The Case for Lowering US Corporate Tax Rates

by JT McGee

Lowering corporate income taxes in the United States is never very popular, yet US corporate tax rates are some of the highest in the world at 35%.

I blame this partially on the media, which publishes stories on issues like General Electric’s low 2010 tax bill.

There exist two reasons why companies do not pay US corporate taxes. In the case of General Electric, it had large losses which it could carry forward against future income. GE Money Bank, which issued anything from credit cards to subprime car loans, wasn’t exactly a downturn success story. If a company loses $500 million in one year, it can carry forward those losses against $500 million in future income.

The second reason is not so easily justified, at least to the voting public. Companies resist paying US corporate income taxes because US income taxes are too high.

Pay 35% or 15%…or 2.4%

Large, multi-national businesses have a leg up on their purely domestic competition. An American-based company that earns income in other countries can avoid hefty US taxes by “investing” in quality legal and tax teams.

Google is a perfect example. The company pays most of its taxes in Ireland, using two subsidiaries to register most of its profits abroad. Another capital “flight” (hehe) to the Cayman Islands and this tax deferral strategy really starts to bring in the benefits. Google paid a 2.4% tax rate in 2010.

Of course there are downsides to “Double Irish” tax deferral. For one, Google only temporary delays paying US taxes. Once the capital is moved back to the US – bam! Uncle Sam wants Google to pay up. Thus, most tech companies keep their cash overseas. And boy, tech firms sure have a lot of money!

tech company cash, corporate taxes

Accounting + Finance

When you put accountants and financiers together you have a match made in heaven. Accountants know bringing cash back to the US is a bad idea, as it will generate a tax liability. Financiers know debt is not income, and thus rally the troops to issue new, local debt. Google (or any company with overseas cash) issues debt in the US to finance operations without triggering a cash tax burden.

In May, Google sold some $4.2 billion in corporate bonds (see Google’s capital structure) to raise funds for domestic operations. The firm has cash, $44.6 billion as of the last quarterly report, but as you can imagine that cash isn’t on US shores.

Paying a low rate of tax-deductible interest is much better than paying a very high, one-off charge for cash taxes. Besides, Google is banking on a tax holiday that would allow it a one-time chance to bring money back to the US.

Google would prefer to pay a minute amount of tax-deductible interest on US fundraising operations while its lobbyists work their magic for a one-time tax holiday.

Tax Holiday Politics

Tax holidays are nothing more than corporate welfare. Advocates say that allowing companies to bring cash back to the US without paying income taxes would create jobs. Opponents say previous tax holidays have generated very little net job creation.

The opposing viewpoints are equally ill-informed talking points that you would expect to come out of the mouth of a used car salesman – or Dave Ramsey. This really is a pathetic debate. The political right knows that low long-run tax rates create economic output, so it advocates for low rates in the short-run – a one-time tax holiday. The political left knows that the last tax holiday hardly resulted in economic activity, so naturally a long-run reduction in US corporate income tax rates would have the same immeasurable effect.

Both sides of the debate are correct in their assertions – low rates in the long-haul spark economic activity just as low rates in the short-run do not. Yet, one side wants a short-run tax holiday (with no long-term change to tax rates), and the other side wants no tax holiday nor long-term tax reductions for corporations. Figure that one out.

Drop the Corporate rate to 2%

Since Google managed a 2.4% effective tax rate, it should be the goal of the United States to undercut Google in its tax avoidance. Instead of a high tax rate that encourages companies to pay other countries’ tax rates, we should incentivize companies to pay our low tax rates.

It makes perfect sense. Every corporation in the world would love to operate in the United States, where political stability and private property rights are well respected. Besides, we already have the best financial markets in the world – companies would flock here in numbers. Those that don’t relocate would at least move as much of their productive capacity as is necessary to claim the United States as the home country for their business operations.

And let’s not forget the companies that are not large enough to play tax games with the big boys. Small, growing start ups can’t afford overseas legal teams, and pay the full cost of US taxes. Larger, established businesses with a local (usually physical) product don’t enjoy the same favorable tax conditions as do firms that create mostly intellectual property.

Corporate Taxes Aren’t a Big Winner

A full 8% of all government revenues come from US corporate income taxes:

US tax revenues, us corporate tax revenues, US government revenues 2011

Corporate taxes generate less than $200 billion in revenues for the US government, an amount that is easily ecilipsed by the job creation, economic activity, and general increase in valuations that would come as a result of a permanently low tax rate. Take, for example, my favorite little health care company, Metropolitan Health Networks, which is entirely US-based. The company’s net income would grow by 50% if taxes were dropped to 2%.

My shares, then, would also gain by 50% overnight. I would pay a 15% capital gains tax on my earnings. See, this is perfect!

