With Tax Reform, Save the Forest Rather Than Cut Down Trees

Published in RealClearMarkets

Despite statements by the Trump administration and congressional leadership about their intention to reform the U.S. tax code this year, many in the policy world believe that the road to the finish line won’t be an easy one. But at least we’ve reached the starting point as the House Ways and Means Committee holds its first tax reform hearing tomorrow.

Hopefully this is a sign of movement towards a productive tax reform conversation as up to now, the positive tone of the deliberations at the beginning of the year have turned into an unproductive discussion of the details rather than the big picture. Yes, details are important but updating our tax code, especially on the business side, is a task we need to accomplish if America wants to regain competitiveness with the rest of the world.

First, tax reform is an arduous process as competing interests vie for the ear of lawmakers and a new administration. Second, we stand at the precipice of actually passing substantive policy reform that will have an impact for decades to come. Thus, it’s even more important now to sort through the misleading noise surrounding the reform debate so that we keep our eyes on the prize: achieving comprehensive tax reform.

For example, earlier this year, a recent Institute on Taxation and Economic Policy report claimed that between 2008 and 2015, 100 out of the 258 profitable Fortune 500 companies paid no taxes for at least one of the years in that period. Companies named in the study called it “deeply flawed and misleading.” Their frustration is understandable.

Figure that the study was conducted using financial statements from the companies’ annual reports. There are many differences between “book” income, or income reported in financial statements, and taxable income, due to the differences between financial accounting rules and IRS rules. For example, there are timing differences between when a loss is recognized in financial statements versus in tax documents. Many corporations suffered large losses during the 2007-2009 recession, which continues to have tax ramifications. Tax policy changes can also create additional differences between financial statement and tax income.

But there is a bigger issue than potential methodological mistakes. The study tries to make a policy judgment based on a very small sample of U.S. companies. Corporate America is not made up of just 258 profitable companies. Even the report itself recognizes that some companies are paying higher taxes than their counterparts, like Deere and Company of Illinois paying 31 percent of its profits in U.S. corporate income taxes.

According to IRS data for 2013, there were close to 1.6 million corporations in the United States. We do not know the exact amount of taxes paid by each company, but we can rely on government and private calculations of effective tax rates paid by overall U.S. corporate businesses. A recent study by PricewaterhouseCoopers reviewed the ranks U.S. effective corporate tax rates against major competitors, including the European Union and OECD.

As the PwC study points out, the United States always ranks among the top four countries in terms of the highest effective corporate tax rate. According to the European Commission, in 2015 the U.S. had the second highest effective marginal tax rate among 35 countries, which included the European Union, Japan, Canada, and five other major economies.

The most recent government study, published by the Congressional Budget Office (CBO) in March 2017, also confirms the rank of the United States. Based on 2012 tax data, the CBO found that the United States had the highest statutory rate, third-highest average corporate tax rate, and fourth-highest effective corporate tax rate among the G20 countries.

Any tax reform package should center on lowering this rate to put it on par with our global competitors. Both tax reform plans put forth by the White House and the House Republican leadership have proposed just that.

For the first time in three decades, U.S. lawmakers have an opportunity to reform the tax code to foster GDP growth, boost wages and employment, attract greater foreign investment, and discourage inversions. To achieve these worthy economic goals, we need policymakers to focus on saving the forest instead of cutting down a few select trees.

Pinar Cebi Wilber, Ph.D., is chief economist at the American Council for Capital Formation, a non-profit, non-partisan organization advocating tax, energy and regulatory policies that facilitate saving and investment, economic growth and job creation.

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Dr. Pinar Cebi Wilber

Pınar Cebi Wilber’s research interests are diversified and include energy policy, tax policy, international trade and finance, and general government policy. Recently, Pınar has researched issues related to climate change legislation including the impact of such legislation on the U.S. economy. She has also done extensive research on the effect of government policies on retirement saving as well as the use of annuities in retirement.