Tax Justice Digest stories about Corporate Taxes

McCain's Transformation Complete: Tax Cuts for the Rich, Even if We Cannot Pay for Them

April 25, 2008 3:00 PM | Permalink

Last week Senator John McCain finally completed a process that has been underway for some time now. McCain has worked his way back into his party's good graces by coming out in support of running massive budget deficits to extend the Bush tax breaks and give new tax breaks to business.

It's difficult to remember now, but Senator McCain had said back in 2000, "There’s one big difference between me and the others -- I won’t take every last dime of the surplus and spend it on tax cuts that mostly benefit the wealthy." He also said of the tax plan George W. Bush proposed while running for president in 2000, "Sixty percent of the benefits from his tax cuts go to the wealthiest 10% of Americans -- and that’s not the kind of tax relief that Americans need."

The New John McCain

Let's compare this to the new John McCain, who fleshed out his latest ideas a bit more during a tax day speech in Pittsburgh.

McCain said he would extend the Bush tax cuts, even though over half of the benefits would go to the richest one percent and the cost would be $5 trillion over a decade. He would cut the corporate tax rate down from 35 percent to 25 percent, even though measured as a percentage of GDP, U.S. corporate taxes are among the lowest of any developed country. He would double the personal income tax exemption for dependents to $7,000, which would do the most for those families in higher income tax rates and nothing for low-income people who pay payroll taxes but who do not have taxable income (meaning a family of four with income of less than $25,000). He would abolish the Alternative Minimum Tax, even though about 9 tenths of it is paid by people with incomes over $100,000.

He would enact first-year deduction or "expensing" of "equipment and technology investments, which, along with a lower corporate tax rate, will create new opportunities for tax sheltering by the wealthy. He would ban internet and cell phone taxes permanently because he seems to believe that new technologies need to be granted a waiver from taxes that lasts forever. (If only Thomas Edison had thought to lobby for laws shielding his inventions from taxes.) He would make permanent the research and development credit because he believes innovation comes from the private sector, except not really, because apparently he also believes that no one will invent anything unless we give them a subsidy through the tax code.

And, most tantalizingly, he would offer a simplified alternative income tax that people can choose, at their option, to file. It's optional, presumably because everyone claims they want a simpler tax form but no one can agree on actually giving up the various deductions and credits that make filing ones' taxes complicated. Rather than simplifying tax filing, this will probably lead some people to calculate their tax liability under two different systems to determine which will result in lower taxes.

Massive Cuts in Public Services Would Be Necessary to Pay for McCain's Tax Plan

The Tax Policy Center has calculated that McCain's plans would cost $553 billion in 2012 alone. That's not even including the interest payments on the additional debt that will result, but let's put that aside for a second. McCain claims he can avoid increasing the national debt, at least to a degree, by cutting spending. But the cost of his plan in 2012 is about 17 percent of all projected federal spending that year according to estimates from the OMB (on page 134 for anyone interested). That's a whole lot of spending to cut. Looked at another way, it's more than all the non-defense discretionary spending that year and about equal to discretionary spending on defense.

During his Pittsburgh speech, McCain said he could get $100 billion in "savings from earmark, program review, and other budget reforms" but was not any more specific. The Senator's oft-mentioned earmarks are said to account for only around $18 billion at the most.

McCain has also said that he will obtain $30 billion in revenue by closing corporate tax loopholes. But his corporate tax cut alone is estimated to cost $143 in 2012.

Actually, You Should Just Bill My Grandkids

Then finally, on Sunday, McCain said on ABC's "This Week" that his tax cuts would take priority over balancing the budget.

To get a sense of what a huge shift this is for McCain, remember that during presidential debates he tried to explain away his opposition to President Bush's tax cuts in 2001 and 2003 by claiming that he thought cuts in federal spending should have accompanied those tax cuts to ensure that the nation's fiscal health would not deteriorate.

Of course, what he said back in 2000 also touched on the fact that the benefits of the Bush tax cuts would go mostly to the rich, but the new McCain is apparently unwilling to remind anyone about this.

On "This Week," George Stephanopoulos asked McCain, "If Congress does not give you the spending cuts you say you can get, will you hold off on signing the tax cuts?"

