Japan looks likely to cut its corporate tax rate by 2 to 3 points in 2015, according to Bloomberg : Japan ’s corporate income tax may be cut by more than 2 percentage points next year and reduced to less than 30 percent within five, Economy Minister Akira Amari said. “Reports of a cut of 2.4 percent or 2.5 percent aren’t far from the truth,” Amari said today in Tokyo, referring to reductions in the company tax rate for next fiscal year. “We want it done in as few years as possible, and to have an impact.” Japan currently has a corporate tax rate of 37 percent, the second highest in the developed world after the U.S., which has a corporate tax rate of 39.1 percent (federal plus state). With this cut, Japan would be roughly tied with France for the second highest corporate tax rate in developed world, at 34.4 percent. Spain has also announced a 2 point cut in its corporate tax rate for 2015, as has Portugal , with plans to go lower . Factoring in these announcements for 2015 means the U.S. is falling further behind in terms of corporate tax competition, as the following chart shows. In 2015, the average corporate tax rate in the developed world outside the U.S. will be 24.6 percent, which is 14.5 points lower than the U.S. corporate tax rate. Follow William McBride on Twitter
The Washington Post has denounced the inclusion of bonus depreciation in the just-passed tax extenders bill for 2014. The correct term is “partial expensing.” There is nothing “bonus” about it. The partial expensing allows businesses to deduct immediately (expense) half the cost of their equipment spending in the year it is made, with the rest to be written off over time. The Post calls it an investment subsidy. The Post states: “[T]he tax code has long permitted companies to deduct gradually the costs of new equipment, buildings, and the like: the sound economic principle is that big-ticket items produce output over time, so the expense of acquiring them should be “matched” with that revenue stream. Bonus depreciation allows companies to claim a much higher than usual percentage of those deductions up front.” These critics are misinformed. The “matching” of the write-offs with the time frame over which the asset produces income is an arbitrary accounting convention adopted for the convenience of the bookkeepers and the sake of appearances. It evens out the reported flow of expenses to make profits look less volatile, which might needlessly scare the shareholders, and it avoids carrying losses on the books if a big lumpy outlay is undertaken. But it is not a “sound economic principle.” The sound economic principle is that a cost occurs the year the money is spent, and it should be counted at that time. That is when the money is tied up in the asset and is not available for other uses. In economic terms, the “opportunity cost” is immediate and should be recognized as such. That is real “common sense.” Nor is lengthy depreciation “usual.” In the old days, before WWII, firms were allowed to write off their expenses in whatever pattern made the most sense for them. Only the need for more wartime revenue spurred the Treasury to start dictating procedures, “permitting” businesses to report costs only at the government’s convenience. Making a business wait years to claim a business expense overstates the business’s income early in the period, and understates it later on. It accelerates the timing of the business’s apparent earnings, and thereby brings the business’s tax liability forward for the benefit of the government. It artificially raises the cost of equipment and buildings by making companies wait to realize costs, as if the time value of money were zero. That is not good economics. As a result of the higher cost of equipment and buildings, less investment is done, especially in longer-lived assets. Less capital is accumulated, workers are less productive, wages are lower, and jobs are fewer than would be the case in a non-distorting tax system. This became blatantly obvious during the 1970s inflation, when the inflation slashed the real value of the delayed write-offs below replacement costs, and investment fell behind the growth of the work force, resulting in plunging productivity and after-tax wages. Long-lived depreciation was enacted to raise more money for the government, and has since been rationalized as a tax on capital income on the theory that it would enhance the redistribution of wealth. Its real effect is to slow capital formation and hurt the working population, especially in capital intensive manufacturing, mining, the energy industry, and the construction trades. The government ends up losing money due to the weaker economy and the smaller incomes of the population. Major tax reform proposals such as the Flat Tax, the Personal Expenditure Tax, the Nunn-Domenici USA Tax and its successor introduced by Congressman English, the National Retail Sales Tax, and the Bradford X-tax have all moved in the direction of expensing (immediate write-off of investments). Their goal is to end the tax bias against long-lived assets, generate more capital formation, higher wages, and more jobs. The Post has correctly expressed concern over the lagging wages of the middle class over the last decades. Well, one of the contributing factors to the weak wage growth is our depreciation policies that have led to underinvestment in capital goods and encouraged companies to manufacture off-shore. Regaining a vibrant middle class requires putting better tools and equipment in the hands of blue collar workers—which will only happen with expensing as a normal part of the tax code. The only legitimate complaint in the Post editorial about the extenders bill is that the extension of partial expensing came at the end of the year, leaving people unsure what the tax treatment and cost of capital would be in 2014. If people doubted the extension, and did not invest earlier in the year, it is too late now to incentivize them for 2014. The partial expensing provision should be enacted on a permanent basis if it is to have the greatest impact on reducing the cost of capital and prospectively encouraging more investment and job growth in the years ahead. Even better would be full expensing of all investment, not just half of equipment outlays. Instead of criticizing faster depreciation as a give-away to business, the Post should endorse a permanent extension of expensing as a means of raising middle income wages.