Competitive Advantage

We rock the world in intellectual property. No other country can match the American dominance in consumer and business technology. Google, Apple, Microsoft – they’re all US-based firms. We absolutely kill in the sciences, too. Look to health care and pharmaceuticals, two industries where American firms open a can of whoopass.

All of these industries have one common thread: they all produce intellectual property. These businesses destroy all the competition because they enjoy access to a well-educated American workforce plus US corporate tax policy that gives favors to their profits “earned” from intangibles – coding, design work, patents, etc.

The United States could have the same tech success story in every single industry if it would allow for every industry to enjoy favorable corporate income taxes. It is certainty. All it takes is a little practical algebra to find a common link between what firms do well, and what firms do not. Just think what we could do for manufacturing in the United States, for example, if manufacturers paid the same effective 2% tax rate that producers of intellectual property pay. (Conveniently, companies based on intangibles have virtually zero regulatory oversight. That’s another topic for another day.)

Let’s level the playing field so that we can see success in every industry to the same degree that we see it in technology and finance, two industries that easily operate in the US yet offshore their tax burden.

Jobs Program, baby!

With US corporate taxes at 2% of profits, companies would flock to the United States to make it their go-to place for business. They’d set up shop in the ailing US commercial real estate market, boosting property valuations.

Companies would hire US workers to fill their brand new headquarters. These US workers, previously unemployed, would begin to pay income taxes once more. Stock valuations would soar for wholly US-based companies, pushing soon-to-be retirees into full blown retirement. New workers would fill their positions, sending the unemployment rate even lower. We’d import new talent to the United States, and new industries.

A rising tide really does raise all ships!

So why won’t the US government lower corporate income taxes? Because any financial debate in this country is excused from intellectual consideration. It’s always a rich vs. poor argument, even though the interests of any classes in a jobless America are perfectly aligned.

{ 16 comments… read them below or add one }

Darwin's Money February 12, 2012 at 21:50

There was the typical “anonymous” leak from the administration this week on lowering the corporate tax rate. Great headline. Shit details. Along with it, will go elimination of deductions and taxing investment income earned abroad (which is where all the growth is now). Gee, thanks, I’ll keep the old system… It’s just another money grab to “increase revenue” which is sly for collect more taxes to piss even more away. I like your proposal, but without a cut in spending, which is the real problem, no credible tax rate deductions will fly I’m afraid.

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JT February 13, 2012 at 15:20

I love the whole “increase revenue” thing. It’s a great way to frame the debate as if we’re short on income and not long on spending. It’s all kind of silly.

Net-net, I really do think favorable corporate tax rates would work out to be a net positive for government revenues. People who go back to work are a double whammy. They no longer receive unemployment, and instead pay into it. That’s good stuff!

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cashflowmantra February 13, 2012 at 05:12

I agree there should be some revamping of the entire tax code, but there is no political will or leadership to get it done nor the spending cuts required.

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JT February 13, 2012 at 15:21

Of course not. Every politician is gets elected and reelected because of “tax cuts” that are more like corporate/personal welfare through a bloated tax code.

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PK February 13, 2012 at 12:10

A well-reasoned post on corporate taxes, and you didn’t even have to mention tax incidence!

I think an oft under-reported trend in the business press is the propensity for large tech firms to make large purchases overseas because of current national tax laws. The media is more concerned with the hordes of money than the accounting rules which give incentives for companies to park money overseas and issue debt in the United States to fund domestic purchases. I have my fingers crossed for reform!

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JT February 13, 2012 at 15:12

I almost hit on tax incidence, in a way. The current corporate tax structure makes it so that poor people pay for high taxes due to lacking jobs – how’s about that?!

I don’t know why we wouldn’t want to encourage any opportunity to make every industry a massive success story like tech. Sure, innovation is great, but there aren’t nearly as many innovators as there are people who could help in other ways to take a product to market. We need those jobs too!

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Daniel February 13, 2012 at 18:05

It’s all about what will generate the maximum revenue. Do you have any stats to show that a 2% tax rate will be better overall? We’ll only be collecting a sliver of the current revenue we get from taxing corporations.

If I were a politician, my platform would be increasing taxes and cutting spending. Doing one isn’t enough to significantly reduce the national debt in the next decade (and only proposing one isn’t going to get any support from the other side). Isn’t that the ultimate compromise?

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JT McGee February 13, 2012 at 20:52

This post was written with an emphasis on the efficient use of resources more so than the national debt. As it stands, the United States dominates the world in intellectual property because of the tax advantages that come with it.

We’ve created a distortion in the marketplace that trickles through most anything. Even if we simply pick a percentage amount that maximizes revenues and economic development, we’re still picking favorites so long as it is above the rate of the lowest payer. If we pick 5%, for example, a manufacturer will still pay twice as much as Google would pay. It makes no sense; you’re essentially allowing for the manufacturing sector to subsidize the tech sector.

