David Cay Johnston

If President Barack Obama can persuade Congress to reduce the corporate income tax rate to 28 percent from 35 percent, he will move tax rates closer to what other modern countries charge.

But his plan to treat “manufacturing” as a special category, with a 25 percent tax rate, brings us to what I call Obama’s hamburger problem.

The problem is how to define manufacturing. To paraphrase Justice Potter Stewart on obscenity, I know manufacturing when I see it; I just don’t know how to define it in tax law.

Assembling automobiles is considered manufacturing. So what about assembling two hot protein discs with special sauce, lettuce, cheese, pickles, onions — all on a sesame seed bun?

The notion of hamburger-making as manufacturing may seem silly, a bit like the 1981 U.S. Agriculture Departmentproposal to classify ketchup as a vegetable for school lunches. But classifying activities as manufacturing or not becomes crucial if manufacturers pay taxes at a reduced rate.

Imagine all the high-paying jobs Obama’s plan would create. Companies of all kinds will want to hire more tax accountants and lawyers making the case their client’s business activity is manufacturing. These are not the sort of additional jobs America needs.

There could also be more work for economists, engineers and historians whose expertise would be tapped for creative ways to expand the definition of manufacturing. We have the prototype for the reduced manufacturer’s tax rate in the Domestic Production Activities Deduction, a law implemented in 2005 which comes with a plethora of complex eligibility rules that already create more work for tax professionals.

DRAG ON ECONOMY

Scrutinizing tax returns to determine what is and is not manufacturing would further require a diversion of IRS auditors, lawyers and specialists from the more important job of hunting for calculated tax evaders. Inevitably there would be litigation aplenty, a boon to trial lawyers but a drag on the economy.

Building an automobile obviously involves manufacturing. Rocks must be refined to turn their useful elements into steel and aluminum. Much of the added value will be in the engine and transmission, where steels made with special alloys must be heat-treated and machined to endure enormous, and rapid, twisting forces. Increasingly cars are built with plastics, sophisticated chemical compounds that must be created from base materials and then molded or extruded.

But should mere assembly of an automobile qualify as manufacturing? Does fitting the already manufactured pieces together qualify as manufacturing? And what if the parts were all manufactured in, say, Japan while the only activity in the United States was assembling them into a whole?

Would tax law define manufacturing as the process of making a car as a whole? Or would companies lobby for laws that break it into parts with profits earned at different stages of production taxed at different rates? Would that, in turn, mean accounting practices that load costs onto one stage of production to take profits at the 25 percent rate and losses, such as an assembly line, at the 28 percent rate?

Imagine a car company that reports a $200 million profit to shareholders. Now imagine that it reports a $300 million manufacturing profit taxed at 25 percent and a $100 million assembly line loss at the 28 percent general corporate rate. The company’s profit would still be $200 million, but its blended tax rate would be just 23.5 percent.

Hamburgers may seem like pure assembly, but a case can be made that they are more like manufacturing than assembling a car from finished parts made overseas.

Your local hamburger joint starts with raw meat, fresh or frozen. If it comes in lumps then someone must make the meat into uniform discs or squares. Then the protein must be fried, grilled or broiled. Only then can the meat, lettuce and whatnot be assembled.

Eight years ago the Bush administration used this very example to warn about the unintended consequences of tax incentives for manufacturing.

The 2004 Economic Report of the President asked, “when a fast-food restaurant sells a hamburger, for example, is it providing a ‘service’ or is it combining inputs to ‘manufacture’ a product?”

The comment, put in a box on its own page to draw attention to the issue, also noted that “sometimes, seemingly subtle differences can determine whether an industry is classified as manufacturing. For example, mixing water and concentrate to produce soft drinks is classified as manufacturing. However, if that activity is performed at a snack bar, it is considered a service.”

Taxing different corporate activities at different rates is a bad idea unless you think we need more national income spent on gaming the tax system. Let’s not go there.

PHOTO: Russia’s President Dmitry Medvedev (2nd  L) and U.S. President Barack Obama (R) eat their hamburgers during lunch at Ray’s Hell Burger in Arlington, Virginia, June 24, 2010.     REUTERS/Kevin Lamarque

With President Barack Obama and leaders in both parties favoring lower corporate tax rates, Washington seems poised to enact change next year. They need only resolve details like how much the rates should be cut, which tax avoidance strategies should be barred and whether to give manufactures a discounted rate.

