American businesses and businesses that make money in the United States do not pay enough taxes. Even as profits have skyrocketed, tax payments have declined. Fifty-five of the nation’s largest companies – including FedEx, Nike, and agribusiness giant Archer Daniels Midland – paid zero federal income taxes in 2020, though they collectively reported more $ 40 billion in profits, according to the Institute on Taxation and Economic Policy.
The federal government allows companies to avoid taxes by shifting profits made in the United States to countries with lower tax rates. Every year, American companies, especially in the tech and pharmaceutical industries, brazenly claim to make billions of dollars in microstates like Barbados, Bermuda and the Cayman Islands, which are more than happy to play the game. Businesses and countries are profiting at the expense of the United States.
American policymakers have rewarded this bare masterpiece with rounds of tax cuts, the latest in 2017, partly justified as necessary to make companies not cheat. Tax cuts have also been sold as a magic fertilizer that will accelerate the growth of the economy.
This laissez-faire policy has piled money in the pockets of wealthy shareholders while depriving the government of necessary revenue. But it failed to deliver the advertised benefits. Allowing companies to keep a larger share of their profits has not catalyzed corporate investment, nor has it provided Americans with runoff prosperity.
There are few clearer examples of the failure of the reflexive market deference ideology that has dominated economic policy-making in Washington in recent decades.
In a welcome correction of course, President Biden is proposing to raise corporate taxes and spend the money on infrastructure. His plan would raise the statutory corporate income tax rate to 28% from 21%, still well below the pre-2017 level of 35%. The administration estimates it would raise $ 2.5 trillion over the next 15 years.
The US economy could use a healthy dose of fiscal and spendthrift liberalism. As Treasury Secretary Janet Yellen recently and rightly noted, “In choosing to compete on taxes, we have neglected to compete on the skills of our workers and the strength of our infrastructure.
However, raising more money is not as simple as raising the corporate tax rate.
In 2017, multinationals hid 40% of their profits, or more than $ 700 billion, in tax havens like Luxembourg and Bermuda, according to a study by economists from the University of California at Berkeley and the University of Copenhagen. Raising tax rates, in isolation, would encourage evasion. It would be like sucking up water with a larger sieve.
The heart of the Biden plan is therefore not the increase in the legal rate. Rather, it is a set of complementary measures aimed at taxing the profits that American companies store in other countries.
Under the plan, companies would be subject to a 21% tax on income that would have been earned in other countries, alongside a 28% tax on domestic profits. Businesses would get credit for taxes paid to foreign governments; the United States would collect the rest. A company that reported $ 1 billion in profits in a country with a 10% tax rate would pay $ 100 million in taxes there and an additional $ 110 million to the US Treasury Department. This simple solution would significantly reduce the incentive to shift profits to low-tax countries.
Setting the tax rate on foreign profits at the same level as the rate on domestic profits would further reduce incentives for profit shifting. But among the developed democracies that make up the Organization for Economic Co-operation and Development, the average corporate tax rate is 23.5%. A higher tax rate on foreign profits could put some of the legitimate foreign operations of US companies at a competitive disadvantage.
The Biden administration is also pushing for an international agreement to establish a minimum corporate tax rate, so foreign companies cannot continue to use tax havens. The benefits would extend beyond the United States. Developing countries are particularly dependent on corporate tax revenues. The International Monetary Fund estimates that profit shifting robs them of $ 200 billion in annual income.
An international agreement is not, however, a precondition for achieving the balance of the Biden Plan. The legitimate foreign affairs of American businesses are primarily conducted in countries with relatively high corporate tax rates. And even without a deal, the United States could put pressure on tax havens.
The Biden plan would impose tax penalties on U.S. branches of foreign companies based in countries that keep rates low. The Obama administration deployed a similar strategy in 2010 to crack down on tax evasion by wealthy individuals by penalizing foreign banks that failed to provide information about their clients to the Internal Revenue Service.
Businesses and many economists warn that higher tax rates will discourage investment by increasing the return necessary for an investment to pay off. They say workers will also feel the pain of rising tax rates, in the form of slower wage growth.
But recent history belies such grim predictions. After all, before the 2017 tax cuts, American businesses paid about 40% more in income taxes each year. A comparison with the rest of the developed world is also instructive. In the United States, taxation of corporate profits was just 0.96% of gross domestic product in 2018, compared to 3.14% in the average developed democracy, according to OECD data.
It is also a mistake to assess economic policy solely on its contribution to overall economic growth. The distribution of prosperity is also important; taxing businesses to pay for public services is a worthwhile compromise. And there is good reason to believe that the negative effect on business investment and on wages would likely remain relatively small.
Income tax is designed to protect the investment. The government, for example, allows businesses to deduct interest payments from taxable income. A business that borrows to build a factory pays taxes only on profits in excess of the cost of the loan. The money that is taxed is primarily what economists call excess returns and what a Louisianian might call lagniappe – profits greater than what is needed to motivate investment.
The Biden administration is also proposing a final layer of income tax hardening: a requirement that companies with revenues in excess of $ 2 billion per year pay in taxes at least 15% of reported income to investors. The average U.S. multinational paid just 7.8% of its revenue in corporate taxes in 2018, according to the Congressional Joint Committee on Taxation, so imposing a higher minimum has obvious political appeal.
But businesses that pay less than 15% of their income in taxes can take advantage of tax breaks that serve a legitimate public purpose, such as encouraging research spending or investing in affordable housing developments. If the alternative minimum tax allows for these reliefs, it will not make a lot of money. If it doesn’t include those breaks, it would undermine those goals. In practice, it is a choice between a meaningless gesture and an error.
Instead of using an alternative minimum tax to correct problems with the main tax code, Congress can directly address the use of existing tax breaks. The necessary changes can and should be made within a single corporate tax structure. Raise the legal rate, crack down on the use of foreign tax havens, and buy something nice to the nation.