Corporate income taxes - where are they headed?

Corporate income taxes--where are they headed?

The amount of income taxes paid by corporations has been increasing for the past seven years. Will this trend continue? Are there viable alternatives to the nation's need to increase federal revenues? Members of FEI's Committee on Taxation lead a discussion which examines the perception that an increase in corporate taxes is justified. Many financial executives view with concern recent increases in corporate income taxes. The Financial Executives Research Foundation (FERF) has issued a study on The Corporate Tax Burden in the United States. The FEI Committee on Taxation is also following this development, and recently Frederick L. MacDonald of General Motors, and a member of the study's advisory committee, led a panel discussion of these issues.

Members of the distinguished panel were: William G. Dakin, supervisory tax counsel, Mobil Corporation Frederick L. MacDonald, assistant general tax counsel, General Motors Corporation Mark L. McConaghy, Price Waterhouse, Office of Government Services Gillian M. Spooner, Peat Marwick, coauthor of The Corporate Tax Burden in the United States MacDonald: There is a public perception that corporations are not paying enough taxes, and I think we here share a concern that the business community is going to be targeted as a primary source of increased federal revenue. Mark, what kind of a need does the federal government have? McConaghy: The Office of Management and Budget has forecast numbers that show that the Gramm-Rudman-Hollings target will be met next year without revenue increases. However, these projections assume current services (that is, no new programs) and are based on fairly optimistic assumptions. I hope those assumptions come true. On the other hand, the Congressional Budget Office has projected that the Gramm-Rudman-Hollings target for next year will not be met and that $25 to $30 billion will have to come from a combination of spending cuts and revenue increases in order to avoid sequestration. CBO's assumptions are less optimistic and tend to follow the average of the 1980s. If I had to guess today, I would say that it is likely that somewhere between $5 and $10 billion in revenues will be needed. Spooner: Whether the amount of the additional revenue is $5, $15, or $25 billion, we know it's not all going to come from individuals. Some people are talking about additional excise taxes meeting our needs, but I don't think that's going to happen alone. You're not going to get any tax bill without some base broadeners for the corporate sector. McConaghy: I agree with Gillian. It's an eye opener when you read the results of a 1,000-person telephone survey that was commissioned by FEI's Committee on Taxation. According to its findings, the general populace believes by a ratio of about 2 to 1 that corporations are not paying their fair share of taxes. I remember Ken Duberstein once said that when you can keep revenue increases on page two of the business section, the general public isn't as concerned that a tax bill is being enacted. Spooner: It is also easier politically to change the more complicated technical provisions, rather than something like rates, which everybody can understand. Dakin: Yes, and the complexity of the corporate tax law produces a divided corporate world. Some companies are very capital intensive and are affected by capital recovery provisions. Other companies are highly labor intensive and have very little interest in capital recovery. Those with domestic operations do not care how the U.S. taxes foreign source income, whereas companies that do business abroad care about it a lot. Each corporate taxpayer or group of taxpayers sees its interest from its own point of view. McConaghy: A good part of the corporate community does agree that the deficit is the nation's number one problem. The difficulty arises when you look at the numbers and see that spending cuts alone may not be the complete answer. If revenues are needed, the question is where do they come from. Spooner: One issue is how the additional revenue burden is going to be allocated within the corporate sector. That is why the division among corporate views is so important. Do you raise revenue by cutting back on the capital cost provisions? Or do you raise it by cutting back on benefits within the foreign provisions? Dakin: You can get a consensus on the proposition that if you tax the creation of income too heavily you get distortive effects. And you can get a consensus that present tax law is biased against savings and investment because it relies too heavily on income taxes. But it's hard to get a consensus to go beyond that. Spooner: One of the problems is that corporate tax expenditures will be reduced from $111 billion in 1986 to $67 billion after 1992, or by one third, while individual tax expenditures will be reduced from $396 billion in 1986 to $311 billion in 1992, or by only one fifth. The numbers alone show much more potential revenue is coming from individuals, but that may be misleading because it ignores the political environment. MacDonald: Maybe we should stress that the business community seeks a certain amount of stability for planning purposes. And that all the major tax bills in the last decade have created