As the topic of "unpatriotic" 'tax inversions' becomes a political issue, we thought it interesting to examine how big an economic issue it really is. How much income tax do U.S. companies actually pay every year to the Federal government? As ConvergEx's Nick Colas notes, the simple answer is “Not much”, at least as compared to any other major source of revenue. In Fiscal 2013, Colas adds, the total was $274 billion, or just 9.9% of all tax and withholding receipts. Your political leanings will inform your opinion about whether that number is too high or too low, of course; but we point out that, as Reuters reports, a former international tax counsel at Treasury explains Obama could "slam dunk" dictate an end to 'tax inversions' without Congressional approval (by invoking a little known 1969 tax law).
But just how big an economic deal is this (via ConvergEx's Nick Colas)...
Back in 1971, the Rolling Stones were in a bit of bind. While commercially successful, their onerous contracts with various managers left them with little in the way of actual cash flow. Their financial manager at the time, a savvy Bavarian prince named Rupert, cooked up a plan to remove them from the United Kingdom. Taxes on their income in the U.K. were over 80%, a rate that would not allow them to ever cover their sizable expenses and pay off their previous managers. So the Stones decamped to the south of France, where tax rates were much lower for residents.
The outcome of the move was twofold. First, the Stones recorded large chunks of their classic album “Exile on Main Street”. The title was a nod to their awkward financial situation – tax exiles from their homeland. The second was that the Rolling Stones finally got on sound financial footing for the first time in their careers, since the royalties from that album escaped the UK tax authorities’ high marginal rates. The rest, as they say, is music history.
If the same thing happened today, the Stones would be accused of “Tax inversion” – moving domiciles to reduce taxes. This topic is much in the news of late, with various U.S. companies considering the move to lower tax rate countries and away from official “American company” status. At a headline level, the move makes sense. Corporate tax rates in the U.S. are 35% on annual income over $18.3 million, a level most public companies certainly earn. The “Main Rate” on corporate income in the U.K., by contrast, is 21% on the same amount. A far cry from the days of “Exile”, to be sure, but a large enough difference versus American rates to make a difference.
Lost in the debate, however, is a more central question: just how important are corporate tax revenues to the finances of the United States? You’d think that with reported corporate pretax profits in the U.S. of $2 trillion annually (according to the Federal Reserve’s Distribution of Annual Income Data), we’re talking about some big numbers here. Not so much, as the Office of Management and Budget (OMB) data clearly shows:
- For the most recent fiscal year 2013, which ended in September, Federal corporate tax receipts were $274 billion. This amounts to 9.9% of the total tax and withholding proceeds that Uncle Sam received in that year, or 1.6% of Gross Domestic Product. One geeky note: corporate payments for Social Security and other social programs are not included in this number. Rather, this is the tax burden tied to reported corporate income.
- By way of contrast, individual income taxes represented 47% of last year’s total Federal tax receipts. The rest of the payments “Pie” came from withholding for Social Security and Retirement Receipts (34%), Excise Taxes (3%) and Other (6%).
- These numbers aren’t unusual in terms of historical norms. The average percentage of Federal revenues that come from corporate income taxes has been 10% since 2000 and 9.9% since 1980. You have to go pretty far back in the records – the 1960s, actually - to find numbers over 20% and World War II to see corporations funding more than a third of the national budget.
- Since the Federal budget is a leviathan of almost unimaginable proportions, let’s put corporate tax revenues in some context. Looking at annual government expenses through the lens of the Daily Treasury Statement (the nation’s checkbook), we can see just how far $274 billion goes. For example, it pays for all of Medicaid, the health program for low income Americans, which cost $260 billion in Fiscal 2013. Corporate income taxes also comfortably cover the salaries of all Federal workers ($171 billion), with enough left over for NASA ($16 billion), and taking care of the nation’s veterans ($46 billion).
- How are corporate tax receipts doing for year-to-date 2014? The Daily Treasury Statement shows gross deposits of $265 billion through July 24, or pretty close to last year’s $274 billion for the whole of Fiscal 2013. Last year at this time, corporations had paid $243 billion, so this year shows a 9% increase over 2013. Not bad, considering GDP growth is so sluggish in the U.S. through the first half of calendar 2014.
- At the same time, the OMB had much higher hopes for this year, as their budgeting spreadsheets (available on the White House website) show. They had expected 2014FY corporate tax revenue of $333 billion – a 22% improvement from prior year receipts. How did they get this so wrong? GDP growth has been below expectations, so that is certainly part of the problem. At the same time, the OMB also budgeted corporate tax revenues to rise to 1.9% of GDP from 1.6% last fiscal year. The long run average since 1980 is 1.7%, which would likely be a more realistic estimate for 2014FY.
