Tuesday, May 1, 2012

Corporate Tax Myths

At the beginning of April, Republicans made a big deal about how the United States had the new distinction of having the highest corporate tax rate in the world. This, they argued, was what was strangling corporations and preventing them from creating jobs. Senator John Barrasso (R-WY) even went so far as to write a column for Fox News entitled, "No Joke -- Obama's Corporate Tax Rates are Highest in the World." Never mind the fact that the corporate tax rate hasn't been changed in almost 20 years or anything, or the fact that Obama proposed cutting them. But I digress.

How true is this idea that the U.S. has the highest corporate tax rate in the world? Well, not very, as it turns out. The statutory rate, that is, the rate on paper, might be the highest at 35%, but the average effective rate, the rate that corporations actually pay, is much, much lower--in 2011 it was 12.1%, a 40-year low. For the sake of comparison, here's a few charts comparing the average corporate tax rate paid in industrialized countries between 2000-2005:

So, in reality, we're on the low end of the spectrum in terms of corporate tax burden, and the high statutory rate probably isn't causing us to be "uncompetitive." As the graph says, this is largely because our tax code is riddled with so many tax breaks, credits, loopholes, and offshore tax havens. Some of you might say that the record-low levels of corporate taxation are due to the recession. That's a fair point to try to make, but in reality, corporate profits have already surpassed their pre-Great Recession peaks and are breaking new records.

Now, that doesn't mean that we have an ideal corporate tax code--quite the contrary. Our current tax code is hugely distortionary, with different types of investment taxed at wildly different levels. For example, investment in petroleum and natural gas structures are taxed at around 9.2%, while computer equipment investment is taxed at a whopping 36.9%! Another great example of this is that equity-financed investment (when corporations sell stocks to pay for stuff) is taxed at an average of 36%, while debt-financed (that is, corporations sell debt bonds to pay for stuff) investment is taxed at an average of negative 6%. Just to be clear, that negative 6% means that when corporations sell bonds to pay for their investments, instead of paying taxes on their investment, we, as taxpayers, subsidize it. Needless to say, this is hugely distortionary.

What do I mean when I say something is distortionary? Well, when firms make investment decisions, they have to take all relevant costs and benefits into account. For example, taxes on certain behavior, like payroll taxes on work, change the relative cost of working versus that of, say, lazing around. Working, since it is taxed, gets you less happiness (money) than being lazy, so you may choose to work less. The degree to which this applies on an individual level is still hotly debated, but I don't want to get into that right now. Anyway, this study by the Center on Budget and Policy Priorities has a bit that explains it perfectly:
"If all forms of investment are taxed alike, the tax system will not affect decisions about what type of investment to undertake. That benefits the economy, since it means that investment dollars will be directed based on where they are expected to yield the highest return rather than on where they will receive the greatest tax benefit."
So basically, firms would then have a level playing field in terms of their tax burdens, so that they will make choices based on what is really best economically, not what is best based on their tax costs. So ultimately, I feel like the best policy choice for corporate taxes is to largely eliminate many of those loopholes, credits, and deductions, and to lower the actual top rate to something around 18-20%. As a result, we'd likely get more economically efficient decisions made by firms, while simultaneously raising some more revenue from corporate taxes. Oh, and before some of you ask, the evidence that slightly higher corporate tax rates will make it difficult for the U.S.  to "compete" in a global economy is pretty thin.

Anyways, back to my initial point: don't listen to people like John Barrasso; corporate taxes in the U.S. are actually pretty low. Is the system perfect? Hardly, but there's definitely room for improvement.