True tax reform is complicated, and the current bastardized faux-reform is moving through Congress in such helter-skelter manner that a comprehensive evaluation is near impossible. But it can be helpful to examine key issues that are complex and often misrepresented — often on purpose.
One is the overall tax burden on businesses, especially corporations. This is the subject of much demagogy. President Donald Trump himself has asserted that U.S. corporations are the most heavily taxed of any country in the world. This is nonsense.
What is true that the U.S. corporate income tax has a marginal rate that is among the highest of all industrialized nations. But this is only one factor in taxation of corporations.
First, while the marginal rate — that paid on the next additional dollar of income — is high, the average rate — all income tax paid divided by all income, is much lower than that and falls in the middle of the pack among similar nations. The large difference between the two rates is because there are many exemptions, special credits and exclusions that collectively might be deemed “loopholes.” These significantly reduce actual tax paid my most corporations and bring it all the way to zero for a surprisingly large number of those on the Fortune 500.
Secondly, while the income tax is the primary national-level tax paid by U.S. corporations, it is not for most in Europe or for large emerging economies like Brazil or South Korea. The United States stands nearly alone in not having a value-added tax as its center of national government financing.
A value-added tax is one on the value of the goods or services sold by a business minus the value of the inputs it purchased, whether raw materials, components, electricity, fuel or similar costs of doing business. Labor costs are not subtracted, nor is interest paid. In VAT systems, this tax on value-added is paid all along the production and distribution system. Retailers add it to the price of the goods sold and remit the money to the government after deducting the value of the goods gotten at wholesale. So to the customer it is like a sales tax. And that is how the media usually explains it to the American public, as a “national sales tax” borne by consumers.
But it is not as different from the U.S. corporate income tax as one might think. For our income tax, one takes the value of sales and deducts allowable expenses. What is left is called “income” and that is taxed. For a VAT, one takes the value of sales and deducts allowable expenses, The balance is called “value-added” and that is taxed. The allowed expenses are different under a VAT than under our corporate income tax. But the taxes both are ultimately borne in part by the consumer and in part by the owners of the business.
Beyond the issue of corporations in other countries having to pay VAT that U.S. companies don’t on their domestic business, there are differences in social insurance taxes. In the U.S., any employer nominally must pay half of FICA taxes for retirement, survivors, disability and Medicare. They also pay a portion of the unemployment taxes due to the state and must procure workman’s compensation insurance. Employees also pay part of FICA, typically as a payroll deduction.
In Europe and Latin America in particular, such social insurance taxes are far higher because they usually encompass the whole retirement system for the nation. Mandatory retirement benefits also often are larger. And the entire health care system often is funded by taxes on employers. So the cost of labor above the amounts actually paid to employees is usually well above levels in the United States.
So yes, U.S. corporations do face a higher marginal corporate income tax rate than in other countries. And yes, in many economic decisions, what happens at the margin determines what action is profit maximizing. But when one looks at average income tax paid, the United States is down in the pack. And when one looks at all taxes paid by companies relative to sales or to government revenue or to GDP, the U.S. has a more lightly-taxed business sector than most countries, especially many of those we consider economic competitors
Reducing such loopholes to provide revenue to offset a cut in the marginal rate, often called “broadening the base,” was the approach of some Reagan-era tax changes. These were not “revenue neutral” as some claim. The reduction in loopholes was far from broad enough to cover the reduced revenue from the lower rates. But this approach remains one viable basis for true “reform.”
Over the 30 years since the last Reagan-era changes, myriad special provisions have crept back in to benefit sundry interest groups. Each of these introduces some distortion or perverse incentive that reduces the efficiency of the economy as well as the overall fairness of our tax system. Yet in the mindless political hurly-burly of “reform” that is going on now, no one is suggesting any systematic cleansing of loopholes. Nearly all the details discussed, like eliminating deducibility of state income taxes or raising the standard deduction, pertain to the individual income tax — not corporate. Yet it is the corporate rate that is scheduled to get a major whack.
Another misconception hangs over current debate, that the Reagan-era changes were revenue neutral. They were not. They permanently reduced the fraction of federal revenues that come from taxes on corporations. They reduced such taxes as a fraction of business profits and relative to the value of total national output. In the 25 years leading up to the first Reagan tax law, corporate income taxes averaged some 18 percent of all federal revenues. In the quarter-century after the last Reagan changes it has averaged 10.3 percent. Over the same periods, the average for corporate income tax revenues relative to GDP dropped from 3.2 percent to 1.8 percent. Reagan era tax laws effected a sharp reduction in business taxes as a portion of federal finance. In contrast, FICA taxes — paid, as we said, by both businesses and workers — increased sharply.
There is potential for reform of corporate taxation in our country that could improve both fairness and economic efficiency. But nothing like this is detectable in Republican proposals so far.