Although many businesses and trade groups have long advocated changing the U.S. corporate tax system, the prospect of having a lower tax rate but losing various loopholes has made some companies nervous about reform – particularly in the manufacturing sector.
It’s an oft-repeated maxim that U.S. businesses pay a higher corporate tax rate than businesses in most other industrialized nations. The current U.S. corporate tax rate is 35 percent, compared to 26 percent in the U.K., 15 percent in Canada, and 25.5 percent in Japan. Few U.S. companies, however, actually pay 35 percent. Their effective tax rates – or the real amounts they pay – are determined by a complex series of tax break provisions (or “loopholes”) that are different depending on industry sector.
Total corporate federal taxes paid hit a low of 12.1 percent of profits in the U.S. in 2011, according to the Congressional Budget Office. This is the lowest level since 1972. Between 1987 and 2008, this figure was about 25.6 percent.
Corporate tax reform has been an industry issue for years. Reform, should it come, could theoretically take the form of a lower flat tax rate (25 percent instead of 35 percent) that applies to everyone. In exchange for this lower, all-inclusive tax rate, companies would give up their special tax breaks.
While it sounds attractive on paper, some businesses are beginning to get nervous now that actual tax reform may be imminent. Few companies or industry groups want to let go of their special provisions, as a flat tax with no loopholes may actually result in higher payments.
According to an analysis from the New York Times, there is a large gap in effective tax rates by industry, with electrical utilities in the eastern U.S. paying the top rate of about 33.8 percent. Drug and biotech companies, at the bottom, pay an average rate in the mid-single digits thanks to extensive tax breaks for research.
President Barack Obama is keen to reform the lopsided model.
“It makes no sense, and it has to change,” Obama said in his 2011 State of the Union address. “Get rid of the loopholes. Level the playing field. And use the savings to lower the corporate tax rate for the first time in 25 years — without adding to our deficit. It can be done.”
Lobbying groups representing businesses from roofers to beer brewers have weighed in with the House Committee on Ways and Means, which is tasked with tax reform, to protect their provisions. The oil and gas industry has lobbies to preserve breaks for exploration and drilling. The U.S. Chamber of Commerce has declared that any tax reform should protect breaks for capital investments, such as new machinery, while pharmaceutical and technology companies maintain that tax credits for research should be preserved.
Manufacturers may have the most to lose in tax reform because they have one of the lowest effective rates: 17 percent, thanks to loopholes such as accelerated depreciation on manufacturing equipment. Manufacturers that operate on U.S. soil can also deduct nine percent of their taxable income. That particular loophole is worth about $8.9 billion each year.
The National Association of Manufacturers (NAM) supports lowering the tax rate but also believes that some credits for research and development and accelerated depreciation should be maintained to ensure that reform doesn’t raise effective rates.
“Because of the critical importance of manufacturing to our nation’s economy, any effort to rewrite the federal tax code should result in a fiscally responsible plan that allows manufacturers in the U.S. to prosper, grow, and create jobs and also enhances their global competitiveness,” Dorothy Coleman, NAM’s VP of tax and domestic economic policy, told IMT. “Manufacturers have long held that in order to achieve these goals, we need a comprehensive tax reform plan that both reduces the corporate tax rate to 25 percent or lower and includes permanent lower rates for the nearly two-thirds of manufacturers that are organized as flow-through entities.”
Coleman added that any comprehensive tax reform must include a shift from the worldwide system of taxation that is in place today to a competitive territorial tax system, a permanent and strengthened R&D incentive, and a strong capital-cost-recovery system.
It seems unlikely, however, that the Obama administration will sign off on any deal that involves lowering the corporate tax rate without closing loopholes, a move that would cause a net loss in tax revenue. The House GOP budget led by Representative Paul Ryan of Wisconsin, calls for a reduction of the tax rate to 25 percent without eliminating any tax breaks, which is unlikely to find bipartisan support in its current form.
Industrial companies know the current system needs reform, and the opportunities being presented to them seem moderate compared to others: Senator Bernie Sanders of Vermont has proposed taxing corporations’ overseas profits at U.S. rates, a move that would raise $590 billion over 10 years. While Sanders’ proposal is unlikely to see the light of day anytime soon, political shifts in the future (such as a Democrat House Majority, for example) could put such proposals – and the loopholes – back on the table.