McCain replied, "Uh, no, of course not, because we don't want to increase people's taxes during a recession..."

It's worth pointing out that none of the candidates are actually talking about raising taxes (with the possible exception of the capital gains tax). Allowing parts of the tax cuts to expire exactly as the Republican House, Republican Senate and Republican White House wrote them to expire can hardly be called a tax increase. Further, it would be interesting to know how McCain might explain the prosperity that followed Clinton's tax increase or the economic doldrums that have followed George W. Bush's tax cuts.

Tax Day Bill Approved by the House Would End IRS's Use of Private Debt Collectors

April 18, 2008 2:53 PM | Permalink

The House of Representatives approved a bill on "tax day" that would end the IRS's use of private debt collection agencies to locate unpaid taxes. The Taxpayer Assistance and Simplification Act of 2008 (H.R. 5719) would ban the federal government from entering into new contracts with the private collectors and the extension of the existing contracts with two companies. (A third company, a scandal-plagued firm based in Texas, was dropped from the program for reasons the IRS would not make public). Similar legislation was passed by the House last year but the Senate did not act.

The IRS's private debt collection program pays contractors a commission of 21 to 24 cents for every dollar of tax debt that they recover, while it's estimated that IRS employees can do the job for about 3 cents for every dollar collected. The private contractors are paid on a commission basis unlike IRS employees, so there is a concern among many that they have an incentive to be overly aggressive and less respectful of taxpayers' privacy rights.

In the Senate, Byron Dorgan (D-ND) has introduced legislation (S. 335), with 23 cosponsors, that would end the private debt collection program. However, the Senate Finance Committee chaired by Max Baucus (D-MT) has not yet acted, and the committee's ranking Republican, Charles Grassley (R-IA) has been particularly vocal about allowing the private debt collection companies, one of which is based in his state, to continue the work for IRS.

The Congressional Budget Office and the Joint Committee on Taxation have estimated that ending the private debt collection program will cost over half a billion dollars over a decade (since that's the net revenue the private companies would collect if allowed to continue). Of course IRS employees could collect much more for the same level of funding, but the budget "scoring" process does not treat funding for the IRS in a manner that accounts for the vast return on every dollar spent on tax collection.

As a result, the House had to come up with provisions that would raise revenue to offset the costs of the bill. One would require that people using money from a health savings account (HSA) provide more evidence that the money was used for a medical expense. HSAs, introduced as part of the Medicare prescription drug law in 2003, are accounts to which individuals can make tax-deductible contributions and which are connected with a high-deductible health insurance plan (plans with deductibles of at least $1,050 for an individual or $2,100 for a family). One fear health care advocates have about HSAs is that they will, over time, encourage healthier and wealthier people to leave the traditional health insurance market, which will make health insurance even less affordable for those at-risk workers and families who really need it. A fear tax fairness advocates have is that HSAs are just a way for better off people to shelter money from taxes. The deduction is worth the most to well-off families who will likely have health insurance with or without a tax incentive.

Another revenue-raising provision in the bill would close a tax loophole that is used by Kellogg Brown & Root (KBR), which until last year was a subsidiary of Halliburton. As we explained a month ago, KBR used the loophole to avoid hundreds of millions of dollars in federal Social Security and Medicare taxes by pretending its Iraq-based employees are working for a Cayman-Islands based "shell company."

Both of these are provisions that would be worthy even if Congress was not trying to raise revenue and they make the overall bill even more praiseworthy. Predictably, the President has threatened again to veto any legislation that ends the private debt collection program, in line with a pattern of positions that choose the private sector over the public sector even in situations in which the latter is able to operate far more efficiently.

Senate Approves Foreclosure Bill that Mainly Helps Business; House Takes a Different Approach

April 11, 2008 4:05 PM | Permalink

On Thursday, the Senate approved the Foreclosure Prevention Act, an $18 billion package of tax breaks and spending that proponents argue will ameliorate the housing crisis, by a vote of 84 to 12. The bill consists of the tax breaks criticized here last week and costing about $10.8 billion over ten years, around $4 billion to be spent through the Community Development Block Grant for local governments to buy or redevelop abandoned and foreclosed homes, and other amendments approved before passage that raised the cost by around $3 billion.

