Corporate income taxes are very much in the news these days. The New York Times has investigated General Electric's tax payments (or paucity thereof). Businesses are clamoring for a reduction in the federal corporate income tax rate, which stands at 35 percent. President Obama has offered to swap lower rates for getting rid of loopholes. Everyone seems to agree that the corporate tax code is a monstrous loophole-ridden contraption that is easily gamed, an enemy of economic efficiency, and a royal pain. (Except, of course, for the thousands of highly paid professionals whose job it is to game the system.)
Since the devil is in the details, the tax code is likely to be subject to endless hours of negotiations, threats and complicated deals in the coming months. But I've got a tax-reform proposition that's so simple even a CEO could understand it: We'll cut your taxes. But you'll have to agree to pay them.
As I've noted, we focus too much on our spending problem and not enough on our taxing problem. In recent history, federal taxes have usually amounted to about 18 percent of gross domestic product. The past couple of years, however, they've come to less than 15 percent. One of the reasons is a decline in corporate income taxes, in absolute and relative terms. At the OMB's website, Tables 2.1 and 2.3 break down federal revenues by source, and as a percentage of GDP. At the height of an economic cycle, the corporate income tax is a big contributor: a record $370 billion, or 2.7 percent of GDP in 2007. In down years, when many companies rack up big losses, both figures fall sharply. Between 2007 and 2009, corporate income taxes paid fell nearly in half, from $370 billion to $138 billion. They snapped back in 2010 to $191.4 billion, which is about what the tax brought in for 2004. This in a year when corporate profits were a record $1.625 trillion.
As seen in this chart, which tracks corporate taxes as a percentage of GDP over time, the federal tax burden on companies has decreased over time.
In the 1940s and 1950s, the ratio ranged from 4.4 percent to 7.2 percent. But it fell as companies got more sophisticated about gaming the system, and as government became friendlier toward corporations. Between 1985 and 2005, it generally hovered in a range between 1.8 percent and 2.2 percent. After peaking at 2.7 percent in 2006 and 2007, the ratio fell sharply to a record low of 1 percent in 2009. That's less than half the median level of 2.4 percent clocked between 1934 and 2010. Last year it stood at 1.3 percent. In the past three years, corporations paid just $634 billion on the $4.145 trillion in profits they earned -- about 15 percent.
Boosting corporate income tax collections back to the median historical level of GDP would bring in more than $150 billion per year, enough to close about one-tenth of the deficit. But how can we do that? Raising the 35 percent statutory tax rate would be counterproductive. As David Callahan of Demos points out in the accompanying video, American companies are world-class evaders. They drive semi trucks through loopholes. They keep earnings overseas, and offer to bring them home -- but only if they get to pay ultra-low rates on those profits. A higher tax rate would create greater incentives for tax evasion.
But just cutting the tax rate to a lower level and getting rid of some loopholes wouldn't do the trick either. Companies are different than you and me. We have a guy at H. & R. Block; they have huge tax departments. We can call our Congressman to complain; they use lobbyists, consultants and campaign donations to reshape the tax code. So long as companies have tax bills, they will have incentives to find ways to reduce them. If the U.S. were to abolish the corporate income tax entirely, I'm quite sure General Electric would still figure out a way to get tax rebates.
But what if we could remove some of those incentives? The federal tax code has a pretty powerful mechanism to stop individuals from abusing deductions and loopholes: the Alternative Minimum Tax. First enacted to ensure that millionaires didn't get away with paying crumbs in taxes, the AMT limits deductions for things such as state and property taxes to ensure that filers pay a minimum of 26 percent (or 28 percent if you're a high earner) on marginal income. Taxpayers calculate what they owe based on the rules and available exemptions and deductions, and then recalculate what they owe under the AMT -- and then pay the higher sum. Since it seems designed to nail people who live in coastal areas where incomes, house prices and local taxes are high, I've dubbed the AMT a secret tax on Democrats. (The Tax Policy Center says about 4 million taxpaying units were hit by the AMT in 2009.)
So what if we were to pair a reduction in the corporate tax rate with an AMT for corporations? By all means, slash the statutory rate from 35 to 30 percent. Eliminate some loopholes. Keep some of the tax-based incentives that we, as a society, decide we need. But place limits on the deductions, and don't let reckless companies use massive losses racked up in a single year to wipe out taxes owed on profits in future years. Impose a minimum rate that is pretty close to the effective rate that companies pay. (New York University's Aswath Damodaran indicates that for companies that make profits, the effective rate is about 29 percent. Catherine Rampell of the New York Times says the effective corporate rate is about 25 percent.) Why not mimic the AMT for individuals: 26 percent for smaller businesses and 28 percent for larger companies.
A corporate AMT would likely bring in more revenues, free up capital currently spent on tax evasion compliance, and free up muckraking journalists to delve into other subjects.
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- gross domestic product
- economic efficiency
- tax evasion