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Big Taxin’ Deal: Reforming Corporate Income Taxation

by Steven Pressman

Oct 26, 2021 | Economy, Politics

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The United States began taxing corporate income in 1909, with a 1 percent tax on profits exceeding $5,000 ($150,000 in today’s dollars). The top tax rate peaked at around 50 percent between World War II and 1978. It then declined slowly, reaching 35 percent in 1998. President Trump’s 2017 Tax Cut and Jobs Act cut the rate sharply—to 21percent starting in 2018. The Brookings Institution, an economic think tank, estimated that this last change reduced corporate tax revenues in the United States by 40 percent, or $135 billion.

These are legislated rates; the rates companies actually pay are much lower. Last year, 55 highly profitable U.S. companies paid nothing in federal income taxes. Some firms, including Amazon, Facebook, and Nike, have paid few or no taxes to the federal government for many years.

One reason for this is that corporations book their profits in subsidiaries located in international tax havens, such as Bermuda and Ireland, as well as in corporate-friendly states like South Dakota and Delaware (as revealed in the recently disclosed Pandora Papers), where corporate profits are taxed lightly, if at all, and related information is closely guarded.

This is easy to do, in part, because firms do business with their subsidiaries. They buy things from their subsidiaries and sell things to their subsidiaries. The price they pay is not set by the market; it is not the going price. Rather, firms set these prices in order to distort the amount and source of their profits. When companies pay high prices to their tax-haven subsidiaries, the subsidiary makes a great deal of money; the rest of the firm (located outside the tax haven) earns little. One famous example of this is Nike’s trademarked “swoosh,” owned by a Bermuda subsidiary responsible for most of Nike’s profits. Bermuda doesn’t tax corporate profits, and the United States doesn’t tax profits that are booked abroad and remain abroad.

The result is a race to the bottom. Nations compete for corporate tax revenue by lowering their corporate tax rate. Lowest rate wins. The consequences are just what one would expect. In the 1950s, corporate income taxes provided around 30 percent of U.S. federal government tax revenues. By the 1980s, the figure was 10 percent. The 2017 tax bill cut this to under 7 percent. As corporations pay less in taxes, governments accumulate more debt to finance their expenditures and come under increasing pressure to cut their spending.

A standard objection to taxing corporate income is that it involves “unfair” double taxation—after corporations get taxed, their shareholders are taxed again when reporting dividends and capital gains on individual income tax returns. Other critics claim the tax is regressive, paid by workers and consumers, because firms pass taxes along via higher prices and lower wages. Neither claim is true.

Corporate income taxes are paid mainly by firm shareholders. If workers did pay the tax via lower wages, cutting the corporate income tax should lead to large wage gains (as President Trump promised when promoting his 2017 tax bill). But this hasn’t happened. As corporate tax rates have fallen since 1978, wages have stagnated, increasing by not much more than inflation. Firms have had greater incentives to squeeze workers because the firm gets to keep most of the gains from cutting wages and benefits since it pays very little in corporate income taxes.

The double-taxation objection is also fatuous. Our income gets taxed many times. It is taxed by the federal government, state governments, and local governments. Then people pay sales taxes when buying things and property taxes on their home.

The real problem, though, is not double taxation but untaxed corporate income. Jeff Bezos provides a good example. Most of his wealth consists of Amazon stock. His pay as CEO was a bit more than $1 million annually. Amazon pays no dividends. Profits remain within the firm to help boost stock prices. Bezos’s capital gains are not taxed unless he sells his Amazon stock; and these gains can be passed tax-free to heirs because of estate tax loopholes. Unless Amazon’s profits are taxed, the majority of Bezos’s income remains untaxed, making it easier for him to accumulate vast wealth.

Of course, the filthy rich who want to avoid taxes as much as possible, generally borrow at low interest rates to meet immediate spending needs above their annual salary. This lets them avoid taxes on stock gains and to continue earning high returns on their stock holdings.

Taxing corporate profits is an important step toward getting the rich to pay for expenditures required to run the country. It would also provide revenue to fund essential government spending. And both the rich and large multinational corporations benefit significantly from these social expenditures.

