Corporate Taxes: Democrats Have the Right Question but the Wrong Answer

Senators Byron Dorgan (D-North Dakota) and Carl Levin (D-Michigan) deserve some credit for being smart enough to go to the GAO and ask a sensible question when they commissioned a recent study on why more than two thirds of foreign corporations and about half of the domestic companies doing business in the US get away with not paying corporate taxes in any given year.

The report indicates that many companies write their profits off against corporate losses, a dynamic which is standard to how businesses operate and which particularly benefits small businesses. Dorgan and Levin wisely chose not to focus on that aspect of the issue. But what they did focus on were the many companies both US-based and international which use their presence in other countries to transfer profits out of the US so that they are reported for their divisions in other countries which have a more favorable corporate tax policy.

Senator Dorgan called the report "a shocking indictment of the current tax system." In a joint press release Levin and Dorgan singled out the use of foreign subsidiaries to remove profits from the US to tax haven nations, reporting that:

"Tax haven subsidiaries are designed to duck taxes, and some tax havens have a history of delaying or impeding U.S. tax enforcement. The question is how much tax dodging is going on. This issue cries out for additional investigation."

Not surprising.  With trillions of dollars in sales if those companies were paying their full 35% in corporate income tax, that might mean billions of dollars in additional government revenue, perhaps enough to cover the current deficit and pay for expanded social programs which Democrats desperately want to add to the budget.

In the press release they announced that:

"Dorgan said he will offer legislation to eliminate any tax breaks that U.S. multinational firms get when they set up offshore subsidiaries for tax purposes. Levin is preparing to introduce legislation to combat abuses associated with both offshore tax havens and illegal tax shelters."

The report estimates that less than half of potential corporate taxes are actually paid overall and that "large U.S. corporations today are paying an effective tax rate of 15 percent."

Levin's conclusion that "too many corporations are using tax trickery to send their profits overseas and avoid paying their fair share in the United States," may be true.  But his determination to close so-called 'loopholes' is the wrong answer to the problem, which he may have reached because he did not understand the real question this report raises. The question is not "why are corporations avoiding paying US taxes." The answer to that question is obvious. They're corporations. They want to maximize profit. The question which Levin and Dorgan ought to be asking is "how can we make corporations want to pay taxes to the United States rather than to tax haven countries."

Dorgan and Levin fall into the trap of their flawed assumptions when they conclude that closing loopholes and increasing enforcement will bring in revenue. It won't. It will just cause those companies to move entirely overseas, costing us jobs and more loss of tax revenue. The real answer which this report points to should be obvious. We should change tax policy so that instead of driving companies away, we make America the country to which these companies, and other companies around the world, want to bring their business.  We should become the tax haven and  the country with the most business friendly environment.

It is a national scandal that our corporate tax rate has now become one of the highest in the world, encouraging our own companies to take their profits and their business overseas. America is supposed to be the model of capitalist enterprise for the world, yet we have one of the highest corporate tax rates of any major nation; now tied with France, which recently lowered its tax rate to match our 35%. If the traditionally overtaxed and business-hostile French are lowering their corporate tax rate and ours is as high as theirs is, we are doing something very, very wrong. Even worse, if you add in our state corporate taxes, on average our total corporate tax rate is 39.27% which is higher than every developed nation except Japan, and 24 states have a total combined corporate tax rate even higher than Japan. No wonder companies want to take their profits out of the US or leave altogether.

The GAO report says that because of the business they are transferring overseas, companies are paying an effective tax rate of about 15% in the United States. The rational response to that news should be to follow the natural trend of the market and lower the corporate tax rate to 15% or lower. Ireland did exactly that a few years ago, lowering their corporate tax rate to 12.5% and as a result, they became one of the fastest growing economies in the world. Suddenly, they found companies from all over the world falling over themselves to open up offices in Ireland, or move their entire operations to the Emerald Isle. Instead of losing tax revenues when they lowered the corporate tax rate, they saw a massive increase in tax revenues, not only from all the new businesses which came to Ireland, but also from secondary sources, like sales and personal income taxes from increased salaries and additional salaries of immigrant workers brought in by those companies or attracted to the booming economy. The result is that their new lower corporate tax rate brought the government far more money than it had received at the previous higher tax rate.

Rather than cracking down, as Levin and Dorgan suggest, the United States should be looking to the example of Ireland. Our corporate tax rate should be no higher than 15% and perhaps as low as 10%. Previous reductions in the corporate tax rate have produced proportional increases in tax revenue. When the corporate tax rate was lowered by 31% from 46% to 35% in the 1980s it was followed by a 33% increase in corporate tax revenues, as a percentage of GDP, over the next 20 years. Further reductions would likely produce a similar increase in revenue. A 57% reduction of the current rate to 15% would probably produce $200 billion in additional direct tax revenue, create many new jobs and generate lots of secondary revenue from sales taxes and personal income taxes.

If we are serious about protecting American industry and expanding American jobs, if we want more jobs at better wages for more Americans, the answer is not to crack down on existing businesses which are slipping away from us, as Levin and Dorgan suggest. That will just drive businesses away. Instead we must welcome business back to America by making it the the economic engine of the world once again. We should be the country where corporations want to do business, build factories and hire workers, not the country whose high taxes drive them away.

The need to lower the corporate tax rate ought to be obvious.  That Levin and Dorgan come up with the exact wrong answer is symptomatic of the anti-corporate groupthink which has come to dominate the political left.  It makes me want to grab them by their blue serge lapels and try to shake some common sense into them.  The actions of these businesses are showing us the answer if we just pay attention.   We need to substantially cut corporate taxes to make us competitive with tax haven countries like Ireland and bring the businesses here. Better to collect 15% on a growing tax base than to demand too much and get only a fraction of it while driving businesses away from our shores.

Dave Nalle
The Republic of Dave