uncertainty. We need a pause until we can assess the impact of these changes over the last 10 years. McConaghy: You're right, Fred. The system is close to being unmanageable. Gillian's firm and my firm have difficulty keeping up with changes in the tax law. I'm sure you do, too. But I'd like to carry your point one step further. I think there's going to be a substantial increase in compliance costs due to return-preparation consultants, audits, litigation, etc. Dakin: Speaking of compliance, why can't we put more emphasis on the amount of tax which is owed and not paid each year on legally earned income--by the moonlighting plumber or bartender? Between $80 and $100 billion dollars of federal income tax owed on this legal income goes uncollected each year, whereas the amount of tax that goes unreported or uncollected from the corporate sector, which is audited more closely, is very small. Spooner: Yes, corporations on the whole comply with the rules. But what I fear is that the rules are so expensive and difficult to comply with, that even very conservative taxpayers--corporations who in the past have not thought it worth their while to play games with items like inventory--may now consider the rules to be too burdensome. They may now take less conservative positions, and not comply as well as they have in the past. Dakin: I would like to suggest another question: what is the correct level of taxes for corporations to pay? In my personal view, the answer is exactly the same level as would have been paid had the income been earned by an individual. The right question is not how much tax should be paid by corporations; it is how much tax should be paid on income which is earned in corporate form. Spooner: Are you arguing for a single level of tax, Bill? Dakin: If you had a perfectly integrated system, there would be no tax cost to the privilege of doing business in the corporate form instead of doing business in partnership form or any other form. McConaghy: Many economists will state that some form of integration makes sense. I see one major problem with it. Full integration is expensive and would have to be phased in. I also think that the issue of how to treat tax-exempt organizations has to be resolved. But Bill is absolutely correct in trying to move to a system that exacts only one level of tax. Dakin: Our major industrial competitors already do this, and have done it for years. Japan has it. Germany. The U.K. France. Spooner: There's also a perception problem here. Why should I as an employee be paying X amount of every dollar I earn to the federal government, when huge corporations would not be required to pay the same percentage of their earnings? Dakin: That's focusing on who pays the tax rather than on the stream of income that is to be taxed. What I'm saying is to focus on the income rather than on the entity that earns the income. McConaghy: Economists will tell you that corporations don't pay taxes; individuals pay taxes. Corporations will pass through as much of that tax as they can. However, Bill, your idea would result in corporate taxes being shifted to individuals. There would be only one level of tax on that income. If the government is going to require the same level of revenue, taxes on individuals would have to go up. And that would not be perceived in Congress as moving in the right direction. Dakin: You are absolutely right with respect to income which corporations distribute, but I believe corporations under such integrated systems would continue to pay a tax on an income which they did not distribute. It's not that corporations wouldn't pay any tax. They would not pay tax on the income which they earned and distributed. McConaghy: A dividends paid deduction, a gross-up and a credit for dividends paid, would be less expensive, particularly if it were some percentage of the dividends paid below 100 percent. However, it would have to be done at a time when revenue is not driving tax changes. Dakin: Well, that's because we're indirectly taxing the local hospital, the universities, and our churches--all of whom are investors in the stock of corporations. Any tax that is paid by the corporation reduces the stream of revenue that gets paid to these tax-exempt entities. When you go to an integrated system, the corporations could get a deduction for the dividends they paid out. This would affect people more, because not all dividends are paid to tax-exempt recipients. But it should, in theory, increase the return to tax-exempt investors like pension funds, which collectively invest to pay benefits for blue collar workers. Spooner: How do you suggest we deal with the perception problem? How do you deal with the studies that draw conclusions from financial statement income and the financial statement current tax expense? When you don't read the footnotes to financial statements, for example, an investment tax credit that you flowed through over a long period of time can look like a big refund when, in fact, it isn't refund. Dakin: I think it's an uphill battle to win that fight. In general, I think that you have got to concentrate on the legislators rather than on the man in the street. You're just not going to get the average reader of the local tabloid to focus on the footnotes in the annual report. MacDonald: Let's look at Bill's fair