If Corporate Profits Are at an All-Time High, Why Are Corporate Taxes Near a 60-Year Low?

By Derek Thompson

Apple is a unique company in many ways, but when it comes to the cavernous difference between its historically high profits and its relatively low corporate tax rate, the company isn't an outlier. It's a microcosm. In fact, corporate profits have been rising as a share of the economy since the early 1980s ... just as corporate income taxes' share has hovered near its 20th-century lows. Here's that sentence in a graph, via The Economist:

Why is this happening? I went back to the tax experts who walked me through the Apple congressional report. They both gave the same answer: Basically, it's all about globalization and pass-throughs.

Business profits are escaping U.S. corporate income taxes in three big ways. First, business is literally moving away from the U.S., as multinational companies have expanded abroad.  Second, large companies are wise to the tricks they can use to move income through foreign subsidiaries that avoid America's high statutory rate. Third, smaller companies are finding ways to avoid corporate taxes, altogether.

Let's flesh each of those out, briefly.

First, global companies are still globalizing. At large multinationals, the share of income from overseas increased from 37.1 percent in 1996 to 51 percent in 2004, according to one report. After the recession, nearly 75 percent of new jobs at 35 large U.S. multinationals were created overseas, according to a Wall Street Journal analysis.

Second, as the business has traveled overseas, multinationals have benefited from lower tax rates and credits against American taxes. "The US combined federal and state corporate tax rate has been stuck at 39% since 1986, while nearly all other countries have cut their rates. Canada, for example, is now down to around 20 percent," said Gary Hufbauer at the Peterson Institute for International Economics. So global corporations will "do their best to report earnings anyplace but in the U.S." What's more, corporate tax lawyers have predictably responded "by devising more ingenious ways to route income abroad." This is the sort of ingenious that leads to the Dutch Sandwich, the Double Irish, and other clever tax-loophole nicknames that when lined up, look like the menu for a European continental breakfast.

Third, the most important reason why corporate taxes are falling while corporate income is rising might be that the government no longer taxes most corporations as Corporations, with a capital C. Sole proprietorships (like any one-man biz), partnerships (like law firms), and S-corporations (like a small real estate company) are examples of "pass-through" businesses, where income is only taxed once. In other words, the income "passes through" the corporate tax code and goes straight to the owners.

"The explosion of pass-throughs" is the main reason for the forking of corporate income and corporate taxes, said Howard Gleckman at the Tax Policy Center. Look at the chart above, one more time. Between the 1960s and today, the percentage of overall business activity conducted by plane-old "C corporations" has declined from about 85 percent to 50 percent. So even as corporate income has increased, "C-corp" revenues have actually fallen as a share of the economy, Hufbauer said.

Lower-c corporations don't mean poor corporations, just smaller ones. Four in five dollars of all pass-through income is earned by taxpayers with earning more than $100,000; and more than a third of all pass-through income goes to millionaires, according to the Congressional Research Service.

The corporate income tax has eroded both because globalization happened and because we let it happen in the way we tax business income. We can't change the first. We can change the second.

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This article available online at:

http://www.theatlantic.com/business/archive/2013/05/if-corporate-profits-are-at-an-all-time-high-why-are-corporate-taxes-near-a-60-year-low/276164/