Corporate tax reform: California points the way

By Bill Parks
February 10, 2014

The arcane, outdated and inefficient U.S. corporate tax code is costing our country jobs, factories, industries and tens of billions of dollars of badly-needed tax revenue each year.

Our tax system is supposedly based on the idea that U.S. companies should pay taxes on all profits, no matter where they are earned. Yet this is undermined when companies are allowed to “defer” taxes on profits made in other countries until those funds are repatriated to the United States.

This loophole encourages multinational corporations to move production and intellectual property, such as patents and trademarks, out of the country. Or they juggle their books to make it appear that a major portion of their income is made outside the United States. Then they keep it abroad, expecting to persuade legislators to give them “tax holidays” that allow them to repatriate the funds with minimal tax consequences. (The last holiday in 2004 offered a 5.25 percent tax rate). This set of incentives has resulted in up to $2 trillion of profits staying out of the country to defer taxation. This amount grows every year.

Many across the political spectrum are calling for reform. The left emphasizes doing something about the lost revenue and jobs. The right wants rate reductions. What if there is one reform that gives the left and the right what they want, while also improving our international competitiveness?

California’s “sales-based” corporate income tax could be a model for this reform. Passed by 61 percent of voters in a November 2012 state referendum, Proposition 39 requires a “single sales factor” corporate income tax. Corporate tax collections are predicted to increase by about $700 million per year.

Prop 39 taxes every corporation that sells goods and services in the state — treating U.S. and foreign corporations the same. The state taxes a portion of each corporation’s U.S. earnings based on a simple percentage: total sales in California divided by total U.S. domestic sales. By basing the tax calculation on in-state sales, businesses can no longer use various schemes to make it appear that profits were earned out of state.

Calculating what every company owes with the single sales factor is simple and addresses the “what if’s” listed above. This is a big improvement over the devil’s bargain that allowed corporations to choose how they were taxed.

The U.S. tax system now requires authorities to keep track of where American companies run their operations and where they make their profits. Companies are taxed more if they operate in the United States — which encourages many to shift assets abroad. In addition, Washington lets companies defer taxes on profits from business outside the country, but allows them to write off expenses immediately.

If our federal tax code was amended along the lines of California’s Prop 39, we could stop this absurd money chase. Every multinational corporation (foreign and domestic) selling products and services in the United States would still want to sell in the world’s biggest consumer market. They would also continue to release accurate information about –domestic sales because they would want to reward shareholders with the returns from selling in the U.S. market. We would simply tax the percentage of their global profits represented by their U.S. sales.

Adapting the California tax system for the nation would make U.S. businesses competitive in global markets, without rewarding companies for moving production and assets abroad. It would also help smaller domestic firms compete with large multinationals that now pay little or no corporate taxes.

By no longer trying to tax companies based on whether they have U.S. operations and employees, we could eliminate some of the disincentives that our current tax system imposes on domestic manufacturing and employment. Jobs, factories and profit centers could return here. And we would bring in more tax revenue from foreign companies that sell in the United States, but now get a free ride.

By taxing foreign companies on the Toyotas or TVs they sell in the United States, a sales-based system would bring in more money from a broader base. Judging by Prop 39’s more than $1 billion in additional tax revenues, it is logical to conclude that increased revenues from a similar national system could make it possible to lower the overall corporate rate while still raising more funds for reducing the deficit and investing in the economy — giving liberals and conservatives something to cheer about.

Adapting California’s sales-based system for the nation would be a win for tax reformers on the left and right. Conservatives would get to limit taxes to profits on domestic sales instead of worldwide sales, and possibly at a lower rate. Liberals, though they would have to accept not taxing worldwide income, would not only see increased federal revenues, but could take satisfaction from forcing today’s notorious tax avoiders to pay their fair and proportionate share of corporate taxes.

It would also be a win for all Americans who want more revenue to invest in the country’s future, a win for corporations that want a simpler, less burdensome system to help make them more competitive in the global marketplace and a win for U.S. workers.

Even the companies that take advantage of today’s failing system would ultimately win, by sharing in the success of a stronger economy.

