The Paradox of Corporate Tax Reform

The White House is proposing to give the horribly pockmarked corporate tax system a major facelift today. The U.S. currently has one of the highest tax rates on corporate income in the world, but it raises a smaller share of GDP than the average developed country. Why? Loopholes, credits, exemptions and the ability to keep money overseas are part of the reason. The tax system is a piece of Swiss cheese that has become more holes than cheese, and the Obama administration is proposing a simple-sounding solution: We'll give you a lower tax rate if you give back the loopholes.

Oh, but it's so not that simple.

The problem with saying "corporate taxes are too high" is like the problem with saying "people are too tall" or "candy is too orange." It ignores a lot of variation. Analysis compiled in the New York Times looked at average effective tax rate by industry. I've charted a selection of the findings here (click to enlarge):

Screen Shot 2012-02-22 at 11.12.56 AM.png One thing you're seeing is that companies with high R&D spending or a large overseas presence pay very little, and companies that do business mostly inside the U.S. -- especially those who also have to pay excise taxes -- pay higher rates.

If you drilled deeper into each column, you'd find more variation. You'd also discover that some big companies have gotten smart to our loopy law. In the last five years, Boeing paid a total tax rate of 4.5 percent, David Leonhardt reported. Southwest Airlines paid 6.3 percent. Yahoo paid 7 percent. Prudential Financial paid 7.6 percent. General Electric paid 4.3 percent.

What do these companies have in common? Here's one thing: You have heard of them, because they are big and rich. Big and rich companies can devote resources to reducing their effective tax rate by moving money around the world and learning their way around the IRS labyrinth. GE's tax department is practically the best tax firm in the world because the company brass has decided that employing some of its smartest people in a tax-investigative unit was a wise business decision.

This remarkable fact cuts both ways. The idea that brilliant, rich, potentially productive citizens are spending their time sniffing for tax loopholes should make you a little mad. They could be making stuff with their brilliant, rich productive minds, after all. But now that this complicated system already exists, tax loopholes are the weapon that corporations use to lift after-tax profits. Washington will call this "filling the holes in the cheese." That sounds nice and pat. But for many companies, it will basically feel like "taking my cheese away."

Corporate tax reformers want to make our companies more competitive, productive, and wealthy by reducing the penalty on earned income by companies. It's a noble goal. But our most competitive, productive, and wealthy companies will be among those fighting hardest against changes in the rules to create a level playing field precisely because such a system cannot be as easily exploited by a wily tax-investigative unit. And that's just one of the many paradoxes of corporate tax reform. 

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Derek Thompson is a senior editor at The Atlantic, where he writes about economics, labor markets, and the entertainment business.

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