IE 11 is not supported. For an optimal experience visit our site on another browser.

Corporate tax battle enters fiscal cliff fracas

If you’re enjoying the name-calling and political hair-pulling in the debate over raising the tax burden on wealthy individuals, you’re going to love the coming battle over reforming the corporate tax code.

“It's not going to be easy, it’s not going to be fun and it's going to be as bloody probably as the fiscal cliff charade,” Caterpillar CEO Douglas Oberhelman told CNBC. “But it has to be done.”

Business leaders this week stepped up pressure to include an overhaul of corporate taxes as part of the broad budget battle unfolding in Washington. On Wednesday, the Business Roundtable, a non-partisan group of U.S. chief executives, implored in a full-page ad in national newspapers that "it's time to act." Agreeing to a broad package of increased revenues and entitlement reforms, the CEOs urged, would give them the confidence to "invest in new factories, equipment and employees."   

NBC/WSJ poll: Public wants compromise to avoid fiscal cliff

American corporations have never been shy about asking Congress to make changes in the U.S. tax code. After decades of lobbying, they've succeeded in larding the law with a thicket of exemptions, deductions, exclusions and other givebacks. 

It’s tempting to think that closing just some of those loopholes would make a big dent in the federal budget deficit. But even if fiscal cliff negotiators agreed to eliminate every dollar of corporate tax breaks, the amount “saved” would cover about 15 cents of every deficit dollar.

“It’s negligible,” said Scott Hodge, president of the Tax Foundation, which supports deep cuts in corporate taxes. “There’s about $1.1 trillion worth of so-called tax expenditures in the tax code and about $900 billion of that is for individuals.”

The biggest obstacle to tax reform? You are

Still, American corporations love their tax breaks. Among the world’s advanced economies, the U.S. has the highest tax rate on corporations – the starting point in calculating how much they owe Uncle Sam every year. But by the time American companies have subtracted a long list of deductions from their tax bill, the average effective tax rate is more like 27 percent.

In relation to the size of the U.S. economy, however, American corporations pay the among the smallest tax burden in the developed world. And corporations have been paying a shrinking share of the total tax burden for decades. Corporate tax receipts are less than 2 percent of gross domestic product, down from a peak of 6 percent in 1950.

That shrunken share is, in part, an illusion. Beginning in the late 1980s, following a major overhaul of the tax code, many businesses changed their legal status to take advantage of individual tax rates. 

These so-called “pass through” companies (so-called because they pass through their taxable income to owners or partners) now make up more than 90 percent of all business tax returns – and as much as half of all business taxes paid.

The average corporate tax rate also masks a wide variation in what different companies pay. Some, for example, pay no tax at all, according to a study last year by Citizens for Tax Justice. That big disparity is one reason proponents of corporate tax overhaul think it’s time to blow up the existing code and start over again.

“In the negotiation to start this, you have to start from zero because everybody is going to have their pet deduction, their pet credit, whatever it is,” said Caterpillar's Oberhelman. “But let's all agree we start from zero, whatever that tax rate is, and go from there.”

Though there are dozens of industry-specific provisions in the code, very little of the total cost of these tax breaks – about 8 percent – goes to specific industries. Tired of those giveaways to the oil and gas industry? Eliminating them would save just $2 billion, or about one-tenth of one percent of the $1.3 trillion deficit.

Some of those targeted tax breaks turn out to have unintended consequences. A tax break for manufacturers that make their products in the U.S. sounds like a good idea in theory. But in practice, it doesn’t always produce the incentives it was designed to create.

“If you’re McDonalds and grind hamburger for your own purposes, you can’t take the manufacturing deduction,” said Hodge. “But if you’re some other company and you grind hamburger to sell to McDonald's, you can. It’s insane.”

Most corporate tax breaks – about two-thirds of the total in dollar terms – are available to all companies. One of the most popular allows companies to write off the cost of buying new equipment. It’s not likely to be cut or reduced, especially until the economy shows more convincing signs of strength.

“The locomotive that pulls our economy is investment in equipment and software,” said FedEx CEO Fred Smith. "It's our reduced level of capital investment that's produced our low GDP growth rates and our high unemployment."

Investment by business has rebounded since the end of the 2007 recession, in part because of a provision in the 2009 stimulus package that provided more generous tax breaks for purchases of new plants, equipment and software. But that capital investment is still some 13 percent below the peak in the second quarter of 2007. The expiration of those temporary tax breaks next year could slow the pace of investments, adding further drag on economic growth.

The goal of overhauling U.S. corporate taxes is to eliminate the thicket of tax breaks to lower the top tax rate for all companies, making them more competitive around the world. But proponents of deeper cuts argue that the burden of corporate taxes ultimately falls on American taxpayers and consumers.

“If the price of fuel goes up, companies generally don’t eat that cost,” said Hodge. “It’s passed through to consumers through higher prices, or they have to lay off workers to afford those higher costs, or shareholders get less through dividends because profits are less. Same goes for taxes.”