Are US Corporations Actually Scamming the Tax System?

The system itself is broken

I’m sure you’ve noticed there have been many articles in major newspapers and other publications over the past several years that have argued the corporate tax system is broken. Most of these articles use one or two high-profile firms as anecdotes to illustrate variations on the common theme of a broken non-competitive corporate tax system.

Exactly why the tax system is broken however is sometimes less clear and often the articles have directly opposing views about what makes the system flawed how to correct. First, to understand what is broken with our system and what we want to fix about it prescribing tax policies based on extreme anecdotes that sell newspapers might be like setting construction requirements for door frames based on the height of NBA players.

The danger being that the cost of implementing those policies might outweigh the benefits. If the policies are based on unusual or extreme examples so what are some commonly held beliefs about corporate taxes and what do the data actually tell us about those conceptions. The first commonly held belief is that large US multinational companies pay very low or even no corporate income tax this idea comes from a number of articles that have appeared over the past several years. In the popular press some of the most widely circulated articles publicize Google’s 2.4% tax rate or GE’s 1.8% tax rate or even caterpillars 2.4 billion in tax savings. These articles were adorned with the names of common tax Haven countries like the Cayman Islands, Switzerland and Ireland. 

The average publicly traded US company pays about $0.28 of every pre-tax dollar it earns on income tax to governments around the world. Of course there’s some firms that pay very low tax rates like those highlighted in the articles that you’ve probably seen. But, there are also companies that pay very high tax rates. About 1/4 of publicly traded US companies pay more than $0.35 of every pre-tax Dollar in taxes to governments around the world. So how do Google GE and other companies managed to pay such low tax rates?

Many of these companies have substantial earnings in foreign countries that have lots of intangible property like patents and trademarks they also take advantage of tax credits for research and development manufacturing and energy. They have sophisticated sometimes and very creative tax departments. Why do we have a tax system that gives tax credits and is fraught with so many loopholes? While your gut reaction might be to explain the tax system is broken to be a more complete answer is definitely more complex the objectives of the tax system are multifold.

Lower local tax rates

It is true that one objective is to raise revenue is also the case that the government use of the tax system to encourage investment. Certain types of assets, or in specific Industries the government also use the tax system as a tool to stimulate economic growth to achieve social goals like wealth redistribution.

The average US Corporation has a lower effective tax rate today than 25 or 30 years ago when the tax system was last reformed. Another commonly held belief is that the US tax system encourages us companies to invest overseas instead of here in the US .The US tax system is designed to achieve capital export neutrality. The US tax rate is expected to drop in the future because of tax reform, or tax holiday. Then the US companies will face lower taxes on foreign earnings then domestic earnings, moreover there is an accounting benefits for an earnings as long as those earnings are determined to be indefinitely reinvested then there is no requirement to record a tax liability for those earnings.

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