The ruckus over corporate inversions has opened up another discussion about corporate taxation in the United States. As companies engage in mergers outside of the country designed to lower their domestic taxes, the Obama administration is calling for "economic patriotism", while some analysts suggest that corporate taxes be nixed altogether, perhaps to be replaced with a sort of consumption-based tax.
Should corporate income taxes be eliminated, or, at least, lowered? Probably not the former, any more than personal income taxes should be eradicated. There is a case for the latter, however, though not because taxation of corporations is bad for business, or morally wrong, but because it is the sensible thing to do.
The truth about corporate taxes
It is an indisputable fact that the U.S. has one of the highest effective corporate tax rates in the world, as this table from KPMG clearly shows. If you click on the expansion link, you will see that the 40% is reached by adding the effects of state and local taxes as well, making the effective tax rate higher than the top 35% federal income tax tier.
On the other hand, this percentage is assessed on the taxable income of a corporation, much like personal income tax is computed after deductions are taken. This fact is likely the reason why big companies rarely pay that 35% tax rate.
A shrinking tax base
Corporate income tax has been ebbing away for decades. Joseph Stiglitz, economist and professor at Columbia University, notes that only 9.9% of federal revenue in 2012 was made up of this tax, a mere shadow of its 1943 contribution of 39.8%. The Congressional Budget Office recently revised its estimate of the 2014 federal budget deficit, reporting that a $26 billion drop in revenue is expected, largely due to lower corporate income tax receipts.
A report last year from the Government Accountability Office showed that profitable companies paid around 13% in federal income taxes in 2010, or an effective tax rate of 17%. When unprofitable companies' tax rates were factored in, the rate rose to 22.7% -- still lower than Canada's 26.5%, where Burger King is pursuing an inversion merger.
Change is needed
If most U.S. corporations don't generally pay anywhere near the top 35% corporate tax rate, then what is all the ballyhoo about? In my opinion, this issue is more about perception than actual taxation. In other words: a 35% top tax rate is one of the highest in the world, so it must be a bad thing, regardless of whether it is actually affecting your company. Because of its very existence, it must be changed.
Similarly, the boatloads of tax loopholes employed by corporations to lower their tax rate are technically legal, and making use of them doesn't make these companies unpatriotic. These loopholes exist, and companies can't resist using them. Why should they?
For example, the "bonus depreciation" tax credit allowed companies to write off half of equipment purchases in the same year, instead of depreciating them over a longer span of time. Put in place during the early 2000s, the credit expired at the end of last year, and is currently being considered for permanent renewal.
The effects of corporations gorging on this rule has become clear, the result of which is companies are reporting higher profits – largely due to the fact that they have used up their depreciation expense right away, and cannot use bonus depreciation this year. This leaves them with more profit to report, though not because business is picking up.
The difference is huge. Utility companies have used the rule to reduce their effective tax rates below zero, and Waste Management will pay about $80 million in corporate taxes this year, now that this particular credit is no longer available.
Did corporations really need to purchase all that equipment, or did they do so merely to take advantage of the tax break? No doubt some of the upgrades were necessary, but it certainly sounds like corporations may have over-imbibed simply to take the opportunity to lower their taxes.
There are many other tax dodges that could be jettisoned, as well. For instance, is it fair to allow companies to deduct fines and penalties – like energy companies and banks often do – from their tax liability?
Wouldn't lowering the corporate tax rate and expunging all these confusing tax loopholes make things much simpler? Doing so would have another benefit, too: Without complicated tax finagling, corporations would be much more transparent, giving shareholders a better view of their true financial health.
Without all those tax dodges dangling in front of them, companies could spend more time growing their businesses – and their profits. With a newly lowered top corporate tax rate, I'll bet that turning in their taxes to Uncle Sam won't hurt as much, either.
Amanda Alix has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.