If the corporate tax rate is cut, should the rates for dividends and long-term capital gains be increased?

That issue was inadvertently put on the table by a leading free market organization, the American Enterprise Institute. The AEI, as part of its support for cutting the corporate tax, promoted the idea last month that workers, not investors, bear the burden of that tax. In taking that line, however, the AEI has undercut its own argument for tax relief for investors. Indeed, it shifts the debate toward higher taxes on capital gains and dividends and lower taxes on wages.

We’ll follow that logic later. But first, who bears the burden of the corporate tax? Is it the owners of a corporation, through a lower return on their investments, or is it workers, through lower wages? This question is endlessly debated by economists.

Many people assume corporations just pass the corporate tax on to consumers through higher prices. This is true for monopolies, such as corporate-owned electric utilities, whose prices are set by governments. But it is not true in a competitive market.

The idea that owners bear the tax burden took hold after economist Arnold Harberger wrote a 1962 paper that quickly became a classic of tax economics. I studied his work in more than one economics course in the late 1960s and into the mid-1970s.

When that paper was written, the United States dominated industrial production, the legacy of the devastation of World War Two on the economies of Japan and Europe. As global manufacturing increased, Harberger, who taught at the University of Chicago, refined his theory. In later works, Harberger wrote that while the corporate tax burden falls on owners in a closed economy, in a global economy, where capital flows freely, the burden shifts toward workers, who cannot move so easily.

TAXES & THE MIDDLE CLASS

AEI economist Aparna Mathur makes this case in the current issue of the organization’s online magazine, in a piece headlined “How Taxing the Rich Harms the Middle Class.”

“Workers bear a large portion of the burden” of the corporate income tax, Mathur told me. She suggested that half or more of the cost falls on workers, and perhaps all of it.

Her views, to which AEI drew my attention amid the debate on cutting the corporate tax, grow from research between 2006 and 2010 by Mathur and Kevin Hassett, AEI’s director of economic policy studies. In their latest paper they looked at official data on manufacturing wages from 65 countries. They concluded that higher corporate income tax rates depress wages.

Mathur noted that if capital stocks are depleted, because taxation encourages new investment to shift to lower tax countries, the result must be falling wages. In this she and Hassett rely on economic theory going back at least to Adam Smith.

On the face of it, the AEI argument suggests workers should be joining the calls for Congress to cut corporate income tax rates. But, if the argument is correct, then workers should also be calling for cuts in their own income taxes and an end to reduced rates on dividends and capital gains.

Here’s why. Investors often complain they are taxed twice on their profits: once through the corporate income tax and again through taxes on their dividends and capital gains.

But if the AEI’s argument is correct — that workers bear the burden of the corporate income tax – then investor complaints that they are taxed twice are false. Under the AEI argument, it is workers who are taxed twice: first through lower wages due to the corporate tax and then through levies on their wages, however low they may be.

Double taxation of investor returns was the logic used to justify the capital gains tax cuts in 1997 under President Bill Clinton and in 2003 under President George W. Bush, who also included dividends.

Without double taxation of corporate profits, that justification evaporates. Workers can now use AEI’s arguments to bolster their arguments for higher pay and lower taxes. I put this to Mathur of the AEI, who agreed that it is reasonable to conclude that double taxation is falling on workers. But, she said, lowering taxes on workers would not encourage investment.

Let’s debate this thoroughly before Congress changes the corporate income tax again, lest more relief go to those who do not deserve it at the expense of those who do.

Congress will spend a trillion dollars more than it levies this year, so how do Washington’s politicians respond to the 11th consecutive year of federal budgets in red ink? They plan to shrink the IRS.

Go figure. Cutting the IRS budget by more than 5 percent in real terms makes as much sense as a hospital firing surgeons or a car dealer laying off salespeople when customers fill the showroom.

Shrinking the IRS makes sense if you believe government is too big and that cutting everywhere is the best way to shrink government. But this is the staff that generates revenue, and there is easy money to be made.

