The US government has a corporate tax problem of epic proportions. On a statutory basis, America has the highest corporate tax rate on income in the developed world. Theoretically, 35% of the worldwide income of US based corporations is to be paid as federal income tax, after deducting for foreign taxes, other credits and preferences such as depreciation. State and local taxes can bring the theoretical tax rate to over 40% of income.
In a recent report commissioned by Senators Carl Levin (D-Mich.) and Tom Coburn (R.-Okla.), the GAO looked at taxes paid by profitable U.S. corporations with at least $10 million in assets. Even when foreign, state and local taxes were taken into account, the companies paid only 16.9% of their worldwide income in taxes in 2010. So how is it possible that almost 25% of all corporate profits are not being paid as taxes?
Unlike other countries that tax only corporate profits made within its borders, the US taxes worldwide corporate income but then allows companies to postpone the payment of income tax on profits that remain abroad. As a result, many large companies simply do not repatriate most of their profits or shift income to subsidiary entities abroad. The American worldwide income tax regime perversely encourages corporations not only not to bring their profits home. It also discourages them from investing those profits in the US, where the profits on future investments will be subject to continuing high tax rates. If those companies build new factories in foreign low tax countries, future profits will not be subject to taxes.
The solution to the lack of corporate profit collections is to revise the US tax code to have a lower rate on regional profits. But nothing is easy in Congress today. Bipartisan efforts at tax reform are dead in the water for this term, with Senator Majority Leader Harry Reid stating that any reform he permits to come to the senate floor for a vote must include higher revenues in exchange for lower rates; a non starter for Republicans.
So what is the US government supposed to do to end a Mexican standoff with corporations that refuse to gratuitously pay taxes they can easily avoid? Diogenes believes that Congress should enact a one time only tax holiday in 2013 on corporate profits held abroad that are paid out as dividends in excess of 105% of those paid out in 2012. In other words, pay no corporate taxes on marginal increases in dividends paid out.
The profits repatriation dividend would:
- stimulate the economy
- increase the total amount of taxes paid
- discourage corporations from moving more investments abroad
There is about $1.9 trillion held abroad as unrepatriated profits. The overwhelming bulk of those funds are held abroad to delay/defer the payment of US taxes rather than for operational needs. Let’s assume that $1.5 trillion would be returned to the US and paid out as dividends under the one time tax “holiday” being proposed. About 80% of American stocks are held individually by Americans or through mutual funds and retirement plans. Not all taxpayers are in the highest brackets paying 39.6% federal taxes, but they own stocks so presumably most are above median income levels, so let’s assume a 25% federal rate. This one time event would/could generate $1.5 T X 80% Individuals X 25 % tax rate = $300 billion. And $1.2 trillion would be left over for Americans to save or spend. It’s a “free” stimulus!
We give most small businesses the option to file as LLCs or Subchapter S Corporations. These structures give liability limitation benefits to owners similar to those of larger corporations and still allow for a single level of taxation. Under the Diogenene proposal, we turn that policy inside out by offering the benefits of one level of taxation to companies that have already limited their liability.
In an ideal world, no tax regime should use one time gimmicks, but our tax code is dysfunctional. It does not raise taxes and it encourages our companies not to invest here. This proposal is not ideal, but it is better than other workable options right now. Perfection is the enemy of the good.