10-12-10 - Corporate Tax

I don't understand corporate tax. What exactly does it tax? Obviously "corporate income", but what does that mean exactly? In particular, since salaries are deducted as expenses, the only things I can think of that are actually taxed are : 1. corporate profits that are kept as cash reserves, and 2. dividend payouts. And for (1) any corp worth its salt is going to find a way to defer that accounting against some future cost, so all I can is dividend payouts. But furthermore, since the tax accounting of expenses is different than the real accounting, you have plenty of corps that pay out dividends and yet have "no profit" for tax purposes (eg. GE). So I'm a bit confused and I wonder if I'm missing some other category of money that counts as corporate profit.

Anyway, the thing that's been bothering for a long time is that I've read a few times that sales or VAT taxes, eg. consumption taxes, don't hurt economies, but income taxes do. That just makes no sense to me, I don't understand it all. It seems to me that for economic growth you want to maximize fluidity, the ease of money flow, and you want more transactions. Assuming there is some +EV utility from each exchange, more exchanges = growth. To encourage echanges you should minimize friction. It seems to me that consumption taxes are a direct friction and should discourage purchases, and thus be very bad for economies.

So far as I can tell, the argument against corporate tax comes down to people like this : News N Economics O.K., so the Senate rebukes the VAT for what exactly

who pull some data and draw a pretty questionable line on it :

There's some major fallacies in this argument. First of all, correlation is not causation. Even if this did show that high corporate income tax rates are (negatively) correlated to GDP growth, that doesn't prove that lowering CIT helps growth. There are any number of possibly reasons they could be correlated. One that seems obvious off hand from the graph is that it seems developing or poorer nations tend to have lower CIT for various reasons, and developing nations tend to have higher growth. If that hypothesis is correct, then the correlation of CIT to growth is purely incidental. Another possibility is that countries with healthy economies don't need high CITs to raise enough taxes. You can't just take two axes of a many-dimensional data set, you need to look at all the axes and do PCA to pull out the most correlated dimensions.

In any case, the graph is just showing the wrong thing for the X axis. It is showing the *nominal* CIT rate. That's bananas retarded bullshit. What you need to show is the *real* CIT rate. Perhaps even better is to show the dollars of CIT as a percentage of total tax collected - then we can see how having a large CIT as a fraction of your tax bundle affects growth.

This is clearly a case of disinformation, where people pull some numbers and make graphs and make it look like it was researched and studied and it's good hard facts - when in fact it is completely distorted bananas bullshit.

Interestingly, if you look at CIT collected as a fraction of GDP, the US actually has the 4th LOWEST CIT in the OECD - just 1.8 % , vs. a 2.5 % weighted average. (Germany, also nominally one of the highest averages only 1%). CBO paper (PDF)

Obviously the vast majority of corporations find ways to wind up with no "income". (BTW there is an IRS watchdog that's supposed to catch executives who just check their profit number at year end and increase their salaries by that amount, but obviously there are plenty of legal ways to accomplish the same thing).

One reason is that the rules for what CIT applies to are not uniform across the OECD, so showing the nominal rate across countries where the word "corporation" doesn't even mean the same thing is kind of retarded. For example : in the US , over 50% of businesses are not subject to corporate tax , because they are sole owners who prefer to take the income as personal income tax : taxanalysts.com Featured Articles -- The Corporate Tax Conundrum

What The Top U.S. Companies Pay In Taxes - Forbes.com
The truth about tax burdens - OECD Observer
The Gap Between Statutory and Real Corporate Tax Rates
Tax Reform Would Pay Dividends
Roubini Global Economics - U.S. EconoMonitor
Putting U.S. Corporate Taxes in Perspective � Center on Budget and Policy Priorities
OECD Tax Database
Most U.S. firms paid no taxes over 7-year span - SFGate
Ezra Klein - The corporate tax shuffle
Dave Johnson Tax Tricks -- Do Corporations Pass Taxes on to Customers

There are a few canards going around that I think we can debunk.

1. High corporate income taxes discourage economic activity. It seems to me the opposite is true, high CIT encourages corps to pay out all profit as salaries or reinvest it in a deductable way. If anything that should be a stimulating motivator. Similarly, the idea that some executive are going to work less because of higher CIT is absurd since it simply doesn't apply to their income.

2. Corporations pass on income tax bills to their customers. As Dave Johnson wisely argued, this is just bunk. Corporations already price their goods as high as the market can tolerate. The floor of pricing is set by cost, and CIT is not a cost, since it applies to profit. Therefore CIT should have zero effect on prices to consumers. If anything CIT is a tax on investors who receive smaller dividends.

A few issues about high CIT that we should actually care about :

1. Very high nominal CIT coupled with extensive deductions forces corps to spend a lot of money on tax preparation. Obviously simplification of the tax code all around would be beneficial. Oddly, it is the corps themselves who have lobbied us into this morass of special exemptions.

2. The overlap of CIT and dividend tax is obviously a little weird. IMO dividends need to be taxed as normal income to close the loophole of major shareholders getting such low tax rates, and if that was fixed then CIT would have to come down. Or dividends could just be deducted from corp income, but then what would it be exactly?

3. Variation of CIT across countries for international corps creates strange incentives. Though of course tax variations across states and even special breaks in certain cities create weird distortions as well (see for example Microsoft's dodge in Nevada below).

Not related, but I also found this amazing piece of partisan claptrap from our own lovely government : The Economics of the Estate Tax
it starts out with "The estate tax, also known as a death tax," and then only gets better from there. With official studies like that from government committees, is it any wonder that we can't get our discussion above the level of absurdism ? BTW Also found some references on how the step-up in basis actually makes the estate tax a tax *break* for many heirs. Estate tax elimination could cost heirs
5 estate-tax myths that won't die - MSN Money

Also not related, but I found a huge site devoted to Microsoft's massive tax evasion : Microsoft Tax Dodge
Broke-ass Washington State Set to Give Microsoft $100 Million Annual Tax Cut and Amnesty for $1 Billion in Tax Evasion, Feed


ryg said...

On Germany: The huge difference in nominal corporate tax rate vs. real taxes paid partially stems from some spectacularly stupid changes to German tax code in the late 90s. The law was changed so that multinational corporations can write off their losses / investments in other countries against their taxes in Germany. Basically no big corporation in Germany has paid taxes since. It also threw a shitload of municipalities (which were the main receivers of corporate taxes) into serious money problems, greatly weakening the power of local politics in general because they're now completely dependent on state/federal money to make ends meet.

cbloom said...

"The law was changed so that multinational corporations can write off their losses / investments in other countries against their taxes in Germany."

Yeah, the same loophole exists roughly in the US.

In theory something like that makes sense, however with corporations ability to move profits from one country to another, and the variations of tax codes, it means they can choose to take their profit or loss in the country that is most favorable to them.

My understanding is that Germany also has very generous tax credits for environmentalism, R&D, etc.

I believe the general policy of having high taxes and then lots of deductions and credits for specific things is very bad. But that's pointless ranting because it will never change.

old rants