It could be argued that instead we should just put hit Google with a tax penalty. Google isn’t going to leave the United States (the biggest economy going) just because of the tax issue. But it sure wouldn’t give reason for foreign companies to bother establishing themselves, here, either.

It sucks either way. We can maximize revenues and tilt the whole economy of the United States toward intellectual property. Or we can seek a level playing field and perhaps bring in less money than we do today from corporations. I think the second option is far better. We create a level playing field, encourage investment in all businesses – not just finance, and tech – and likely boost employment along the way.

Here’s an article that may interest you: http://online.wsj.com/article/SB10001424053111904875404576528123989551738.html
A single city in Switzerland manages to pull down some of the largest companies in the world just because of a low tax rate. It has no real economic advantages otherwise. It was just a farming community. In fact, taxes aren’t even that low. Companies pay ~15% in taxes and they’re still giddy.

They’re practically turning businesses down because they don’t have the commercial real estate nor the residential real estate to grow. Not only do we have plenty of real estate of both varieties, but the United States is far bigger than just one small city in a single country. Plenty of opportunity to move more than just corporate brass, but the whole firm. From the article a business leader apparently “told of a client that wanted to bring in 100 staff members but is instead starting with 25 for lack of space.” They have to import talent, because unemployment is less than 2%. Again, not a problem we have.

It’s a trade-off that won’t pay off immediately. From the article, it took nearly a decade for Zug’s low tax rates to gain traction. Given that it lacked in a lot of qualities necessary to move a business – infrastructure, trained workforce, and even marketing – I’m certain that a global move to the US would be far, far faster than the time it took for Zug to catch on.

I should have included this in my article.

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Daniel February 13, 2012 at 21:02

I’m just starting to read the article now. But 2% seems pretty arbitrary. So if someone else has a 1% tax rate, we should lower ours as well? This seems pretty reactionary. America has a lot to offer, I don’t think we need to offer exactly what everyone else does just to compete!

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JT McGee February 14, 2012 at 13:09

It was pretty arbitrary. Point is, lower rates will work. I’d prefer to shift rates to 2% so as to ensure a level playing field, but hey, even 15% would be better.

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Financial Samurai February 13, 2012 at 21:50

I do believe adding even more incentives for corporations will provide for better competitive advantage and more hiring. That said, we are in an era where corporations are evil.

As the economy recovers, just notice how the angst against corporations start dissipating.

Better to lower our damn person income tax rates!

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Wayne @ Young Family Finance February 13, 2012 at 23:05

What I took away from this post is that employment and wages are usually held out as the innocents who suffer the burden of tax incidence. However, it seems that cash shifting is the predominate strategy. If that’s the case, then there isn’t likely to be much employment or wage gains from the cash coming back on shore.

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Dividend Monk February 13, 2012 at 23:14

I think the country needs a substantially streamlined tax overhaul, which should include a much lower corporate tax rate.

I’d also like to see a shift away from payroll taxes, which have increased as a percentage of total tax receipts over the last several decades. Specifically, taxing a company for hiring an American worker makes little sense. It makes labor costs too high. High corporate tax rates result in corporations moving money abroad, and high taxes on labor are a factor in moving labor abroad, which most would agree is even worse.

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Laura Vanderkam February 14, 2012 at 15:33

What I’ve been amazed by, in conversations with people, is that even if it could be objectively shown that a lower corporate tax rate would generate more revenue than the current scheme, politically, it’s considered a bad idea. Because people don’t think corporations deserve a tax cut. Which may or may not be true, but “deserving” gets us into all sorts of trouble. As it is, now we have a situation where a company like Wal-Mart pays a reasonable amount of taxes, and is widely disliked, and a company like Google pays almost nothing, and yet is viewed as some progressive, cool entity. Go figure.

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Barb Friedberg February 14, 2012 at 16:26

I certainly like the idea of lowering the corporate tax rate somewhat. It would help keep some more jobs in the USA. But the right level is a tough one ot determine. This is not an easy issue.

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John @ Curious Cat Investing Blog February 14, 2012 at 19:08

I don’t mind having corporation pay a fair amount of tax. But the current rules don’t work. Corporations pay lawyers and lobbyists to avoid paying taxes and the high rates only get paid by companies that are either honest or too small to buy favors or pay for schemes that violate the intent of the laws but are allowed (either do to laziness or what amount to brides – cash payments for favors).

The current corporate tax system needs to be changed – but I am doubtful much will really change as long as we elect people that focus on giving favors to those that give them cash. It does seem given the way things are working now lowering the tax rates makes sense. Also reducing the games that can be played would be a big help – but is unlikely until we elect different types of people to office.

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