Trump’s Reaganesque Approach to Business
One of President-elect Trump’s better ideas is to ease regulation, especially the regulatory burden on business. Some of the regulations that bedevil business are woven into the corporate income tax. Besides easing those tax-related regulations, Trump wants to lower the federal corporate income tax rate to 15 percent. Such a tax rate cut, in one fell swoop, would be truly Reaganesque. Indeed, it might even out-Reagan Reagan. But is 15 percent the right rate?
The casual reader may believe that the U.S. has the highest corporate income tax rate in the world. On August 18, the Tax Foundation ran “Corporate Income Tax Rates around the World, 2016” that contrasts corporate tax rates in various nations. The authors are Kyle Pomerleau and Emily Potosky who report (italics added):
The United States has the third highest general top marginal corporate income tax rate in the world, at 38.92 percent. Due to the recent reduction in Chad’s corporate tax rate, the U.S. rate is exceeded only by the United Arab Emirates and Puerto Rico.
Take note of that “top.” You see, the corporate income tax has several statutory rates. There are eight such rates, and they kick in as taxable income rises. But these rates seem rather screwy, for as incomes rise, the tax rates rise but then fall, and then the rates rise and fall again. E.g., taxable income between $100,000 and $335,000 is taxed at 39 percent, but above $18,333,333 is taxed at 35 percent. Passing strange, no? See the Tax Rate Schedule on page 17 of the instructions for the 2015 Form 1120, (the form for the corporate income tax.) You’ll notice that the lowest statutory corporate tax rate is 15 percent, just what Mr. Trump wants to lower all corporate income tax rates to. But wouldn’t a 15 percent rate cause a hefty shortfall in tax revenue?
One problem with some tax analyses is that they sometimes lump federal taxes in with state and local taxes; there are even a few cities that levy income taxes. When one sees large discrepancies in tax studies, look to that lumping. (This article tries to address only federal corporate income taxes.) Another problem when discussing any type of tax rates is failing to mention whether you’re talking about statutory rates or real rates, what’s called “effective” rates; i.e. the rate at which a taxed entity actually pays taxes.
Exceptions are what create effective rates. If there were no exceptions, the effective rate would be the statutory rate. The term “exceptions” refers to the exemptions, deductions, write-offs, loopholes, depreciation, and provisions that a taxed entity can use to lower what it owes in taxes. Congress could set a tax’s statutory rate to its effective rate and bring in the same amount of revenue if and only if it simultaneously eliminated every exception in the Tax Code. (Of course, that’s a static, not a dynamic, analysis.)
For years, I’ve argued for such radical simplification for the federal individual income tax. It might work for business, too. But different sectors of the economy pay income taxes at quite different effective rates. Look at Table 1on page 2 of “Average Effective Federal Corporate Tax Rates” from the Treasury Department. You’ll see that for 2007-2011 the lowest effective rate was that of the utilities sector, at 10 percent, and the highest rate was 28 percent for the services sector. (Perhaps the different sectors of the economy should each have their own corporate tax rate, as it makes sense for a vital sector like utilities to have a lower tax rate than, say, the entertainment industry.) The average for all sectors was 22 percent.
Again, if Congress eliminated all the exceptions that lower what corporations owe, they could set the federal corporate income tax to 22 percent (or whatever the average effective rate now is) and be revenue-neutral. However, if Congress were to cut tax rates but not cut exceptions, there’d be a revenue shortfall.
Unlike statutory tax rates, which can be reported with certainty, effective tax rates are difficult to pinpoint. In 2013, the Tax Policy Center’s Howard Gleckman reported: “Large firms that made a profit that year  paid an even lower effective rate -- an average of 16.9 percent in worldwide taxes and only 12.6 percent in U.S. federal tax.”
On August 16, MarketWatch ran “Why the corporate tax rate in the U.S. should be 15%” by Bill Bischoff, who wrote: “ … a 2016 Government Accountability Office (GAO) study estimated that large profitable U.S. corporations paid an average effective federal income-tax rate of only about 14% in between 2008 and 2012.”
Well then, why not set the rate to 14 percent, or even Gleckman’s 12.6 percent? Indeed, a reasonable case can be made that corporations shouldn’t be taxed at all, (it’s not as though “corporations are people”). But, for the foreseeable future, whatever the new corporate income tax rate is set at, it needs to continue bringing in a comparable amount of revenue to the federal treasury. Here’s why:
Each November the Treasury Department publishes the GAO’s financial audit. The audits cover the same ground, make the same projections, and even use the same language. This year’s audit came out on Nov. 14. What is particularly bracing is the “Debt Held by the Public” section on PDF-page 20, where we read: “Of the marketable securities currently held by the public as of September 30, 2016, $7,969 billion, or 58 percent, will mature within the next 4 years (see Figure 3).”
That $7,969 billion is $561B higher than last year’s projection. Also, this year’s four-year projection includes any 10-year Treasury notes sold in 2007 and 2008, the years immediately preceding the four trillion-dollar deficits of 2009-2012. So the GAO’s four-year projections in 2017 and 2018 should be sharply higher. It would seem that we’re in the calm before the storm, the debt storm.
This kid is all for lowering federal corporate income tax rates, but only down to their effective rates, what they’re actually paying, so that the feds don’t lose any revenue. Soon the feds will be tacking into stronger fiscal headwinds and they’ll need more revenue just to pay rising interest costs.
The history of the corporate income tax over the last 80 years is that it has become less and less of a source of federal revenue (chart). In the early 1940s, the corporate income tax provided more revenue than the individual income tax, but not anymore. In fiscal 2014, the individual income tax provided 40 percent of total federal revenue, while the corporate income tax provided just 9 percent.
Let’s try to continue getting that 9 percent until we get through our debt problem. After that we can start lowering the real corporate income tax rate. But we can immediately lower statutory tax rates if we cut exceptions. The more exceptions that we cut out of the Tax Code the more that tax rates can be cut without negatively affecting revenue. I say cut them all out.
Tax simplification is a “tax cut” in itself; compliance is costly. Exceptions affect a corporation’s decisions and planning. Why is Congress making businesses jump through all these hoops? If “good business is where you find it,” then let’s make America a great place to do business again.
Jon N. Hall is a programmer/analyst from Kansas City.