Congress should listen to the national taxpayer advocate, a position it created to make sure taxpayers had a voice in how the IRS operates. In her annual report, released last week, advocate Nina Olson said Congress needed to “ensure that the IRS continues to be effective, either by reducing the IRS’ workload or by providing adequate funding to enable it to accomplish its assigned mission.”

Instead of cutting, we should be expanding the revenue-generating staff because there is plenty of tax money to be had, even in this awful economy.

IRS data show that auditors assigned to the 14,000 or so largest corporations found $9,354 of additional tax owed for every hour spent testing tax returns in the 2009 fiscal year. The highest-paid IRS auditors make $71 an hour. Based on a 2,080-hour work year, that works out to around $19 million of lost revenue annually for every senior corporate auditor position cut from the payroll.

WHY CUT?

It makes no economic sense to trim the ranks of auditors who generate more than a hundred times their annual salaries. Run a business that way and you go broke.

So why would President Barack Obama and Congress cut the IRS budget? Their actions illuminate the rise of corporate power and values, and the diminishing voice of Joe Sixpack, thanks partly to how we finance election campaigns. Then there is the growing army of corporate lobbyists and the Supreme Court’s decision in Citizens United, which allows corporations (and unions) to spend all they can afford on influencing elections.

Keep in mind the IRS costs just a half penny for each dollar of tax collected. Its proposed $11.8 billion budget would be less than the Agriculture Department spends each month.

If the IRS budget is cut, the losers will be workers and ordinary investors, who will find it harder to get their questions answered and their problems resolved by the agency. On the whole, these people do not cheat on their taxes because their incomes are easily checked — through reports by employers, mortgage banks and others. Under a law taking effect in stages between last year and next, brokerages must report the cost basis of securities. This change will reduce capital gains cheating.

TAX CHEATS

The winners will be tax cheats among sole proprietors and other business owners, who are subject to less verification. The latest IRS tax gap report, issued Jan. 6, estimates that just one percent of wages escapes tax, while 56 percent of “amounts subject to little or no” verification do so.

America’s biggest corporations, those with more than $250 million in assets, also may escape some tax if the IRS budget is cut. These nearly 14,000 companies pay about 86 percent of corporate income taxes.

Audits of these big firms were down even without a budget cut. And audits have become far more complicated, partly because Congress changed the tax code more than once a day on average from 2001 through 2010, Olson reported.

From 2005 to 2009, hours spent auditing the biggest corporations declined by 33 percent, according to IRS records analyzed by the Transactional Records Access Clearinghouse at Syracuse University in New York.

Two decades ago, when the economy was a third smaller, the IRS staff numbered about 118,000. Now it numbers 95,000 and is on the way to about 90,000. The likelihood of a big company being audited has plummeted 50 percentage points from 72 percent in 1990 to 22 percent in 2010.

Big company audits are now limited to specific issues known to the companies in advance, not unlike when cops tip off owners of favored gambling dens before a raid. Each audit also begins with an “estimated time to completion.” Working auditors tell me this is really a hard deadline that allows companies to run out the clock with delays in producing documents.

Some IRS tax detectives privately ridicule this system, calling it “audit lite.”

Whether you like the corporate income tax or think it is an abomination, failing to enforce it with the same rigor as taxes on wage earners and most investors is indefensible on economic, budget deficit and moral grounds.

IRS budget cuts worsen budget deficits and send a corrosive signal that only chumps file honest tax returns. So you have a choice. Do nothing and suffer the consequences or call your congressman, senators and the White House — today — and then vote in politicians who support, rather than undermine, tax law enforcement.

By David Cay Johnston

The views expressed are his own.

Some of the biggest companies in the United States have been firing workers and in some cases lobbying for rules that depress wages at the very time that jobs are needed, pay is low, and the federal budget suffers from a lack of revenue.

Last month Citizens for Tax Justice and an affiliate issued “Corporate Taxpayers and Corporate Tax Dodgers 2008-10″. It showed that 30 brand-name companies paid a federal income tax rate of minus 6.7 percent on $160 billion of profit from 2008 through 2010 compared to a going corporate tax rate of 35 percent. All but one of those 30 companies reported lobbying expenses in Washington.

