A New York Times primer on corporate income tax reform is being much blogged today. The consensus seems to be that it points to the impossibility of reform, because so many companies enjoy so many loopholes. Jonathan Chait despairs:
Guess what? The interest of the companies benefiting from loopholes outweighs the interest of the companies that would like lower rates. If nothing else, loss aversion will drive the loophole beneficiaries to lobby harder than non-beneficiaries. My prediction: nothing happens.
Personally, I found the article incredibly confusing, and the graph attached to it not much more enlightening. It is not surprising that utilities have a much higher effective tax rate than biotech, pharma, internet companies, and so forth. That's because the US government assesses taxes over a period of years, but the effective tax rate is a snapshot of a single year.
To see what I mean, imagine a startup company that doesn't make any money for two years, and then hits big with a blockbuster product in year three. In the first few years of its life, that company will accumulate something called a Net Operating Loss credit (NOL) which it can "carry forward" for a few years to apply against future taxes. This is how the IRS keeps from putting firms with "lumpy" (i.e., episodic) profits out of business.
So in year 3, the company will apply its NOLs from the prior years to this year's income, lowering its effective tax rate. Meanwhile, all the companies that haven't got any profits drop out of your sample altogether--we don't measure the effective tax rate of companies that don't owe taxes. Essentially, if you are on a cycle where you have one fat year for every two lean years--not an unlikely cycle for firms in risky businesses such as biotech--the effective tax numbers will only measure the fat years, at which point it looks as if you have three times as much income as you really do, because you're in a business where that year's income has to stretch over a number of years. (If it confuses you to think about biotech startups this way, think about movie actors).
On the other end of the spectrums, we have highly regulated quasi-public utilities, whose rates are set on a "cost plus" basis and who would have to work really, really hard to lose money. Those firms have a high effective tax rate, because they never have bad years to generate NOL carryforwards/carrybacks.
Now, that's not the only thing going on here, obviously. But it's almost certainly part of it. And the article doesn't really clear up my puzzlement. For example, it discusses Google as lowering its taxes by funneling income through Ireland. But US companies cannot lower their taxes by funneling money through anywhere; their tax rate on income earned abroad is the US tax rate, minus the foreign taxes they've already paid. What a US company can do is leave money it earned in Ireland, in Ireland. I'm also not clear on how the company reduced its effective tax rate by claiming a deduction for research and investment, as the article says, since as far as I know, R&D is an expense for both tax and financial accounting purposes. (Can any tax lawyers comment?)
A lot of the people blogging about this seemed to think that corporate tax simplification would look like personal income tax simplification--just zero out all the deductions and have one flat rate on all income. But it doesn't work this way; a lot of the complexity comes from determining what constitutes income. Otherwise, what you've got is a gross receipts tax, which is problematic on all sorts of levels, most notably because it rewards low-cost service businesses, and punishes any industry that requires substantial operating costs or capital investments.
As I've noted before, the government can assume that the operating costs for a person are basically the same across people--you may think that a 3,500 square foot lake house and a BMW are essential operating equipment, but the government disagrees. That means it can simply tax gross income and leave it up to you to figure out how to make your wants fit your means. But The government cannot assume that a dog-walking business is the same as an aluminum smelter. That means that there will still be deductions for legitimate expenses--and wrangling over what constitutes a legitimate expense.
That doesn't mean that we couldn't substantially simplify the tax code--though liberals should note that this wouldn't just mean taking away stupid export deductions, but also rescinding stupid windfall taxes and the like, such as our bevy of "let's punish large oil companies for being big and selling something we need" special tax provisions. But the deductions aren't going away entirely. If you thought that they were, then yes, you are bound to be disappointed.