We anticipate a lot of “discussion” about the corporate tax rate over the coming months as the country approaches the debt limit/possible government shutdown and candidates across the political spectrum gear up for Slugfest 2016. In advance of all of that posturing, we thought it might be worth taking a step back to examine some of the issues around corporate taxes in layman’s terms.
First, business taxation is very complicated. Let me repeat that, business taxation is very complicated. At first it doesn’t seem so. One could imagine a law that says: All businesses shall pay 35% of their profits to the US Treasury. The problem is that one sentence contains the word profit – and that’s where the discussion gets very confusing, very quickly.
a. Imagine if I bought a forest for ten million dollars, and I make one million dollars per year, selling Christmas trees every winter.
- Am I making a million dollars per year in profit?
- Am I making no profit for ten years, and then a million dollars per year?
- What if I got a mortgage on the forest? Is my profit one million dollars, minus the mortgage payment?
b. How about if my cousin in Ireland and I invent a new chemical that can cure hepatitis, and some drug company pays us a royalty of one million dollars per year to use our invention.
- Do we pay 35% to the US Treasury?
- Do we pay 12.5% to the Republic of Ireland?
- Do we pay both the US and Ireland?
- Do we get a choice depending on where we have the drug company mail the check? (We would probably choose Ireland in that case)
- What if my Irish cousin is working full time producing marketing material for the drug company, and I am on permanent vacation in Palm Beach living on my half of the royalties?
- What if we need insurance on our office, and we create our own insurance company, based in a foreign country, and decide to make the insurance premiums really high so as to generate more income in the other country, and less income in the United States?
c. How about if I become so famous as the chairman of the Patriotic Millionaires that I can make money selling “Morris” brand shampoo. I open a small factory and make some shampoo in New York, and sell it to New Yorkers. I also open a small factory in Ireland and sell that shampoo to Irish people.
- Do I pay US taxes on the money I make in the US and the money I make in Ireland?
- What if all of the profits I make in the US are used to buy American Real Estate, where I plan to build a building and someday rent out, for more income?
- What if all of the profits I make in Ireland are used to buy Irish Real Estate, where I plan to build a building to someday rent out, for more income?
And these questions are just the beginning of things getting complicated. Every country has a different way of dealing with taxes. And while it is true that the United States has a higher corporate tax rate (35% plus state taxes) than almost all other countries (Ireland has 12.5%), it is also true that many of our corporations pay effectively zero in corporate taxes. How can that be?
a. The basic way US taxes work is that that a US person (either a natural person or a corporation) pays US taxes on ALL income earned anywhere in the world. A credit is granted for any income taxes actually paid to other countries. For example, as a US citizen I pay US taxes at the US tax rates on all of my income. I was in Greece for a few weeks last year, and paid the Greek government income taxes of around four thousand dollars. That four thousand dollar payment to the Greek government is accepted as a credit against my US income taxes; so I paid (in total) exactly the same amount of taxes as if all of my income was earned in the US. Tangentially even this basic rule is subject to exploitation. For a time the Saudi government claimed that the oil extracted from their land by US companies was free, but that they charged a special tax on the companies doing the extraction. All or most other countries charge taxes only on money earned within their geographic borders.
b. Businesses that can be trivially moved from one place to another (such as collecting royalties on a patent or copyright) have a special lower tax in some places. The idea is that they assume that companies will move that operation to whatever country has the lowest tax rate, so they might as well have very low taxes and collect some money rather than no money. This is sometimes called a “patent box”.
c. The problem, as perceived by our elected leaders, is that:
- US businesses are becoming part of non-US businesses (either by being sold to foreigners, or merging with foreign companies, etc.) This is seen as bad for our nation.
- When US companies are competing with non-US companies, the non-US companies (sometimes) have a very significant advantage, because they pay lower taxes even with identical profits. This is also seen as bad for our nation.
- Companies with operations in multiple countries (most large companies, Starbucks, Google, Proctor and Gamble, etc.) are incentivized to invest in other (non-US) countries. That is because by earning money overseas, and investing it overseas, it would never be taxed at the high US tax rates. This is the much talked-about problem of cash building up overseas.
One possible solution which seems pretty obvious (at least to many Republicans) is to not have any taxes on corporations. Their reasoning is that corporations are owned by people. They are just groups of people getting together to do something jointly that they can’t do individually. Why shouldn’t each person just pay income tax on his or her share of whatever the corporation makes? (Actually, some corporations do work that way, but that is another story for another memorandum.)
That reasoning is rejected by progressives who believe that the US current fiscal system is predicated on significant income from corporate taxes, in addition to individual taxes. And that corporations already accumulate vast quantities of wealth. Few progressives believe that even more wealth accumulation within corporations would be a good thing. Corporations have various rights and privileges and are essentially “artificial” people. It seems reasonable that these artificial people should pay taxes more-or-less as do natural people.
Natural, artificial, inversions, repatriation, carve-outs, loopholes and extenders. The Patriotic Millionaires recognize that many of the specifics of the corporate tax code are indeed complicated. But our positions on corporate taxes is not. Big businesses get a lot from this country, they should put more back in. It’s that simple.