Another report, by Public Campaign, shows that 29 of those companies spent nearly half a billion dollars over those three years lobbying in Washington for laws and rules that favor their interests. Only Atmos Energy, the 30th company, reported no lobbying.

Public Campaign replaced Atmos with Federal Express, the package delivery company that paid a smidgen of tax — $37 million, or less than one percent of the $4.2 billion in profit it reported in 2008 through 2010.

For the amount spent lobbying, the companies could have hired 3,100 people at $50,000 for wages and benefits to do productive work.

The report – “For Hire: Lobbyists or the 99 percent” – says that while shedding jobs, the 30 companies are “spending millions of dollars on Washington lobbyists to stave off higher taxes or regulations.”

These and other companies have access to lawmakers and regulators that are unavailable to ordinary Americans.

CALL CONGRESS

Doubt that? Dial the Capitol switchboard at 1 (202) 224-3121, ask for your representative’s office and request a five-minute audience, in person, at the lawmaker’s convenience back in the home district.

In more than a decade of lectures recommending this, I have yet to have a single person email me (see address to the right) about having scored a private meeting with the representative called.

Corporations have vast resources to pour into ensuring access — resources that expand when little or no taxes are paid on profits thanks to rules they previously lobbied into law.

Companies form nonprofit trade associations, hire former lawmakers and agency staffers, and have jobs to dole out to lawmakers after they leave office and to friends and family while they’re in office. Thanks to the Supreme Court’s Citizens United decision, corporations can now pour unlimited sums into influencing elections. So can unions, but they are financial pipsqueaks compared to companies.

Then there are political action committees, or PACs, to finance campaigns as well as donations by executives and major shareholders.

Combine all this and you have a powerful formula for making rules that favor corporate interests over human interests, something that the framers of the U.S. Constitution understood more than two centuries ago.

James Madison wrote disapprovingly in 1792 of “a government operating by corrupt influence, substituting the motive of private interest in place of public duty” where eventually “the terror of the sword, may support a real domination of the few, under an apparent liberty of the many.”

FEARS COME TRUE

The late U.S. president’s fears have come to life. For swords, just substitute police with rubber bullets, batons and pepper spray at Occupy demonstrations, including perfectly peaceful ones.

Company reports to shareholders show that among the 30 companies in the Public Campaign report, the 10 firms that spent the most on lobbying during the same three-year period fired more than 93,000 American workers.

Those firings took place in an economy that had five million fewer people with any work in 2010 than in 2008.

All those firings mean higher costs to taxpayers to support those unable to find work, including the more than 4.2 million Americans who are now persevering by applying for jobs after more than a year. Millions more have given up and are no longer counted among the unemployed.

Federal Express spent $25 million lobbying to protect a rule that makes it virtually impossible for its express delivery workers to unionize. That’s 67 percent of what it paid in taxes.

FedEx says it was “educating lawmakers” about a proposal “that would cripple competition in the express delivery industry and hinder our nation’s future economic success.”

The Teamsters, who represent drivers at United Parcel Service, say FedEx was protecting a special interest rule that shorts workers. UPS pays its unionized drivers 53 percent to 104 percent more per hour than FedEx does.

The United States already ranks second among modern nations, just behind South Korea, in the share of its workers in low-wage jobs while too many companies lobby for ever lower taxes, ever smaller wages and ever fewer worker rights to protect the mighty torrents of greenbacks flowing into their coffers. A better balance would make America better off.

PHOTO: Occupy DC movement protesters rally outside the U.S.  Capitol in Washington December 8, 2011. REUTERS/Yuri Gripas

By David Cay Johnston

The views expressed are his own.

In nearly all 34 countries with modern economies, inequality is rising, a new study by the Organization for Economic Cooperation and Development shows. The gap is especially pronounced in the United States where the country’s largest program to alleviate poverty may be adding to the problem, not alleviating it.

The United States ranks fourth in income inequality after Chile, Mexico and Turkey. In the U.S. the best-off 10 percent make on average 15 times the incomes of the poorest 10th, compared to a six to one ratio in the Nordic countries, Austria, Hungary and Switzerland.

