The fix for corporate income tax

May 31, 2013

Apple CEO Tim Cook (C) , CFO Peter Oppenheimer (L) and head of tax operations Philip Bullock are sworn at a Senate hearing in Washington, May 21, 2013.  REUTERS/Jason Reed

“It’s not fair,” my younger son would rant when, as a 5-year-old, life did not go his way.

I resonated to my son’s childhood dyspepsia as I listened last week to Apple’s chief executive officer, Tim Cook, defend his company’s use of perfectly legal accounting tricks to insulate billions upon billions of dollars of profit from U.S. taxes. His description before Congress of the way Apple skips past a loophole-ridden corporate tax code violated my sense of fair play as well as my populist instinct to go after fat cats.

But now a few days have elapsed. My inner economist has regained control. Yes, the corporate tax code cries out for change. But the right change would involve as many pro-business carrots as it does anti-business sticks.

Here’s a ridiculously smart plan, developed by economists who think about this subject all the time, that would raise some corporate rates but lower others. On balance, the plan would leave us with a simpler tax code that cuts out corporate trickery and encourages new investment.

Message to inner populist: Chill.

Indeed, my inner economist recognizes that there’s a good case to be made for abolishing the corporate income tax entirely rather than wasting time trying to fix it one loophole at a time. For starters, the corporate tax is fiendishly complicated, inviting all manner of gaming. Yet it generates a relatively modest amount of money: Only about $250 billion a year, in contrast to the $2 trillion that individuals pay in taxes.

Just because a tax labeled “corporate” might be assumed to go after rich shareholders does not mean it does. Economists have never been sure who bears the burden of this tax: shareholders who are forced to accept less profit; consumers who pay higher prices for goods they buy from corporations; or corporate employees – workers – who get paid less. Tax specialists also disagree.

So what should we root for?

Abolishing the corporate income tax would require rewriting the entire U.S. tax code – a Herculean labor. Besides, abolishing the tax is politically unrealistic, particularly in the run-up to the 2014 elections.

There’s a better option than plugging loopholes piecemeal or abolishing corporate taxes.  Alan J. Auerbach, director of the Robert D. Burch Center for Tax Policy and Public Finance at the University of California at Berkeley, weaving his thoughts over several decades with those of colleagues across the country, has recently proposed a clever, realistic plan to simplify corporate taxes, improve the economic performance of the corporate sector (to our collective economic benefit) and raise about the same amount of money. That’s an impressive trifecta.

To see the beauty of the Auerbach plan, consider the current code’s three large failings.

First, the corporate code now taxes the profit on investments in new plant and equipment – thereby discouraging such investment. Yet new investment is the key to boosting economic output.

Second, the corporate code encourages corporations to take on excessive debt. Take the case of a corporation that needs to raise money to cover the cost of new investment. If it borrows the money from private lenders, the corporation deducts future interest payments on those loans from its taxable income. But if the business instead raises money by issuing shares of stock, it cannot deduct future dividend payments (the return to shareholders on the money they fork over to corporations).  Few economists applaud using the tax code to tilt corporations toward taking on more debt.

Third, the current code fails any test of simplicity and common sense. Apple is far from alone in attributing profit to operations in faraway countries that impose low tax rates – or even no countries at all. Apple pays a tax rate above 35 percent for profit attributed to its U.S. operations, but near zero if it (legally) structures its accounts so that profits appear on the books of its Irish operations. Apple just happens to be far smarter at tricky accounting. Few economists think taxes ought to be levied according to how creative a corporation’s bookkeeping operations can be.

The Auerbach plan has three important parts, none radical.

First, it proposes what economists call a cash-flow tax.  That change would permit corporations to expense investments – subtracting the full amount of an investment from taxable income as soon as the investment is made. Under current law, corporations can deduct the cost of investing in new plant and equipment only over time and in accordance with complicated equations. Expensing would eliminate about four quadrillion pages of complicated tax rules and commentaries – all of those equations – freeing lawyers and accountants to do something useful with their lives.

More important, expensing would, as a matter of arithmetic, insulate the profit on new investment from taxation. The point? By driving the tax on new investment to zero, the tax code would compel business to invest in more new plant and equipment, the primary driver behind rising economic productivity (and rising wages).

Second, the Auerbach plan would have corporations pay tax on money it borrows, eliminating the current code’s unfortunate subsidy for firms that take on debt.

Third, Auerbach’s plan would tax profit only from the sale of products in the United States. In other words, his corporate tax would ignore transactions that U.S. companies undertake overseas.

Let’s pause on this third step. It would eliminate tax-driven incentives for corporations to locate facilities in low-tax countries; physical location of production would then become irrelevant to tax computations. The only fact that matters for taxes is where the product is sold.

None of this plan’s major provisions is startlingly new. They’ve been proposed in one form or another by several economists, including Auerbach, over the years.

Under plausible assumptions, the Auerbach corporate tax code would collect about the same amount of money as the current code, yet it would increase investment and, thereby, leave the economy better off. Overall, the plan would not shift additional burden onto low-income families. Indeed, it would probably help them.

Our inner populism calls for hitting corporations hard. But simple economics warns that such instincts can easily backfire. Let’s root for a corporate code that’s simple. Let’s root for a system that collects an adequate amount of revenue. Let’s insist that any changes not burden low-income families. And let’s root for a code that promotes economic growth.

That’s a tall, tall order. But, courtesy of Auerbach, and other economists who’ve thought through the details, we now know that we can have it all.

PHOTO (Insert A): Apple Inc’s logo at its Apple store in Beijing, April 2, 2013. REUTERS/Kim Kyung-Hoon







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

Michael, one of the major reasons that Apple (and other technology and drug companies that profit immensely from the sale and licensing of their intellectual property) devises and perfects tax avoidance schemes like the “Double Irish” and the “Dutch sandwich” ( sh_arrangement) is that they can reduce to near-nothing the income of their American subsidiaries which create the IP, and increase to astronomic levels the income of their Irish and Dutch shell companies which license the IP back to their American owners.

I do not see a way in which Auerbach’s proposal, which only taxes US sales, will make a dent in this obvious tax-avoidance mechanism.

Thus, for the class of companies like Apple and Pfizer and others which create physical products which contain a lot of intellectual property, they will still avoid the bulk of taxes on their income.

As long as these types of companies have access to this mechanism, other types of companies which produces products that cannot shift their revenue stream by selling their underlying IP rights will ever accede to a proposal like Auerbach’s that leaves them on an unbalanced tax playing field.

Posted by lauradeen | Report as abusive

“Auerbach’s plan would tax profit only from the sale of products in the United States. In other words, his corporate tax would ignore transactions that U.S. companies undertake overseas.”

How is that supposed to work with ‘simplicity’? Apple-Korea builds an iWidgit for $10 and sells the iWidgit to Apple-Ireland for $100; so Apple-Korea has made a $90 profit on the iWidgit. Apple-Ireland then sells the same iWidgits to Apple-America for $100 each which then retails the iWidgits for $100 each to local American customers – making a profit of zero and hence generating zero taxable profit from the “sale of products in the United States”.

Posted by walstir | Report as abusive