The tax breaks include one provision that would allow companies taking losses this year and next year to deduct them against taxes they paid in the previous four years (instead of the previous two years, as currently allowed) even though it is highly unlikely that this will prevent layoffs of employees or do anything for home builders other than encourage them to dump their inventory.

Another break included is a $500 per-spouse deduction of property taxes for homeowners who do not itemize their deductions, which will probably save families $150 at the most. It will be denied to people living in a jurisdiction that recently raised its property taxes, discouraging local governments from raising revenue needed to deal with growing state fiscal problems. Also included is a $7,000 non-refundable credit for the purchase of a foreclosed home which will do little to make housing more affordable and might actually encourage foreclosure.

The House Moves in a Different Direction

Democratic leaders in the House have indicated that they plan to move in a different direction. On Wednesday the House Ways and Means Committee approved an $11 billion package that does not include the loss carryback provision. It includes a refundable $7,500 credit for first-time homebuyers (of any homes, not just foreclosed homes) that must be paid back in equal installments over the next 15 years, which is the equivalent of an interest-free loan. Eligibility is phased out beginning with taxpayers with incomes of $70,000 (or married couples with incomes of $140,000). The House bill also has a deduction for property taxes for non-itemizers, but ,capped at $350 per spouse, it is even smaller than the one in the Senate version.

Whether these provisions will help many people obtain or keep a home seems questionable. Offering people a small interest-free loan and a tiny cut in property taxes doesn't seem useful for those who are facing foreclosure or for communities that want to preserve their neighborhoods. But at least the House bill does not include the Senate's giveaway to business, the loss carryback provision.

Other changes in the House bill include modifications to the Low-Income Housing Tax Credit and other provisions. Both the House version and the Senate version have provisions to allow increased use of tax-exempt housing bonds by states and localities.

The House bill also has provisions to offset the costs of the bill, and these are provisions that should be passed regardless of Congress's search for revenue. One would require that brokers of publicly traded securities report the basis of a given security in a transaction to ensure that capital gains taxes are paid properly. Very generally, a capital gain is the difference between the price a person pays for property and the price the person sells it for later. The "basis" is the initial purchase price, and if it is not reported correctly, this can lead to an underpayment in capital gains taxes.

Another offset would delay and limit an unnecessary tax break for corporations, "worldwide interest allocation," which hasn't even gone into effect yet. Tax rules already let multinationals take U.S. tax deductions for some of their interest expenses that are really foreign. In 2004, Congress actually expanded this loophole with worldwide interest allocation, a change that is scheduled to take effect starting in 2009.

The final outcome for this legislation is unclear given the disagreements between the House and the Senate and given that the White House has signaled that it has misgivings about the Senate bill.

The Senate’s Foreclosure Prevention Act Unfairly Rewards Big Business Over Middle-Class Americans

April 4, 2008 5:09 PM | Permalink

The Foreclosure Prevention Act introduced in the Senate this week includes several measures that lawmakers argue will address the home mortgage foreclosure crisis and the problems plaguing the home construction industry. Judging from the information we have so far, it appears that the tax provisions in the bill are likely to help large corporate homebuilders and yet do little for ordinary Americans who are either struggling to keep their homes or who are hurt by the downturn in the home construction industry. These tax provisions include:

Net Operating Loss Carryback
Cost: $6 billion ($25.5 billion over 2 years, $6 billion over 10 years)

As a general rule, a company operating at a loss in a given year will not have to pay taxes for that year, because its deductions will wipe out its taxable income. Under current law, if a company has excess deductions beyond its taxable income for the year, it can apply those excess deductions not only against earnings in later years, but also against income taxed in the previous two years. That allows it to get previously paid taxes refunded. The Senate bill would expand this benefit by allowing companies to apply losses in 2008 or 2009 to taxes paid in the previous four years.

This benefit would be available for all companies, but proponents in the Senate have argued that this will particularly ease the pain felt by home-construction companies. Proponents say the loss carryback provision will make it less likely that construction companies will need to lay off workers, and that it will somehow reduce the pressure on them to quickly sell their excess inventory at a loss.