Companies are protected by national laws and courts, and by defense spending. They make money using government-educated workers, and transporting goods over government-funded roads and bridges. Firms make profits when hired to participate in government infrastructure and building projects. Further, if companies are people with rights, and can make unlimited political expenditures (as the U.S. Supreme Court ruled in Citizens United v. Federal Election Commission), they should be taxed like people so that they contribute toward protecting these rights.

Even Adam Smith favored high taxes on monopoly profits. For Smith, taxing the profits of large companies facing little competition was desirable because it reduced monopoly profits. Monopoly power has risen substantially over the past several decades. Monopolistic firms have developed enormous political power on top of great economic power. Taxing corporate income would help reverse this undemocratic trend and discourage the rise of large monopolistic firms.

Corporate income taxation is in such disarray because our corporate tax laws were written more than 100 years ago. A century ago, international trade involved parts and goods produced in one country and sold to a firm in another country. There were no foreign subsidiaries muddying the water. Nor was there a problem with trade in services. Today, one-quarter of international trade involves services—advertising, call centers, streaming, intellectual property (Nike’s swoosh), and legal services. Complicating things further, when customer likes and searches are sold to advertisers (e.g., Facebook), it is unclear where “production” takes place and where profits are made. Companies get to decide this, and of course choose tax havens as the place of production.

The good news is that things may soon change for the better. In July, the finance ministers of the G20 countries agreed to a U.S. proposal to change corporate taxation worldwide. The plan has two key provisions. First, a 15 percent minimum corporate tax rate on companies with more than $890 billion in revenue worldwide. Second, multinationals with more than $23.8 billion in revenue will pay 20 percent to 30 percent of their profits (above 10 percent of their revenue) to countries where they sell goods rather than to the countries where they claim to earn their profits. More than 130 nations and jurisdictions have agreed to this plan.

The 15 percent floor would end the race to the bottom. If Ireland retains its 12.5 percent tax rate, other nations can tax 2.5 percent of each corporation’s worldwide profits. Just as important, taxing profits based on company sales rather than a company’s decisions about where it wants to declare profits will reduce tax-haven shopping.

There is a danger that the 15 percent rate will become a ceiling, as all nations cut their corporate tax rates to 15 percent. On the other hand, once countries agree on a floor, they may see the benefits to a higher minimum rate. A global minimum tax rate, once institutionalized, can easily be raised.

And it should be raised. A 15 percent rate is not nearly sufficient; it is the tax rate paid by an average U.S. worker. Large, profitable firms can certainly afford to pay a higher tax rate. Even a 25 percent rate is less than half the rate that prevailed during the post-WWII era, a time of rapid economic growth in the United States and throughout the developed world. So a higher corporate income tax rate should not slow economic growth; firms will forgo a larger fraction of their profits rather than shun those profits.

Key technical and political issues remain. There are questions about how to divide up additional tax revenues (somewhere between $100 billion and $240 billion annually). Here, the United States provides a good model. Many U.S. states use the location of sales and employment to determine the fraction of corporate profits that each state gets to tax. This prevents companies from reporting their profits in low-tax states. States participating in this agreement then have free rein to tax the corporate profits allocated to them.

The key political issue concerns how to get all nations to sign on to new international tax rules. Without approval by all European Commission members, the accord cannot pass. Ireland and Hungary are two of the biggest problems because their corporate income tax rate is currently below 15 percent. Hungary’s Prime Minister Viktor Orbán has called the minimum corporate tax an “absurd” idea. However, in early October both countries agreed to support the new corporate tax legislation, after considerable pressure from the United States and other developed nations.

The new international corporate tax rules must still be officially approved by all nations. Perhaps the biggest stumbling block, moving forward, is whether President Biden can get the Senate to approve new corporate tax laws, when 67 senators (at least 17 Republicans) must approve any tax treaty.

An international agreement on taxing corporate income would be a huge step forward, after decades of government spending cutbacks and rising government debt in the face of reduced revenues from corporations. It would also be a big win for the Biden administration because solving the world’s problems, such as climate change, requires the cooperation of other nations and it would show that the Biden administration has the ability to work with other countries to achieve such ends.

Steven Pressman is professor emeritus of economics and finance at Monmouth University and author of Fifty Major Economists, 3rd edition (Routledge, 2013).

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