The OECD report, published on Monday, cites the U.S. earned income tax credit as an explanation for a sharp increase in the hours worked by low-wage Americans.

The tax credit, the largest U.S. program to alleviate poverty, is meant to be an incentive to work, but it may also contribute to poverty, effectively holding down wages of all low-skilled workers. Now how is that?

Imagine that more people whose skills limit them to low-paid work decide to work more hours so they can get the credit. Add in people who have the skills for better-paid work but cannot find it and so take lower-paid jobs because of the implicit supplement to their wages provided by the earned income tax credit.

The result is more workers seeking more work, allowing employers to hold back wage increases or even reduce wages because of the enlarged supply of labor. The employers benefit. The American median wage, in 2011 dollars, has hovered at just above $500 per week for more than a decade.

Add in the elimination of America’s largest welfare program 15 years ago, Aid to Families with Dependent Children, and the labor market is flooded with single mothers with few job skills. This not only holds down their pay, it also tends to depress the wages of all low-skilled workers.

DECENT LIFE UNAFFORDABLE

A pernicious problem in America is people who work but whose wages are too low for them to afford a decent life.

One in four Americans earns low wages — less than $11 an hour. Among modern countries only South Korea has a larger share of its workers in low-wage jobs and then only by a smidgen, according to a new study by John Schmitt of the Center for Economic and Policy Research, a liberal leaning economics policy organization in Washington.

Schmitt’s work shows that the share of American workers earning less than two-thirds of the median wage has been slowly increasing since 1980, a trend that also goes to the decline of unions due to anti-worker laws enacted by Congress.

The problem is not indolence, the OECD report shows.

America’s lowest paid workers, the bottom fifth, are working far more than they once did. In 1986 they put in 1,030 hours, a bit more than half time. By 2004 they were up to 1,300 hours. That is an increase of 26 percent.

Significantly, in almost every other country in the OECD study, hours worked by the poor fell.

DEPRESSED WAGES

The data indeed show that the flood of low-income workers, especially single mothers, is depressing the wages of all low-skill workers. One of four Americans with a job earns less than $15,000 and average income is less than half that.

Research by Professor Bruce Meyer of the University of Chicago Harris School of Public Policies shows that the largest increase in low-wage work was among single mothers with three or more children. In place of AFDC, as it was known, Congress in 1996 adopted Temporary Assistance to Needy Families with a maximum of 60 months of assistance.

Providing day care for children or poor working mothers has become a growing subsidy expense borne heavily by federal and state governments. In many cases the cost of child care, especially when a single mother has two or more children, exceeds what she can earn even working fulltime.

The earned income tax credit has grown rapidly and now benefits 26 million low-income individuals and families, primarily single parent households. The annual cost is approaching $60 billion.

Milton Friedman, the Nobel prize-winning Chicago School economist, proposed what became the EITC, a form of negative income tax, to encourage people to work. He noted that many people on welfare faced marginal tax rates of more than 100 percent if they left the dole for low-wage jobs. President Ronald Reagan championed the EITC because it required people to work to get benefits.

The credit provides its greatest benefits to people making from about $10,000 to $14,000. Earn more and the credit falls off. Work 1,300 hours at $10 an hour and you are in the sweet spot to get the biggest tax credit. Work an extra week and benefits slip.

If the earned income tax credit, combined with the end of welfare as we knew it, hold down wages for low-skill workers then it is time to find smarter ways than Chicago School theories to reduce poverty for those who work.

By David Cay Johnston

The opinions expressed are his own.

Slyly encouraged by President Barack Obama, Republicans have painted themselves into a tax corner.

Who would have imagined a year ago, when Republicans rode the Tea Party’s anti-tax wave and retook the House of Representatives, that a year later Republicans would be forced to swallow a huge tax cut sponsored by Obama?

The irony is that Obama’s payroll tax cut could have been taken over by the Republicans as their issue, but they flubbed it.

The payroll tax cut, which bestows the most savings on highly-paid workers, resulted from the refusal by Republicans, after they won control of the House in 2010, to extend the Making Work Pay tax credit.

The Making Work Pay tax credit’s benefits went heavily to the working poor, the disabled, and retirees while in effect in 2009 and 2010.