But there is no reason to think that this tax break will have these positive effects. Companies will always have an incentive to lay off workers if no one is seeking to buy whatever the company produces. Handing the companies a tax break with no strings attached does nothing to change that. Contrary to the claims of backers of the tax break, labor groups have persuasively argued that this provision could actually encourage construction companies to dump their excess housing inventory on the market more quickly since the tax break would cushion the losses that result from selling at lower prices.

In terms of its effects on the housing industry, the main effect of this corporate giveaway will be to reward large corporate home-builders who helped perpetrate the sub-prime lending debacle. Other major beneficiaries will be large corporations who use the "bonus depreciation" tax break enacted earlier this year to reduce their taxable incomes below zero, and who will enjoy outright negative tax rates if this NOL carryback provision is enacted.

Non-Itemizer Tax Deduction for State and Local Property Taxes
Cost: $1.5 billion

Currently, homeowners are allowed to take an itemized deduction for state and local property taxes. But less than a third of taxpayers bother to itemize their deductions, because most find it more beneficial to use the standard deduction. The Senate bill would offer non-itemizers a deduction for property taxes on top of the standard deduction this year. The new deduction would be limited to $500 for single taxpayers and $1,000 for married couples.

Proponents of this provision apparently fail to understand the purposes of the standard deduction: (a) to make the tax code fairer and (b) to make tax filing simpler for most people by giving them a simple deduction that is bigger than what they’d get from itemizing.

Right now, the only homeowners who do not itemize their property taxes are those for whom the standard deduction ($10,900 for couples) is bigger than their total expenses for state and local taxes, interest, donations, etc. In effect, non-itemizing homeowners already get to write off more than their total property taxes.

Adding an additional property tax deduction on top of the generous one already implicitly allowed to non-itemizers would make tax filing more complicated and tax enforcement more difficult.

The new deduction would provide little help to those who take advantage of it. Families who have no taxable income already would not be helped at all. For couples with two children, that includes those making less than $25,000. For couples with two children making more than $25,000 but less than $41,000, the maximum tax saving would be only $100. From $41,000 to $90,000 the maximum tax saving would be only $150. And above that level, the vast majority of homeowners already itemize deductions, and would thus get no benefit.

To illustrate how little thought went into the design of this foolish tax break, the new non-itemizer property tax deduction would be denied to taxpayers if their locality raised its property tax rate this year or next. The apparent goal of this strange rule is to punish taxpayers whose state or local governments have mitigated revenue losses caused by declining home values and the economic downturn. The Senate apparently hopes to encourage local government to deal with falling revenues by cutting back on public services such as education instead.

Foreclosed Home Purchase Tax Credit
Cost: $1.6 billion

The bill also includes a $7,000 non-refundable tax credit that can be claimed over two years by people who purchase foreclosed homes during the next 12 months. It seems unlikely that this provision would make foreclosed homes more affordable for buyers who earn enough to take advantage of this subsidy (more than $57,000 for couples with two children). Instead, it will probably lead to higher prices for the foreclosed homes. Indeed, supporters of this provision admit as much. "The $7,000 tax credit for those who buy foreclosed properties should stimulate demand for them and prevent their prices from falling further, said Sen. Johnny Isakson (R-Ga.)," according to the Washington Post (Apr. 5, 2008, p. D1).

President's Veto Threat: Agriculture

February 15, 2008 2:31 PM | Permalink

The House and Senate have been battling each other, as well as the White House, over how to reauthorize various agricultural programs under what is usually referred to simply as the "Farm Bill." The battle is largely over how much the federal government should or should not support farming, which farmers should be supported and how. Proposals to raise revenue for a disaster trust fund, conservation and nutrition have added to the controversy. During the swearing in ceremony of the new Agriculture Secretary, Ed Schafer, Bush said specifically that he would veto any farm bill that raises taxes. House Agriculture Committee Chairman Collin Peterson (D-MN) is working on a new version of the bill to end the deadlock and it's reported that this version will attempt to raise revenue without tax increases.