- The OMB is also much more optimistic in its estimates for corporate tax receipts through the balance of its forecast window. For example, it has $540 billion in expected proceeds for the 2018FY, or just about double last year’s receipts. That would amount to 2.5% of GDP, a level that we’ve only seen in 2 years since 1980 – 2006 and 2007.
With such a small part of total U.S. tax and withholding proceeds originating from corporations, several questions pop to the foreground. Three fall easily to hand:
Should America even bother taxing corporate income? There is, by most estimates, trillions of dollars of corporate cash locked up overseas because U.S. companies would prefer not to pay the taxes on repatriating those funds. Eliminating corporate taxes would allow them to bring that money onshore and use it to reduce debt and return capital to the financial system. Buying back stock inherently carries an 8-15% return on capital for companies that pursue that route, depending on their cost of capital; cash currently returns zero.
- Yes, this is where politics and economics intersect on the Venn diagram of social policy, and it’s an uncomfortable locus. Corporate profits have come back much more quickly than employment since the Financial Crisis. Eliminating corporate taxes would be a boon to the capital-owning class – including senior managements – but a less certain fillip to labor markets. Perhaps tying tax rates to additional headcounts is one logical incentive structure, giving both political parties something to crow about at the next election.
- Do corporations really even “Pay” taxes? Companies take capital, pursue their business strategies, and sell the result to end consumers. Taxes are simply one cost of doing business, and that expense gets passed along to the end purchaser just as employee and raw materials costs do. Lowering corporate taxes might be deflationary in the short term, but would make U.S. corporates more much competitive than their international peers in the medium and long run by reducing a fixed cost.
- How much of the “Tax inversion” game is really about accrual accounting versus cash flow? Ask any stock analyst who covers individual companies what line on their income statement model is the most opaque, and you’ll get a common answer: tax accruals, the piece between pretax profits and net income. Yes, they will typically display a neat percentage number of 30-40%, but how much of that is an actual cash expense? Companies tend to be pretty mum on that point, simply because the math gets quite difficult to explain, especially if there are tax loss carry forwards from prior year losses. And what company doesn’t have those, after the last several years?
In summary, U.S. corporate tax regulation is a potential area for meaningful and value-added reform. Its contribution to national finances is small enough that a well-constructed revamp could improve both prospects for economic growth and kick-start a still-underwhelming recovery in labor markets, boosting national finances in the process. It is, therefore, the lowest hanging fruit for policymakers to grab. All they need to do is stand up and grasp it.
A recent sharp upswing in inversion deals is causing alarm in Washington, with Obama last week urging lawmakers to act soon on anti-inversion proposals from him and other Democrats. But Republican opposition has blocked Congress from moving ahead.
By invoking a 1969 tax law, Obama could bypass congressional gridlock and restrict foreign tax-domiciled U.S companies from using inter-company loans and interest deductions to cut their U.S. tax bills, said Stephen Shay, former deputy assistant Treasury secretary for international tax affairs in the Obama administration. He also served as international tax counsel at Treasury from 1982 to 1987 in the Reagan administration.
In an article being published on Monday in Tax Notes, a journal for tax lawyers and accountants, Shay said the federal government needs to move quickly to respond to a recent surge in inversion deals that threatens the U.S. corporate tax base.
"People should not dawdle," said Shay, now a professor at Harvard Law School, in an interview on Friday about his article.
If the administration were to take the steps he discusses, Shay said, some of the many inversion deals that are said to be in the works might be halted in their tracks.
The regulatory power conferred by the tax code section he has in mind, known as Section 385, is "extraordinarily broad" and would be a "slam dunk" for the Treasury Department, he said.
Section 385 empowers the Treasury secretary to set standards for when a financial instrument should be treated as debt, eligible for interest deductibility, and when it should be treated as ineligible equity.
If a corporation has loaded debt into a U.S. unit beyond a certain level, Section 385 could be used by the government to declare the excess as equity and ineligible for deductions.
"The stuff I'm describing should be putting a crimp in tax-motivated deals," Shay said.
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The Democrats are going to try it... (enabling them to blame Republicans then do it anyway)
Democrats in Congress trying to prevent government from awarding contracts to cos. that save taxes by moving legal address outside U.S.
Bill would bar federal contracts from going to businesses “that incorporate overseas, are at least 50 percent owned by American shareholders, and do not have substantial business opportunities in the foreign country in which they are incorporating,” according to statement
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So while big numbers are being thrown around and "fairness", "inequality", and "patriotism" are all great slogans for the coming election, but the numbers just don't make it a big economic deal.