Do We Really Need Corporate Tax Reform?
Dr. David Mielke, Retired Dean of the College of Buiness at Eastern Michigan University
A couple weeks ago, President Trump released an outline to suggest approaches to both corporate and individual tax reform. Individual rates would be reduced to 3 brackets from 7 and the standard deduction doubled while reducing itemized deductions to only mortgage interest and charitable contributions. Corporate rates would also be reduced to 15%, foreign profits currently in accounts in other countries taxed at 10% or less if brought back to the US and some deductions eliminated. Congress supposedly is working on a bill, but seems stuck with how to do one massive bill covering both individual and corporate reform. Why are they considering one bill, when they could do one bill for each? There is already opposition from the Democrats and others, some suggesting tax reform is not really necessary. Do we need tax reform? What can we learn from Apple? Should the Republicans introduce a corporate tax bill first? What is the “Right Thing to do?” Let’s look at some issues:
- The US corporate tax rate is 35%, the highest in the developed world. There is also an average 5% state tax rate, giving a combined total of 40%. The US also taxes foreign earnings when brought back to the US at 35%. As a result, many US companies keep their foreign profits abroad to avoid the taxes. The US is the only developed country that taxes all corporate profits regardless of where earned in the world. Other developed countries only tax profits earned in their country.
- Other countries have been reducing rates, for example Canada reduced its corporate rate from 43% to 26% in 2000, the UK reduced its rate from 30% to 20% in 2008 and Ireland boasts 12.5% with only a 6.25% rate for profits from intellectual property. Even France’s new President Macron has proposed cutting his country’s from 33.3% to 25%. Other countries only tax the profits earned in their respective country.
- In the US, even the average effective corporate rate, 29% after deductions and credits, is higher than most others, with Canada’s effective rate of 16.2% and the UK’s 10.1%
- Apple reported a couple weeks ago that it has $256 billion in cash on its balance sheet with 90% held overseas to avoid US taxes. That cash balance is 5 times greater than the market value of GM and exceeds the foreign currency reserves of Canada and the UK combined.
- In the last 3 months of 2016 Apple accumulated cash at an approximate rate of $3.6 million per hour. It’s recent market value briefly exceeded $800 billion. About two-thirds of its income is earned overseas, where the money sits because of the US tax system.
- By some estimates, corporations have $2.5 trillion sitting overseas. In recent years US companies have sought to avoid US taxes by inverting, that is merging with a foreign business and relocating their headquarters to lower tax countries. Burger King inverted to Canada and Medtronic inverted to Ireland to realize lower taxes and the resulting higher after tax profits.
- Other companies are borrowing billions to pay dividends and buyback their shares. Given the current low interest rates, it is cheaper to borrow than bring cash back from overseas and interest payments are tax deductible. Apple has borrowed $88 billion to fund shareholder payouts since 2012 and recently announced it would return $300 billion to shareholders through 2019.
- According to the Tax Foundation, Canada’s corporate tax revenues as a share of GDP increased after its rate fell in 2000. Canada’s corporate tax revenues have averaged 3.3% since 2000, compared to 2.9% from 1988 to 2000. The US share of GDP is 2.3%.
- The Congressional Budget Office typically assesses the impact of bills, such as tax reform, using a static model. That is, any reduction in tax rates would “cost” the US economy, reducing tax revenues and potentially increasing the federal debt. They do not take into consideration the stimulative effect of the rate reductions to actually increase the GDP and overall tax revenues, thereby not “costing” the the economy, but potentially increasing overall tax revenues. Canada is a good example.
Does the US need corporate tax reform to help US companies compete on an international basis? Will corporate tax reform increase the federal debt? Does Apple provide a good example for the potential to bring cash back to the US for investment and shareholders? Should Congress delay and complicate possible individual and corporate tax reform by working on one massive bill to change both? Should Congress pass a corporate tax bill first? What is the “Right Thing to do?” We need corporate tax reform now. Congress should not waste time trying to create a massive bill. The bigger the bill, the more parts there are to find fault and to deflect support and passage. There is an estimated $2.5 trillion of US corporate cash sitting overseas. Even if US companies brought back half that amount and paid a rate of 10%, that would generate $125 billion in additional tax revenues. That certainly would cover the Congressional Budget Office “cost” of reform. Canada gives an excellent example of how, even without the one time tax revenue increase due to the repatriation of profits, that the overall tax revenues will increase as a percentage of GDP. Apple provides an excellent example of why we need corporate tax reform.