One measure that the President considers a tax increase is a provision the House attached to its version of the farm bill passed back in July (H.R. 2419). Initially proposed by Rep. Lloyd Doggett (D-TX) and endorsed by Citizens for Tax Justice, this provision would raise $7.5 billion over ten years by stopping foreign corporations with subsidiaries in the U.S. from manipulating international tax treaties to avoid taxes. U.S. subsidiaries of foreign corporations don't have to pay withholding taxes on passive income if they are based in a country that has a treaty with the U.S. allowing that country to have the sole taxing power. But corporations based (on paper at least) in a non-treaty country can shift profits from a U.S. subsidiary to another subsidiary in a treaty country and then shift them to the parent corporation in the non-treaty country, ensuring that they are never taxed. The Doggett provision would simply apply the withholding that would apply if the payment was made directly to the parent company in the non-treaty country in that situation. The White House has singled this provision out as unacceptable.

The Senate passed a farm bill in December that had its own revenue-raising provisions. The largest is a provision that would reduce tax avoidance schemes by codifying what is known as the "economic substance doctrine," which basically means taxpayers will not obtain tax benefits from transactions that were entered into for no other purpose than to avoid taxes. In addition to raising $10 billion over ten years, this provision would arguably reduce the economic inefficiency that comes with the exploitation of tax loopholes. Citizens for Tax Justice advocated for this measure (although calling for a stronger version of it) but it is unclear whether the White House will see this as a "tax increase."

Another revenue-raising provision in the Senate bill takes aim at tax shelters known as sale-in, lease-out (SILOs). These arrangements, which can involve an American bank buying something like a subway or sewer system in another country and "leasing" it back to the foreign government for tax advantages, were already banned starting in 2004 but that ban would retroactively apply to deals made before 2004 under this provision. Some members of Congress oppose any such retroactive changes in tax laws, but the Senate Finance Committee earlier last year tried to include this change in minimum wage and energy legislation.

Now House Agriculture Committee Chairman Peterson is putting together a new version of the farm bill with the help of Republicans on his committee that will not include the Doggett provision. The White House appears to look more favorably on this effort. This bill would still require $6 billion in new revenue, and it's reported that Peterson is working with House Ways and Means Chairman Charles Rangel (D-NY) on provisions that would accomplish that by enhancing tax enforcement. Several members of the Senate, meanwhile, say that the deal would not invest enough in agriculture and are likely to respond with a new bill of their own.

Chair of House Tax-Writing Committee Proposes Comprehensive Tax Reform

October 26, 2007 8:47 AM | Permalink

Congressman Rangel's Tax Bill Would Make the Tax Code Simpler, More Progressive, and the Changes Are All Paid For

House Ways and Means Chairman Charles Rangel introduced his proposal Thursday to address the Alternative Minimum Tax and simplify the tax code without increasing the federal budget deficit. One title of the bill would address the income tax for individuals, including the AMT reform which would be paid for by reducing the Bush tax cuts for the wealthiest Americans and closing some unfair loopholes that benefit the very richest taxpayers. The other title of the bill would simplify the corporate tax by trading a lower corporate tax rate for the elimination of some inefficient loopholes. Lawmakers may take some of the provisions, such as a one-year fix for the AMT, and pass them more quickly as a separate, smaller bill.

Individual Income Taxes Would Be Simpler and More Progressive

Several Republican lawmakers demand that Congress repeal the AMT without replacing the revenue because it was never "intended" to be collected. This is nonsense, because the Bush Administration very intentionally declined to address the AMT when it passed tax cuts. The President's most recent budget assumes that the AMT will, in fact, expand its reach to millions of families after 2007.

Congressman Rangel's bill includes a "patch" for the AMT for this year and then repeals it altogether. The revenue is replaced largely with a surtax on families with incomes over $200,000. These families have benefited the most from the Bush tax cuts. Nearly half of the benefits from the Bush tax cuts flow to the richest five percent of taxpayers, whose income is above $170,000. In 2010 well over half of the benefits will flow to this group if the Bush tax breaks are not repealed. So Congressman Rangel's bill would reduce the bonanza of tax cuts enjoyed by this elite group of families to help pay for AMT relief for families who are somewhat more likely to be middle-class.

