Don't Believe the Economists About 'Low' U.S. Corporate Taxes

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Have you ever been caught in the rain on a day the forecast said was supposed to be sunny and wondered, did the weatherman even look outside before issuing his forecast? Is his weather model really that bad?

So it is with the government economists who continue to issue sunny reports about the burden of U.S. corporate taxes in the face of glaring evidence to the contrary.

The latest of these sunny forecasts comes from the Congressional Budget Office (CBO), which reports that the "average corporate tax rate" was 16 percent last year, up from 13 percent in 2011 and 15 percent in 2012. About the same time, however, Bloomberg reported that since 2012, at least 13 companies have engaged in a form of self-help tax reform by re-incorporating in low-tax countries like Ireland.

So what's reality here? Why would companies such as chipmaker Applied Materials move their headquarters to another country if the corporate tax burden is that low? After all, compared to the 35 percent statutory federal corporate tax rate-the highest in the developed world-paying a 16 percent effective rate after deductions sounds like a pretty good deal.

It turns out that the economists at CBO and a number of government agencies-such as the Government Accountability Office (GAO), the Congressional Research Service, and the White House-are all vastly understating the actual burden of corporate taxes in the U.S. And they are doing so either because of faulty methodology, bad models, bias, or simply because they have not looked out the window at what is really going on outside.

For example, the Government Accountability Office (GAO) also says that the U.S. corporate effective tax rate is low - about 13 percent, or they did until criticism from the Tax Foundation and Drew Lyon of PWC led them to revise upward their estimate to 23 percent. Their mistake was failing to properly account for foreign taxes and foreign income, which is a growing share of income for U.S. based multinational corporations. The GAO also failed to properly adjust for net operating losses carried forward from the financial crisis and other timing issues.

The CBO understated the corporate effective tax rate by using an inflated profit measure that includes S corporations even though they are not subject to corporate tax. That is, they divided C corporation tax collections by the combined profits of C and S corporations. But S corporations are pass-through entities, meaning profits are passed through to owners who report the income on their individual tax returns. S corporations have grown to be about 30 percent of the profit measure used by CBO.

Excluding the S corporation data means the real C corporation effective tax rate is about 50 percent higher than CBO's estimate. The most recent data from the IRS (tax year 2010) on C corporations confirms this, indicating that the effective C corporation tax rate is about 21 or 22 percent (which is lower than usual due mainly to temporary bonus depreciation).

Because of the growth of S corporations and other pass-through businesses, more business income is taxed under the individual code than the corporate code. Indeed, there are fewer C corporations today than at any time since the 1970s. It is clear that millions of businesses have fled the corporate tax code, even though government economists say corporate effective tax rates are low.

The CBO and GAO are not the only ones to get this measurement wrong. President Obama claims to want a lower corporate tax rate, but in a major policy paper from 2012 the White House understated the U.S. corporate effective tax rate and overstated effective tax rates in other countries. The report, jointly published by the White House and Treasury Department and titled "The President's Framework for Business Tax Reform," claims that the U.S. corporate "effective marginal tax rate" for 2011 was below average for G-7 countries - lower than the rate in Canada, the U.K. and Japan.

However, the Tax Foundation recently published an analysis by Jack Mintz and Duanjie Chen of the University of Calgary showing that the White House achieved this ranking by misrepresenting property taxes and failing to account for sales taxes on capital goods. Mintz and Chen publish an annual ranking of corporate marginal effective tax rates (METR) for 90 countries. Since 2007, the U.S. has had the highest METR in the developed world, and now is only surpassed by a few third-world countries in Africa.

This is similar to the findings of Michael Devereux and other researchers at Oxford University, who find that the U.S. has the highest effective rates in the developed world after Japan, and this is before Japan started cutting their corporate tax rate in 2012.

Finally, last month the Congressional Research Service (CRS) issued a report claiming the U.S. corporate effective tax rate is "about the same" as the average among developed countries, when the average is weighted by each country's GDP. This is based on a selection of studies, many of which were done prior to the major corporate tax reforms that have occurred over the last 10 years in countries such as Canada, the U.K., Germany and Japan.

The most recent studies show the U.S. has nearly the highest effective corporate tax rate in the developed world. For instance, the World Bank's latest Paying Taxes report finds the U.S. has an effective tax rate on profits of 28 percent - higher than any developed country except New Zealand.

Another recent report, soon to be published by the National Bureau of Economic Research, is by accounting professors Douglas Shackelford and Kevin Markle, who use the financial statements of thousands of corporations to conclude that the U.S. corporate effective tax rate is 28 percent - higher than any developed country except Japan. Again, this is for tax year 2011, before Japan began cutting their corporate tax rate in 2012.

There is a clear pattern of government economists misreporting the basic facts on corporate taxes and understating the U.S. corporate tax burden relative to that in other countries. Whether this is by intent or incompetence, the result is that these "official estimates" have made it appear that the U.S. tax code is more competitive than it is, greatly undermining the case for corporate tax reform. It is time for these taxpayer-supported economists to either bring their methods up to international standards, or stick their heads out of the window and see for themselves how dreary the U.S. corporate tax climate really is.​


William McBride is Chief Economist at the Tax Foundation. 

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