 

PHOTO (TOP): California Governor Jerry Brown gestures as he unveils his proposed 2014-15 state budget in Sacramento, California, January 9, 2014. REUTERS/Max Whittaker

PHOTO (INSERT 1): The five colors of the new iPhone 5C are seen after Apple Inc.’s media event in Cupertino, California, September 10, 2013. REUTERS/Stephen Lam

PHOTO (INSERT 2):A customer looks over Toyota automobiles at a dealership in Daly City, California, February 2, 2010.  REUTERS/Robert Galbraith

9 comments

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/

If you start or move a company to NY, you get ten years tax free. So how many small and medium corporations in CA will move to NY if they can? With this system I guess it wouldn’t matter as the sales in CA would be taxed the same? Hmmm…

Posted by tmc | Report as abusive

The simple answer is to reduce the corporate tax rate and also reduce the deductions. The corporations do this sort of thing because the US has among the highest corporate tax rate in the world.

Posted by stevedebi | Report as abusive

If corporate tax rates mattered, then Google would have located themselves in Bullnutz, Oklahoma instead of the Silicon Valley.

Fact is, What innovation wants is a supply of smart capable people (not anti-science bible whackos), infrastructure and proximity to good-looking women.

The coasts get the mosts, and the square states get the ghosts. Always was, and always will be. A good accountant can fix taxes on paper. You can’t fix creationist loonies.

Posted by AlkalineState | Report as abusive

The author omits that California currently taxes the bejezus out of any locally based company and is one of the most unfriendly states to do business in. (He also omits all the employee taxes that the company has to pay for example.)

It would be simpler, easier and more efficient just to eliminate corporate taxation altogther and tax the distributions to shareholders (non-domicile shareholders can be subject to a withholding tax). Amongst other things it would eliminate the elaborate and potentially dangerous financial engineering that goes one and this would make American companies much more competitive globally.

If the state wishes to impose a sales tax for revenue substitution then fine, but it should be a Value Added Tax system where input taxes are offset against sales tax collected.

Posted by LondonObserver | Report as abusive

Part of the problem is that here in America we have developed a bizarre tradition of letting companies keep two sets of books: A rosy one for investors (the glossy quarterly reports outlining the billions they are making)….. and then the tax forms, which paint a gloomy picture about how the company won’t even be able to afford gasoline to visit grandma in the hospital.

Why do we allow two sets of books? At least for publicly traded companies, we should be taxing based on what they report to shareholders. Forget the separate tax forms. Your corporate tax = 0.15 X reported revenues. If you can’t afford to pay that, then go out of business and your competitors will pay it.

Posted by AlkalineState | Report as abusive

You are dreaming or smoking something. The US congress is 100% certified fascist, the corporations run the show, and the continuing destruction of the country by capitalist fascists cannot be stopped. Soon there will be only shells of countries and shells of citizen rights, corporations are taking over the world and you will be known by whom you are employed not which country you were born in.

Posted by UScitizentoo | Report as abusive

First we do not have high business taxes. The nominal rate may be highest, but the effective rate is the lowest. This is why GE pays no taxes, as many other companies pay little taxes.

Low taxes and deregulation are not making any longer.

Business that have moved to red states like Texas, the republican model, are finding poor infrastructure, a poorly educated and trained work force. and a poor quality of life.

Posted by Flash1022 | Report as abusive

Whilst I believe in Progressive taxes when it comes to income and payroll taxes, when it comes to Corporate taxes, I think it should be as low as possible or 0%. Corporate taxes does increase costs and hinder investment.

E.g. If a company’s EBIT is $100m, and its taxes at 20%; that $20m could be set aside for enhancement of equipment and maintenance. In this same sense, Ad Valorem taxes are really horrible for the economy, middle class and lower class.

I do stress though, that this is absolutely not true when it comes to individuals. If tax money is needed, it is much better to tax a wealthy person who earns $100 million year 95%; than to tax 10 000 people who earn $10 000 a year 9.5%. Because they rich can survive with with $5million a year, the poor might not.

Posted by PreetSG | Report as abusive

@PreetSG, taxes increase my costs and hinder my investments. Corporations are “people too”, right?

Corporations enjoy ridiculously low/no tax burdens. Sure, they invest – in funds that make more money sitting in an tax-free investment account. If they use their profit, it’s to invest in Emerging Markets in other developing countries. They don’t invest in U.S. expansion. If they were, we would have a better economy.

If the tax laws were changed to provide significant tax breaks for creating full-time and part-time jobs in the U.S., the economy here would improve. Tighten the tax laws that make it more profitable to open up shop in other countries, and corporations will start moving jobs here.

I’m not suggesting we over tax companies, just that we adjust those tax breaks to “guide” their expansion behaviors back home.

Posted by JL4 | Report as abusive