In addition, the bill would eliminate the loophole for "carried interest" as many advocates have urged because it allows wealthy fund managers to pay a lower tax rate than middle-income people.

Congressman Rangel's bill also includes important improvements in the Child Tax Credit and the EITC for childless workers. The Child Tax Credit is currently structured so that the poorest families cannot benefit from it, while the EITC for childless workers is currently so low that childless workers can live in poverty and still pay federal income taxes, in addition to federal payroll taxes.

Corporate Taxes Would Be Simpler and More Efficient

The bill reduces the corporate rate from the current 35 percent to 30.5 percent and replaces the revenue lost from this change by eliminating certain loopholes. Corporations should consider themselves lucky to be offered this lower rate. CTJ has argued recently that Congress should close corporate tax loopholes and not lower the corporate rate but instead use the new revenue for deficit-reduction or to address the many needs this country faces right now.

It's often said that the U.S. corporate tax rate of 35 percent is among the highest in the world, but really the effective rate is much lower because of the loopholes that corporations use to lower their taxes. The United States collects less in corporate taxes as a percentage of GDP than all but two OECD countries. In other words, corporations should be thankful they're being offered any tax breaks at all.

Wisely, the bill includes changes to offset the costs of the rate reduction. These include eliminating several existing tax provisions, including a tax subsidy for manufacturers, an accounting method that allows oil companies to understate their profits, and another provision that encourages companies to move operations offshore.

Republicans Defend Government Interference in the Economy Through the Tax Code, Defend Complexity in the Tax Code

Republicans in Congress have placed themselves in the strange position of defending a system that taxes some millionaires at lower rates than middle-class families, defending a tax system that provides subsidies to certain businesses at the expense of the rest of the taxpayers, and defending the complexity in a tax code that causes business decisions to be made for tax reasons rather than economic ones. Treasury Secretary Henry Paulson went so far as to say (subscription required) "The corporate proposals will hurt the ability of our businesses and workers to compete in a global economy." This is despite the fact that closing loopholes to pay for a lower tax rate is an idea that he and others in the Bush administration proposed during the summer.

Senator Levin Targets Deductions for Stock Options

October 5, 2007 3:35 PM | Permalink

Senator Carl Levin (D-MI) introduced a bill this week to end the disparity between deductions taken by companies for stock options and the expenses that are actually reported on the companies' books for those options. Corporations sometimes compensate employees (particularly executives) with options to buy stock at a set price. The employee can wait to exercise the option until after the value of the stock has increased beyond that price, thus enjoying a substantial tax benefit.

When stock options are exercised, employees report the difference between the value of the stock and the exercise price as taxable wages. The employer reports the fair value of the option at the date it's granted in its financial statements, yet takes a deduction for the value of the option on the date it is exercised, which is often much greater. This "book-tax gap" means that how the options are valued for accounting purposes and reported to stock-holders is different from how they're valued and reported to the IRS. Levin's bill would make the amount deducted for tax purposes equal to the value accounted for in financial statements.

According to calculations made by his staff using IRS data and released in June, firms deducted $43 billion that was not included in financial books in this manner between December 2004 to June 2005. CTJ's 2004 study of corporate taxes cited stock options as one of the key reasons corporations were able to avoid taxes.

Senate Finance Committee Examines Tax Strategy Used by Offshore Insurers

September 28, 2007 3:45 PM | Permalink

American insurance companies came to the Hill Wednesday to complain about a tax-avoidance strategy that they say is giving Bermuda-based insurance companies an unfair competitive advantage. The general idea is that an insurance company can locate or relocate in Bermuda, which has a tax treaty with the United States allowing premiums paid to Bermuda-based insurers by U.S. customers to be free of U.S. tax, except for a 1 percent excise tax. The company's U.S. affiliate sells insurance to U.S. customers and then buys reinsurance (which is common for insurers) from the parent in Bermuda, so that income from premiums is effectively shifted to Bermuda where it can be invested tax-free.

In reality the affiliates are operating as one company just shifting money around on paper. The strategy apparently requires very little in the way of actual employees of facilities physically located in Bermuda.

