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Corporate Taxes
C
orporate taxes have been in the
news recently due to inversions —
deals that allow American compa-
nies to relocate their headquarters to lower
their tax bills. Since 2012, 20 companies
have reincorporated in low-tax countries.
The most recent is Pfiser, who has agreed to
combine with Allegran, based in Ireland.
A related issue is earnings stripping. After
a company completes an inversion deal and
moves its headquarters for tax purposes
outside the United States, the now-foreign
company still has operations in the United
States. The company arranges for the United
States part of its operation to borrow large
amounts from the now-foreign parent. The
indebted American subsidy will pay interest
on the debt to the parent and, under United
States tax code, the interest payment can be
used to offset the American earnings.
The issue of corporate inversion is one of
tax arbitrage, an investment strategy that
attempts to profit by exploiting the price dif-
ferences between tax rates or systems.
The U.S. has the highest marginal corpo-
rate tax rate at 35 percent, and state taxes
bring the rate to 40 percent. In contrast, the
rate in Ireland is 12.5 percent, and
ties based on tax rates. The average
the E.U. average is 22 percent. Tax
tax rates vary widely by sector, due to
arbitrage also exists in the personal
the ability of industries to take advan-
income tax code when different
tage of preferences embedded in the
forms of income are taxed at dif-
tax code by Congress.
ferent rates, e.g. capital gains and
Enormous disparity in effective
earned income. The larger the gap
marginal tax rates across industries
between the two rates, the greater
creates economic distortions and
Jonathan
the incentive to reclassify earned
inefficiency — reducing economic
Silberman
income as a capital gain, e.g. car-
growth. Tax reform that removes
ried interest.
loopholes will improve economic
The corporate tax is the most inefficient
efficiency.
and least defensible of all taxes. The central
The corporate tax code harms the econo-
problem with the corporate income tax is
my in a number of other ways, including:
that, ultimately, only people can pay taxes.
• Decreasing the incentive for businesses
The burden of the corporate income tax, over to invest because it taxes income from capi-
time, shifts to workers. W ith a smaller capital tal.
stock to employ, workers are less productive
• Increasing the incentive for businesses to
and earn lower real wages. Corporate capi-
organize as sole proprietorships or partner-
tal investment has been lagging during the
ships, which are not taxed.
economic recovery and is one reason why
• Increasing the incentive for businesses
productivity and wage growth are low.
to raise capital by borrowing (debt) versus
Corporate taxation, with its large number
selling shares, since interest on the debt is tax
of deductions and complexity, distorts the U.S. deductible.
economy because resources are misallocated.
• Biasing some types of capital investments
This causes inefficiency as economic activity
over others because of depreciation rules that
shifts away from its most valuable opportuni-
allow companies to spread tax deductions for
capital assets over its life span.
• Finally, the complexity of the tax code
requires businesses to spend large sums of
money on tax compliance and planning.
Corporate tax reform is likely when the
new Congress and president take office in
2017. The outlines of corporate tax reform
may include:
• Reducing the general corporate rate to
20-28 percent.
• Eliminating most of the tax expenditures
(special preferences) for businesses.
• Adopting a territorial tax system (taxes
domestic income but not foreign income).
• Diminishing the tax code’s bias toward
debt financing.
• Moderating tax arbitrage by using the
principle that firms engaged in similar activi-
ties should be taxed at similar rates.
These measures will improve economic
efficiency and economic growth.
*
Jonathan Silberman is a professor of economics at
Oakland University. He writes a monthly column on
the economy for the JN. You can contact him at sil-
berma@oakland.edu.
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68 April 14 • 2016