Tax Analysts Blog

The Least Important Part of Corporate Tax Reform Might Be the Rate

Posted on May 2, 2016

There is growing pressure around the world for major changes to corporate tax policy. The OECD's base erosion and profit-shifting project, and the pressures that drove the G-20 to push for action in the first place, is forcing governments to reexamine everything from transfer pricing to tax enforcement. But in the United States, the BEPS project seems to have only motivated lawmakers to moan about foreign countries targeting U.S. multinationals, leading to calls for the United States to address its high corporate tax rate.

This would be poor tax policy. Corporate tax reform that focuses on lowering the rate would be a major mistake. There are big problems with U.S. corporate tax rules, and the rate isn't the most important issue for policymakers to address. And a focus on lowering the rate is bogging down tax reform efforts in Washington.

The U.S. corporate tax rate of 35 percent is among the highest in the world. With Japan and the United Kingdom dramatically slashing their own rates, the United States is even more of an outlier among the G-20 and OECD nations. And 35 percent isn't even the whole story. When you factor in state and local corporate taxes, the OECD says the U.S. statutory corporate rate is about 39.3 percent. That seems awful, considering the United Kingdom's is at 20 percent (and dropping further over the next few years) and the OECD average is 24 percent.

However, the statutory rate isn't all that important. It's effective tax rates that matter. And the U.S. effective corporate tax rate is quite a bit lower than 39.3 percent. The GAO says that the effective corporate tax rate for large, profitable corporations is about 12 percent (although that leaves out state and local taxes). Several studies show an overall effective rate around 25 percent, right at the OECD average. And everyone has read about how large companies like Apple and Google are able to get effective tax rates in the single digits. (And let's not forget the favorite target of Sen. Bernie Sanders, GE, which has spent a lot of the last decade paying basically no corporate taxes.)

The low effective tax rate is why there is no consensus in the business community supporting 1986-style corporate tax reform. Sure, every corporation would love a lower statutory rate. But companies that benefit from deferral, lax transfer pricing rules, separate company accounting, and bonus depreciation don't want to sacrifice to get there. In his tax reform draft, Dave Camp struggled to drop the corporate rate to 25 percent because he was trying to create a revenue-neutral plan. Most in the business community don't want that. They want a lower corporate rate, a territorial system, and preservation of almost all their current benefits.

So the focus on lowering the corporate rate is misplaced. A nominally high corporate tax rate isn't the biggest problem with the U.S. corporate tax system. And it doesn't entirely explain rapidly falling corporate tax receipts. The U.S. tax system's major problem is exactly what the BEPS project has been designed to combat: base erosion. And the factors causing the U.S. tax base to erode are near and dear to U.S. multinationals (and were scrupulously defended by Treasury during the BEPS negotiations). These include out-of-date and poorly interpreted transfer pricing rules, deferral of taxes on income earned overseas, and income stripping using intercompany debt. These rules should be the focus of the next corporate tax reform effort, not a lower rate.

It would be nice if Congress could put together a corporate tax reform plan that lowered the U.S. statutory rate to something closer to the OECD average. But it would be even better if that plan backed up Treasury efforts to stop income stripping using interest payments, included a tax on deemed repatriated foreign earnings, and swept away transfer pricing rules that allow too much income from intellectual property to be sourced to low-tax jurisdictions where little or no actual research or business activity takes place.

Read Comments (4)

Emsig BeobachterMay 3, 2016

1. It's not really all that simple, but it is inclusive. You're correct in
isolating deferral as the main culprit.
2. Worldwide combined reporting and formulary apportionment reduces the need
for complex transfer pricing monitoring to more reasonable levels.
3. Worldwide combined reporting and formulary apportionment will never happen.

Mike55May 3, 2016

I agree that the focus on the statutory corporate tax rate is overblown, and am
always glad when a respected tax commentator points out as much. I'm not sure
how the "broad base, low rates" crowd came to hold such a dominant position in
the corporate tax reform debate, but push-back is badly needed.

I'm curious though: how would you propose to spend the additional revenue
generated by the measures you've proposed? This was a great post either way,
but by not identifying how you'd spend your preferred tax reform "pay-fors"
you've left the audience with something of a cliff hanger!

For what it's worth: my ideal version of corporate tax reform* would do
everything you've identified above on the pay-for front (and more), then use
the proceeds to further accelerate/increase capital cost recovery. In other
words, I'd like to see the brand of corporate tax reform that was once popular
amongst moderate Democrats, but no longer appears to be supported by any major
political faction. It's unclear to me if moderate Democrats have changed course
on corporate tax reform, or simply no longer view it as a priority issue (I
suspect the latter, based on Hillary Clinton's apparent disdain for the
subject). Either way though no one has picked up this torch yet, but should.

*This assumes we need to keep a separate corporate tax in the first place,
which is an interesting but unrelated topic.

Tink TankMay 3, 2016

I'm surprised no serious international tax pundits have talked about Donald
Trump's international tax plan. To your point, he would eliminate all deferral
- no matter the type of income -, he would lower the corporate rate to 15%,
and, over a phase-out period, would eliminate the deduction for interest.
Finally, he would eliminate inversions - although I haven't seen his specific
proposal on that yet. That covers most of what you think should be focused on.
As a former international tax practitioner, I like the plan for its simplicity.

Emsig BeobachterMay 3, 2016

Rather than a;ways playing "catch up," the OECD nations; and probably all
nations, should adopt a different form of income taxation for multinational
firms. Of course, this would be considered collusion but sovereign nations are
immune from prosecution in this area.
For further exposition of different forms of taxation of multinational
enterprises, I suggest you read the May 28, 2014 White Paper of the Roosevelt
Institute authored by Nobel Prize winning economist Joseph Stiglitz.
Of course, nations are free to compete for investment of foreign firms through
tax rates, credits, etc. Some countries will offer cash bonuses and other
inducements as well -- fiscal competition will not disappear under a
Stiglitzian system.

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