There is no doubt that our business tax system can be improved: it is inefficient, it raises less revenue than that of peer countries, and it is mind-numbingly complex. Yet efforts toward reform will need to balance trade-offs between two key goals: stemming corporate tax base erosion and fostering competitiveness.
Business lobbyists, and their hired experts, put the competitiveness goal first. They argue that our current tax system places U.S. companies at a disadvantage relative to companies from other countries. While aspects of our system could be improved, as I suggest below, a clear-sighted look at the facts indicates that our companies are already successful and competitive.
First, after-tax corporate profits are as high as they have been at any time in the post-war period. Over the past ten years, they have averaged over 9 percent of GDP, over the ten years before, 6.3 percent of GDP, over the 30 years before that, 5.7 percent of GDP. In light of these clear facts, it is difficult to argue that our economy is being held back by a scarcity of after-tax profits. Indeed, our companies are awash in cash, but they are missing investment opportunities, due in part to the economic weakness of middle-class consumers.
Second, U.S. companies are dominant in world rankings of the top multinational firms. In the latest Forbes Global 2000 rankings that came out a few weeks ago, U.S. companies are 33 percent of the world’s top companies (measured by sales), 47 percent (measured by profits), and 44 percent (measured by market capitalization), yet the U.S. economy is 22 percent of world GDP. Our shares of the world’s top companies have actually increased over the previous couple years, despite our declining share of world GDP (due in part to the rapid growth of India and China).
Third, we collect less corporate tax revenue as a share of GDP than our peer trading partner nations, by about 1 percent of GDP, due to the combined effects of aggressive profit shifting to tax havens and the movement of business activity out of the corporate sector. My research finds that profit shifting to havens is now costing the U.S. government about $100 billion dollars in revenue each year; other researchers have found similar results. Erosion to the pass-through sector generates similar revenue loss, due to low effective tax rates for pass-through income, estimated at 19 percent in a recent Treasury study.
Finally, effective tax rates paid by U.S. based multinational companies are similar to those paid by companies based in our peer countries, as researchers at the Congressional Research Service, the Government Accounting Office, the Treasury, and elsewhere have found.
In his review of my recent Congressional testimony in The Hill, Douglas Holtz-Eakin referred to these “views” as “far out of the mainstream”. I suppose facts are a little out of the mainstream these days, but these statistics on the competitiveness of our multinational firms are hardly controversial or outside of the mainstream. They are simply facts.
All that said, we can improve both our competitiveness and our corporate tax system. Yet it is odd how observers focus on corporate tax rates when they discuss our competitiveness, even though after-tax corporate profits are at historic highs, and other measures of competitiveness are doing poorly. Our infrastructure is crumbling and our education system is not meeting the needs of American workers and businesses. What policy steps make for a competitive economy? Arguably, steps that foster a strong middle class, solid infrastructure, stable political institutions, labor productivity and education, a stable macroeconomy, and investments in basic research and development. These factors are underemphasized, but essential. And they require government revenue.
So, what should corporate tax reform do? I would emphasize four key objectives. First, it should not lose revenue. We already raise less revenue from corporate taxation that our trading partners, and we can not afford tax cuts in this area. Businesses have record after-tax profits, and there is no evidence that giving them even more after-tax profits will unleash an economic renaissance, despite claims to the contrary.
Second, there is substantial room to lessen distortions in the current system. Statutory tax rates can fall, as long as we protect the tax base at the same time. We should move toward a more even tax treatment of types of business income (corporate and pass-through) and a more even tax treatment of debt- and equity-financed investments. By taxing more types of income at the same rate, complexity and gaming are reduced.
Third, and most important, we should take serious steps to combat our large corporate tax base erosion problem. Profit shifting to tax havens is now costing the U.S. government over $100 billion per year. Ending deferral achieves that goal, but a tough per-country minimum tax would also be a key step in that direction. Such steps would also end the problem of large offshore earnings that companies are loath to repatriate since they hope for favorable treatment or a repeat of our mistaken tax holiday. Corporate inversions can be countered though tougher earnings-stripping rules, an exit tax, and other effective and ready-to-go measures.
Fourth, any tax reform should remember the needs of the middle class. According to the nonpartisan Tax Policy Center, the House GOP (Brady/Ryan) plan gave tax cuts of $213,000 to those in the top 1 percent; tax cuts for the bottom 80 percent were a mere $210, one-thousandth the size. Preliminary analysis of the Trump “plan” suggests a similar skew of tax cuts to the top of the income distribution; his campaign proposals were highly regressive.
These recently proposed tax plans seem like odd suggestions in the wake of 35 years of increasing income inequality and middle-class economic stagnation. Given these economic challenges, tax policy should be moving in the opposite direction, targeting the biggest tax cuts toward those who haven’t benefited from recent decades of economic growth.
Kim Clausing is a an economics professor who teaches trade and finance at Reed College.