In September, Obama asked Congress to cut the payroll tax rate even further. Obama wants the 6.2 percent Social Security wage tax slashed in half, saving $1,550 for workers making $50,000. He also wants to cut the employer side of the tax in a way that favors small business.

Republicans quickly rejected the proposals to expand the cut, which is how they started painting themselves into a corner both with workers and with small business owners.

REPUBLICANS AT RISK

With the collapse of the doomed-before-it-began super committee, the Republicans suddenly were at risk that the payroll tax rate would rise automatically in January, allowing the Democrats to portray Republicans as the party of tax hikes for working people and tax cuts for billionaires.

In recent days House Republicans have signaled that they will support extension of the reduced payroll tax rate, but grudgingly. Tea Party House Republicans continue to oppose the payroll tax cut extension so it is not certain the payroll tax cut will be extended, though that would certainly damage the Republican tax-cut brand.

Congressional Republicans, most of whom have signed the no-tax-hike pledge of lobbyist Grover Norquist, have made no secret of wanting tax cuts at the top. Some want to end the corporate income tax and to slash or eliminate taxes on capital gains, dividends, rents, interest and some royalties.

But numerous opinion polls show overwhelming public support for continuing tax cuts for workers and for raising taxes on millionaires. That has left Republican leaders no choice but to silently cry uncle and agree to the president’s request to extend and possibly expand the payroll tax cut.

Having outsmarted Norquist, Obama gets to run for a second term as the champion of at least a $100 billion tax cut. Obama can even say that if Republicans had had their way, working people’s taxes would have gone up while taxes on billionaires would have gone down. And he gets to tell small business owners that, but for Republicans, their taxes would have gone down too.

This is a marketing fiasco for Republicans to rival the Ford Edsel and New Coke. Already more than 40 congressional Republicans have taken steps to distance themselves from Norquist, who scowls at the mere mention of what could have been his, but is now Obama’s, very popular tax cut.

REGRESSIVE FEATURES

The Republicans will have a harder time tarnishing Obama as a progressive because they insisted on killing his Making Work Pay tax credit.

The payroll tax cut that they ultimately accept would have some of the defining features of the 2001 and 2003 Bush tax cuts — almost everyone who paid taxes got a break, but most people got very little while huge savings flowed to the top. Just one in a thousand taxpayers got 12.5 percent of the savings.

In the same vein, Obama’s payroll tax cut benefits everyone who has a job, but most workers get a pittance. The lowest paid 38 million Americans, the one in four workers who earn less than $10,000 a year, will save on average less than $80 each. Only 45 percent of the savings go to 75 percent of workers, those making under $50,000. But the top 4.8 percent get 16.3 percent of the tax savings, my analysis of the plan shows.

Applying the expected 2012 payroll tax rules to the latest wage data, from 2010, two-income professional couples who each make more than $110,100 would save $4,404 next year. That looks to be about two million households.

These high-income couples were denied Obama’s Making Work Pay credit in 2009 and 2010. That tax cut, which polls indicate hardly anyone knew about, was heavily weighted to benefit the lowest income workers. Everyone except the top 3 percent or so got the $400 tax break.

The switch from the Making Work Pay tax break to the reduction in the payroll tax effectively raised taxes on 51 million households, the Tax Policy Center estimated, by an average of $134 each.

Raising taxes on a third of American workers poses a problem for Republicans who want to be known as the party that never raises taxes — but only if voters know what Republicans did.

Norquist tries to explain this away by saying his pledge does not apply to temporary tax cuts. However, Norquist takes the opposite approach when he talks about the Bush tax cuts, which he says were intended to be permanent, even though Republicans did not make them so when they controlled Congress and the White House from 2003 through 2006.

In this and other ways Norquist damages the brand he created, muddying it with inconsistencies and dubious caveats few voters will grasp.

He and his followers are now stuck in the corner into which they thoughtlessly painted themselves — at least until the political paint dries in November of next year.

PHOTO: White House Press Secretary Jay Carney looks at a countdown clock counting the days until the payroll tax cut expires, in the briefing room of the White House in Washington December 5, 2011. REUTERS/Joshua Roberts