g., employees or property) in that jurisdiction. Technology allows businesses to operate remotely and do business in a jurisdiction without having any employees or property located there. Consequently, a tremendous amount of commerce escapes local taxation.
To correct this problem, there will likely be a paradigm change where businesses are taxed based on where the customer is located. The first example of this is the digital services tax imposed by several European nations. Although some claim this is unfair to American technology companies, as digital commerce replaces conventional commerce, corporations’ propensity to avoid taxes will ultimately shift the tax burden to other taxpayers without this change.
Thus, any discussion about corporate tax rates has to consider global trends as part of the analysis. Many of the Joe Biden proposals are also being considered by other countries. The argument that raising corporate rates will make America less competitive globally is based on a flawed assessment if other countries also raise their corporate tax rates commensurately.
Furthermore, we need to consider who benefits from corporate rate reductions. When corporate tax rates were reduced to 21%, then Treasury Secretary Steven Mnuchin implied that as much as 70% of the corporate tax cuts would inure to workers. Wall Street has seen to it that senior executive compensation is aligned with the shareholders’ interests. Through the use of stock options and other tax-advantaged compensatory structures, senior management gets a huge payday when the stock price increases. So it is not surprising to see that the corporate tax savings were spent in a way to ensure that the stock price increased because doing so maximized the earnings of those senior executives. In most instances, workers’ wages did not keep pace with either the stock price or the executives’ compensation.
In June 2016, when Paul Ryan unveiled his “Better Way” tax proposals, he acknowledged that his proposed corporate cuts would not pay for themselves. Consequently, he anticipated implementing a regressive consumption tax to pay for those tax cuts. Indeed, when the 2017 corporate tax cuts were enacted, the Congressional Budget Office estimated that they will cost the government $1.4 trillion over 10 years. Partially restoring corporate tax rates will go a long way toward restoring the government’s revenue loss.
Although the points discussed in this column are not being discussed among the general population, they are vital to the analysis of this issue.
Jim de Bree, a Valencia resident, is a semi-retired CPA and student of tax policy.