Technically speaking, Vermont’s gubernatorial election isn’t finished yet, but universal health care is. A long-awaited blueprint for the state’s planned transition to single-payer, just released, has been termed “detrimental to Vermonters”—not by the opposition, but by the Governor who made single-payer health care his signature issue. Because no candidate received a majority of votes cast in November’s election, the selection of Vermont’s next Governor is up to the legislature, though there is every expectation that they will grant incumbent Gov. Peter Shumlin (D) a second term. Which isn’t to say that the Green Mountain State isn’t in for a course correction. After two delays in outlining the plan for single-payer, Shumlin finally unveiled the model—which called for an 11.5 percent payroll tax on businesses and up to a 9.5 percent premium assessment for individuals—only to publicly repudiate it. Shelving his proposal, the Governor explained , “These are simply not tax rates that I can responsibly support or urge the Legislature to pass. In my judgment, the potential economic disruption and risks would be too great to small businesses, working families and the state’s economy.” According to the New York Times , alternative designs were solicited from the Governor’s health care team, but “no one could come up with a plan to offer quality coverage at an affordable cost.” Per the Governor : “As we completed the financing modeling in the last several days, it became clear that the risk of economic shock is too high at this time to offer a plan I can responsibly support for passage in the Legislature. It was clear to me that the taxes required to replace health-care premiums with a publicly financed plan that would best serve Vermont are, in a word, enormous.” The word is aptly chosen. The proposed “Green Mountain Care” would cost $4.3 billion its first year, rising to $5 billion by 2020 according to the Governor’s own estimates —in other words, about $7,650 per person. And even the high taxes required by the plan were insufficient; even with a ruinous 11.5 percent payroll tax and public premiums up to 9.5 percent, the program would run a deficit by year four. That would have been on top of Vermont’s existing corporate income tax, with a top bracket of 8.5 percent applying to all business income above $25,000, and a top individual income tax rate of 8.95 percent. The state already ranks 46th on our State Business Tax Climate Index . Predictably, advocates of universal health care are incensed, with some demanding that the plan move forward notwithstanding a chastened Governor’s objections. The experience, however, is instructive. Even Vermont politicians recognize that the tax hikes necessary to fund single-payer health care have the potential to spell economic disaster, and that’s saying something.
