By Alex Engler
Senator Max Baucus [D-MT] made some noise this week when he announced that he had turned his attention to an overhaul of the United States tax code. Not only is the Chairman of the Senate Finance Committee going to address the systemic problems facing the nation’s revenue machine, but he is going to do it in the face of taxmageddon. Also known as the ‘fiscal cliff’, the slew of changes to current tax policy scheduled for January 1, 2013 are quite drastic. Senator Baucus may be correct in assuming that this presents an opportunity for meaningful reform that has not occurred since the 1986 tax code restructuring.
Reforming the corporate tax code was one of the central pillars of Baucus’s ‘Tax Code for the 21st Century’. This isn’t surprising given that talking points on both sides of the aisle have consistently advocated for reconstructing the corporate tax code to either make corporations pay their fair share or increase international economic competitiveness. These talking points have generally understated the issue at hand, but in his remarks to the Bipartisan Policy Center, Baucus made no such miscalculation:
“Today, the code is certainly not beautiful. Instead, it reminds me of Hydra, the mythical beasts with hundreds of heads. Each time you cut one off, two more grow back.”
The Nature of the Beast
The United States has corporate tax rates that, statutorily speaking, are the highest in the developed world. Upon cursory analysis, one would discover that combined state and federal taxes on corporations average 39.2%. This was widely reported when Japan undercut the U.S. by reducing its corporate rates to 38% in April of this year. Title 26 of the United States Code (U.S.C.) clearly imposes a tax of 34% on all corporate profits over $75,000 and 35% on all profits over $10,000,000. Tack on state corporate taxes that range sporadically from 0% to 12%, and the tax system broadcasts a clear message: “Do not place your corporation in the United States, or we will take all of your money.” This is not ideal messaging.
Notably, our system doesn’t collect very much money from the corporations that are actually here. Corporate taxes have netted between 1.3% and 3.2% of U.S. Gross Domestic Product (GDP) during the decade ending in 2009. This has placed the U.S. significantly below the average for OECD countries in every one of these years. Even more telling is the 29.2% effective marginal corporate tax rate. By this metric, which indicates the percentage a firm can expect to pay in taxes on its next dollar of profit, the U.S. ranks third lowest of G-7 countries (above Germany and Italy) and consistently below the OECD average. This tells us that we have managed to create a fiscal regime that outwardly discourages basing corporations in the United States, while collecting comparatively low levels of revenue.
Unfortunately, in terms of absurdity, this is just the tip of the iceberg. Last year, the Treasury Department only reported 56 tax breaks that primarily affect corporations. What these corporate tax breaks lack in number, they more than make up for in vagueness and manipulability. Thousands of lobbyists make a living by altering and parsing the corporate tax code. Congressmen and Senators keep their jobs by doing the same. The resulting statutes constitute a tax code so convoluted that it is almost as prone to absurdity as it is to inefficiency.
- The Domestic Production Activities tax credit (26 U.S.C. 199) was meant to ease rapid losses of manufacturing jobs. Yet in 2008, only two-thirds of the $18 billion in tax exemptions from this break were collected by manufacturers. Where did the other six billion go? Publishing companies qualify for a reasonably sized chunk. Starbucks Corporation collects a share for its four domestic roasting plants. In fact, this tax credit can be applied to the ‘production’ of a hamburger. Now, it is important to understand that it is a very nuanced and complex challenge to define ‘manufacturing’ as necessary for this tax credit. That having been said, hamburgers? Really?
- Punitive damages are included in the standard list of business expenses (26 U.S.C. 162) that are tax deductible. Exxon’s meager $500 million punitive settlement after the infamous Exxon Valdez oil spill can be deducted as a business expense. Enough said.
- The Depreciable Business Asset tax break (26 U.S.C. 179) allows for firms to treat the degradation of infrastructure and assets as a cost. This reduces their tax burden, and in turn, firms generally make more investments. This is based on sound economic theory, and the practice has been adopted across the globe. Where the Internal Revenue Code goes so very wrong is in the crucial determinations of how long it takes for property to devalue. Everyone who has ever been near a television has heard President Obama mention this exemption as it applies to corporate jet owners. Corporate jets can be deducted over five years instead of the standard seven years for commercial airplanes. This may sound trivial, but it costs the federal government roughly $300 million every year. Though less commonly referenced, NASCAR racetrack owners reap a similar benefit, which allows them to calculate track depreciation over seven years in lieu of the estimated 39 years that the courses actually take to wear down.
- Last In First Out (LIFO) accounting allows firms to assume for the purposes of federal taxation that the cost of items sold from their inventory are equivalent to the cost of the most recent purchase of that item. To clarify, using LIFO accounting, if a company makes two purchases of oil in a year, the first for $80/barrel and the second for $100/barrel, that firm would start deducting $100 for every barrel as an expense until sales exceeded the number of barrels in the latter purchase. This allows firms to both undervalue their inventory and deduct higher expenses than under a more traditional accounting scheme. If it is not clear to you how this is different from lying to the federal government in order to pay less in taxes, then you are understanding this idea correctly.
- The Qualified Film and Television Productions (26 U.S.C. 181) tax credit was conceived to push back against international competition with Hollywood. It has exempted the first $15 million of domestic filming costs since 2004. However, the provision that extends the tax break to $20 million if the production is shot in low-income areas raises an eyebrow. Constantine pulled in over $230 million at the box office, and the higher deduction for filming in a low-income area cost the federal government $1.75 million. I, for one, am not convinced that the filming of Constantine in Compton over another locale generated a large enough societal benefit to warrant that much tax relief. Even more absurd is how this provision treats television series. Each individual episode is considered a separate production, so as long as the costs of a series remains under $15 million per episode the filming costs are completely tax deductible. The only instance of a single episode breaking that benchmark was the pilot for the staggeringly expensive HBO series Boardwalk Empire, which required the construction of a fake Atlantic City boardwalk. Effectively, this means that the costs of filming TV shows are fully tax deductible. Except for one detail–the entire deduction disappears after 44 episodes. If this had anything to do with the cancellation of Arrested Development, there will be hell to pay.
This list is not meant to be comprehensive. It excludes tax breaks for machinery depreciation, government bonds, income from foreign corporations, research and experimentation, and many more. In addition, it doesn’t even begin to address the more underhanded tax carve-outs designed for individual businesses. Still, this abundance of absurdity should make it apparent that our corporate tax regime needs some very serious work.
If you’re interested in exploring more of the rabbit hole on your own, I highly recommend the Washington Post’s tax break breakdown.