share point from a different aspect. What is a fair share? We feel you should look at more than just federal income taxes in determining a corporation's fair share of taxes. As Gillian's study pointed out, nonfederal income taxes have grown dramatically in recent years. Spooner: They've gone from 15 percent of federal income taxes in 1972 to 32 percent in '86. MacDonald: At GM, for example, we have paid $22 billion in taxes other than federal income taxes during the 1980s. That's a significant burden in our view, but it probably won't be taken into account. Spooner: It's very difficult to get that kind of information because on tax returns many nonincome taxes are lumped together. We did find that, in 1984, corporate, state, and local taxes other than income taxes were $173 billion compared with something like $78 billion in total corporate income taxes. This is a very big number and includes excise taxes, payroll taxes, property taxes, and various other taxes. But I don't think the policymakers in Washington are going to base the provisions that they are going to enact next year or the year after on what property or other taxes corporations pay. I think the debate in Washington is going to be about federal income taxes. MacDonald: One last question. Gillian, one point your study made was that in the 1970s corporate taxes were 2.7 or 2.8 percent of the GNP. It dropped down in the early '80s to an average 1.5 percent, but now it's on its way back to what it was in the early '70s. Now, a lot of factors have caused this. But how does one answer the point that while the percentage of GNP is going up--to 2.2 percent in 1988 and 2.4 percent from 1990 to 1992--corporations still aren't paying income taxes at the level they were paying in the early '70s? Spooner: A lot of factors can explain why the level has gone down. Corporate profits have changed over time. As corporate profits go down, the level of tax relative to GNP will go down. As corporations finance more of their business with debt rather than equity, the ratio will go down. And, obviously, as tax incentives are introduced, the rate will go down. But I think we should also ask why we are so sure that the particular level of taxes levied in the past was the correct level. What is the correct level? I don't think that the level of taxes in 1960 or 1970 or 1980 should necessarily control what our policy should be in 1990. Dakin: The world was a different place in 1960. We were still coming out of the aftermath of World War II. And we were the dominant industrial power of the world. Now it is nearly 30 years after that, and we are in head-to-head competition with large industrial conglomerates based in other countries--Japan, Germany, the U.K., France, Italy, and even Korea and Singapore. We were able to live with the competition when the reconstruction of Europe was going on. But now the competitive advantage has long been erased, and we can't afford the high taxes we lived with in 1960. The proper question today is: what is the right level for the 1990s? MacDonald: I don't know what is the right level, but in summing up I would say the instructive part is that the general public does not think that corporations come close to paying their fair share. Whereas, in fact, corporations will pay higher taxes as a result of the legislation of the '80s--as a share of the GNP and total federal revenues--than they would have if pre-1987 tax laws had remained in place. Moreover, corporations are not that far away from paying what they did back in the 1970s--again as a share of both GNP and total federal revenues--in spite of a fall in corporate profits and the more rapid growth of other taxes. This certainly says that somebody needs to tell the story--that there is a corporate tax burden, that it is significant, and that it is increasing. Spooner: It's a question of perception. The perception is that tax revenues collected from corporations are not large enough and are decreasing. And that perception will influence tax policy, until we make sure that future perceptions are based in fact. McConaghy: Since the repeal of indexing and the passage of Gramm-Rudman-Hollings, we have seen the need for revenue-driving tax policy. And since I don't see anything happening in the next three or four years that is going to reverse this trend, Congress is likely to look for additional revenue on the corporate side. So business needs to say: Wait a minute. You've taken it from the corporate side since 1981. In fact, you've taken back everything that you gave in 1981, and more. Enough is enough. Dakin: Personally, I think it's going to be necessary to take a look at entitlements also. I would argue that the first thing to do is to hold spending down. I also think that when you tax income, you are taxing the creation of wealth, and that should be held to a minimum. The complexity that we've come to live with in the employee benefits area, in the ERISA provisions, in the foreign area, and domestically, in uniform capitalization rules--all of it is counterproductive. MacDonald: Thank you for joining me in this discussion. I think we all agree that businesses pay enough income and other taxes. Many respected economists believe that increasing business taxes further at this time would slow economic growth. Now we must convince Congress.