There has been considerable discussion about the corporate tax system in the U.S. and the IRS’s global reach in the media over the past year. The rash of corporate inversions was the catalyst for the public discussion of the outdated worldwide corporate tax system, which only six other countries have. The IRS’s global reach also extends to personal income as well. Citizens and green card holders who work abroad must file a tax return for all income over $9,350.00. Although there are tax credits and deductions for income taxes paid to the country of residence, other taxes, such as the VAT, are not deductible. In other words, if the country of residence has a high consumption tax, i.g. the VAT, and a low income tax, then American expatriates could find their wages being squeezed both when they earn income and when they spend it. In addition, citizens and green card holders who work abroad are required to file forms concerning their financial holdings abroad. These individuals must divulge the details of their financial holdings in the TDF 90-221 form, also known as the FBAR, which carries a $10,000 to 50% of an account fine for failure to file or incorrect information. The 8938 form is also required under the more recent Foreign Account Tax Compliance Act (FATCA). It requires more extensive financial details, which is cross checked with foreign financial institutions, and it carries similarly harsh penalties. Are Americans alone in this onerous system? Unfortunately, they are. Only one other country taxes its citizens is this manner. Eritrea, the small country on the northern border of Ethiopia, is the only other country which taxes its citizens who live and work abroad, but unlike the U.S., they have a reduced flat rate for those citizens and none of the reporting burden. What can a U.S. citizen do to escape the worldwide tax burden? Just as corporations have sought tax relief through inversions, citizens can achieve similar results by renouncing their citizenship, and just like inversions, renouncing one’s U.S. citizenship has been on the rise in the last couple of years. The tread of inversions and renounced citizenships is alarming. It speaks to a simple principle of economics, is membership worth the price? Americans abroad and corporate executives are resoundingly saying no and opting out. For the most part, the drop in demand for American membership has been missed by the U.S. Congress, but in the recent report on tax reform from the Republican staff of the U.S. Senate Committee on Finance, they suggest moving away from a worldwide income tax system to a residence based system, matching other OECD countries. This has given many expatriates cause for hope. Tax burdens should be tied to the public services a tax payer uses. Paying one’s “fair share” only makes sense if one is using a fair share. American citizens abroad don’t use American public services and thus should not be responsible for the provision of those services. Maybe it is time we admit that the IRS is truly over-reaching.
While the media has been feasting on Lux Leaks and other stories of “ multinational tax dodging ”, academic accountants have determined that U.S. multinational corporations (MNCs) have no particular tax advantage over U.S. domestic firms. In fact, a new study finds the average effective tax rate for U.S. MNCs is slightly higher than that of U.S. domestic firms: 28 percent versus 24 percent. The study calls into question policy makers’ emphasis on international “profit shifting,” including the elaborate efforts by the OECD and rich-country governments to crack down on MNCs exclusively. The authors of the study, Scott Dyreng of Duke University and three other academic accountants, looked at the financial statements of more than 4,000 U.S. firms over the last 25 years. They found that overall there has been a decline in effective tax rates but the decline has been about the same for MNCs and domestic firms. The effective tax rate for MNCs declined from 34 percent in 1988 to 28 percent in 2012, while the effective tax rate for domestic firms declined from 32 percent in 1988 to 24 percent in 2012. Other studies have shown a similar decline in effective tax rates across the developed world, which is attributable to the decline in statutory corporate tax rates everywhere except the U.S. The mystery is that effective tax rates have dropped in the U.S. despite no significant change in the corporate tax rate over the last 25 years. Nonetheless, the U.S. continues to have one of the highest effective tax rates in the world. The authors of the new study explored many possible explanations for the decline in U.S. effective tax rates, including tax breaks targeting domestic firms, such as the manufacturing deduction and bonus depreciation, and the increased opportunities for profit shifting among MNCs. However, these factors do not appear to explain the trends. As they note: Overall, we conclude that corporate effective tax rates have indeed declined over time, and that the decline is not concentrated in multinational firms. Most of the other conventional explanations, such as the rising prevalence of intangible assets or the presence of more loss firms are equally unable to explain the decline. The decline in statutory tax rates around the world (other than the U.S.) explains part of the decline in effective tax rates, but only for multinational firms. It appears policy makers should go back to the drawing board on profit shifting. We simply don’t have a handle on how big it is or what the causes are. Rather than passing intricate laws aimed at MNCs and their intangible assets, interest deductions, etc., Congress should focus on making the U.S. corporate tax system simpler and more competitive. That requires cutting the corporate tax rate and switching to a territorial system that does not double-tax foreign earnings. Follow William McBride on Twitter