A U.S.-based insurer will generally pay the corporate tax rate of 35 percent on its income, and thus is put at a competitive disadvantage relative to the Bermuda-based insurer. The strategy available to the Bermuda-based insurers should be eliminated for moral reasons, but thankfully there are some powerful U.S.-based insurers that have found it in their own interest to start lobbying for reform.

While some members of the Finance Committee have expressed concern and an interest in a legislative solution, no proposal has been made public yet. The Bermuda-based companies have formed their own lobbying coalition to block reform.

Experts Agree that Corporate Tax Loopholes Should Be Closed, But What Should Be Done with the Revenue?

September 21, 2007 3:47 PM | Permalink

Bush Administration Says Lower the Corporate Rate; CTJ Says Use the Revenue for More Pressing Priorities

Earlier this summer, the Bush Administration floated the idea of closing corporate tax loopholes and using the resulting revenue to offset a reduction in the corporate tax rate. There is even a possibility that a tax bill being developed by House Ways and Means chairman Charles Rangel (D-NY) could include some variation on this theme to win Republican votes. A recent op-ed by CTJ director Robert McIntyre argues that the first half of this plan is a great idea -- close the loopholes that allow corporations to avoid paying their fair share. But there are many pressing needs (healthcare, Social Security, paying off the national debt or just closing the budget deficit during a costly war) that this revenue could be used for rather than a rate reduction for corporations.

And it's not the case that corporations are paying so much in U.S. taxes that it puts them at a competitive disadvantage. In 2005, the most recent year for which data are available, U.S. corporate tax revenue as a share of GDP was only 2.6 percent, lower than in all but two developed countries.

A Lower Corporate Tax Rate?

July 27, 2007 3:50 PM | Permalink

Loopholes Turn Corporate Tax into Swiss Cheese

The U.S Treasury has been causing some business investors heartburn this week by suggesting that some cherished loopholes in the tax code could be closed and the resulting revenue used to lower the corporate tax rate. The argument was made in a report published by the Treasury and then discussed at a conference yesterday. Among the tax subsidies mentioned were the research credit, which Citizens for Tax Justice has criticized in the past, as well as several others that we noted last week in our "Hidden Entitlements in the Federal Tax Code" feature. The report finds that loopholes reduce the Federal corporate tax base by around 25 percent.

It's certainly true that there are plenty of business-oriented loopholes in the tax code that need to be closed. As the report points out, many of these are quite inefficient and result in business decisions based on tax reasons rather than cost-effectiveness.

But it's not at all clear that the revenue generated by closing loopholes should be used to lower the corporate tax rate. If federal revenue is not increased at some point, Congress may have to cut public services that Americans from all walks of life depend on. Further, if the corporate rate falls far below the top personal income tax rate, this may encourage wealthy people to use corporate entities to avoid the personal income tax.

International Tax Avoidance Also a Major Issue

But the report does not address another factor that is seriously eating away at corporate tax revenue: tax avoidance associated with multinational firms involving transfer pricing. Transfer pricing is basically the accounting that must take place when divisions of a corporation that are based in different countries "sell" and "buy" products or services to and from each other. In theory, if an American division of a company buys something from its division in another country, then that purchase can be deducted for American federal tax purposes. The foreign division has revenue and may have a profit, but in theory, the foreign government will tax that profit.

The problem is that a multinational corporation can exploit this system. For example, it may transfer its patents and trademarks to a division in a low-tax foreign country with little transparency (a tax haven) and then have that division "charge" the American division for the use of these "intangibles." The accounting can be done in such a way that the American division appears to have no profits after making these payments, and all the profits appear to go to the division in the tax haven.

A recent report from the Hamilton Project of the Brookings Institution explains the inefficiencies in this system and cites a study finding that a 35 percent reduction in corporate tax revenue results. The report argues that the United States and its major trading partners should switch to a system in which a company's total global expenses and profits are calculated and then tax is apportioned to the various countries where it does business based on sales in each country.

The problems with the current system are evident. The New York Times recently reported on how drug companies are particularly likely to take advantage of transfer pricing. Eli Lilly, for example, only paid about 6 percent in U.S. federal taxes on its profits of around three and a half billion dollars last year.

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