Corporate America must pay fair tax rate

Both President Obama and Republicans have called for lowering the corporate tax rate, citing America’s global competitiveness. But cuts should be reserved for companies that invest in the U.S. and its workers. Other corporations should pay more, and all should pay their fair share.

The federal government first taxed corporate income in 1909. Corporate rates were initially below 10 percent, but following World War II they increased dramatically, to over 50 percent in I951. Between 1951 and 1986, the top corporate tax rate ranged from 46 to 52.8 percent.

Large corporations were also complaining about the tax rate in 1986, the year of the last significant federal tax reform. The rate was reduced to 35 percent, loopholes were closed and the tax code simplified. At the time, the rate was lower than that of most developed countries. But today the 35 percent rate is one of the world’s highest, and it jumps to 39.2 percent when state and local taxes are included.

This rate is double the European average and more than triple Ireland’s 12.5 percent rate. Over the past 25 years, almost every country in the Organization for Economic Cooperation and Development has cut its top corporate tax rate. Corporate America is again arguing that the U.S. rate is a disadvantage for domestic  corporations.

But while U.S. companies often complain about the 35 percent top rate, they don’t like to admit that hardly any of them pay anything close to it. While the United States’ corporate tax rate is relatively high, it’s not a meaningful measure of the actual corporate tax burden.

A 2013 Government Accountability  Office report showed that large, profitable U.S. corporations paid an effective federal tax rate of 12.6 percent of their worldwide income in 2010, about one-third the statutory rate. Adding in foreign, state, and local taxes increased the average effective tax rate to 16.9 percent, which is certainly competitive with other developed countries and is a lower rate than the average teacher or police officer pays. A 2012 study by Citizens for Tax Justice found that over a recent period, 30 of the largest U.S. multinationals with more than $160 billion in profits paid no federal income tax at all.

According to the Congressional Research Service, corporate income taxes have diminished as a source of federal revenue, from 39.8 percent in 1943 to 9.9 percent in 2012, as corporate profits reached record highs. The GAO reported that in 20I2, corporate income taxes generated about $242 billion in federal revenue, while individual income taxes accounted for $1.I trillion.

U.S. corporate tax collection equaled just 2 percent of gross national product in 2011, according to the OECD. That was the lowest in a ranking of 27 wealthy countries.

The reason they pay less in taxes is not because corporations play a less important role in our economy or that corporate profitability has diminished. Rather, it is that corporations have learned how to exploit loopholes in the tax code and retain lobbyists who move well in Washington. And let’s not forget the $2 trillion in profits stashed abroad.

Much of the simplification from the comprehensive 1986 tax overhaul has been lost. Between 2001 and 2010 there were over 4,000 changes festooned to the tax code, resulting in a code of nearly four million words with a sky-high impenetrability quotient.

Nearly six years after the financial meltdown, the economy is still far from recovery. Over 20 million Americans who want a full-time job can’t get one and labor force participation is at its lowest level since 1978. Low wages and stagnant incomes prevail.

Congress should create incentives for companies that invest and create jobs in the U.S. and impose higher taxes on firms that do not. But any tax reform should start from the premise that corporate America has to pay its fair share, and that means no profitable corporation having a lower tax rate than your child’s teacher.

originally published: August 30, 2014

Navigating a free Market (Basket) economy

The bitter clash between factions of the DeMoulas family, the major shareholders in the Market Basket supermarket chain, once again raises the issue of corporate responsibility. Is the sole responsibility of executives and boards of directors to maximize the value of stockholders or are they responsible to a broader array of stakeholders that include customers, employees, suppliers and host communities?

In recent decades, a grand total of two options have evolved for dealing with the issue of corporate responsibility. If you believe businesses should exist unmolested, solely to serve the interests of stockholders, then the late economist Milton Friedman is your man. He was the most outspoken advocate of that view and argued that corporate social programs add to the cost of doing business. Spending money to reduce pollution, for example, makes a business less profitable.

Many management gurus counter that there is danger in focusing solely on profitability. An overzealous pursuit of stockholder returns can encourage maximizing short-term rather than long-term returns. Such an orientation leads to actions like cutting expenditures judged to be nonessential in the short term such as research and development. The resulting underinvestment jeopardizes long-term returns.

The near financial meltdown in 2008 and the subsequent Great Recession demonstrated the large and diverse group of stakeholders who are affected by companies’ actions. In the wake of this shock to free¬≠ market capitalism, the traditional view of corporate responsibility is giving way to a belief that enlightened self-interest requires a business to consider all important stakeholders when running the enterprise, not just stockholders.

Stockholders provide the business with capital, but if customers don’t get value for their money they can take their business elsewhere, employees provide labor and expect commensurate income and job satisfaction in return or they can leave their jobs, suppliers seek dependable buyers , and local communities want firms that are responsible citizens.

To create customer value, most firms rely on a network of stakeholders. In determining company goals and strategies, executives and board members must recognize that each has justifiable reasons for expecting and often demanding that the firm take its interests into account. Family-owned businesses such as Market Basket are no different.

As Southwest Airlines founding CEO Herb Kelleher noted, the key to delivering outstanding customer service is putting employees first. “If they’re happy, satisfied, dedicated and energetic, they’ll take real good care of the customers. When the customers are happy, they come back. And that makes the shareholders happy.” At Southwest, people and profits are explicitly linked and that has accounted for outstanding profitability over several decades in a highly competitive industry.

Leaders at Market Basket and other companies don’t realize that they don’t hold all the picture cards. If they don’t reform their behavior, an angry public will do it for them by boycotting their businesses.

originally posted: August 16, 2014

 

The unimaginable catastrophe of World War I

A century ago, on June 28, 1914, Archduke Franz Ferdinand, heir to the throne of the multi-ethnic Austro-Hungarian Empire, made an official state visit with his wife, Duchess Sophie, to the Bosnian city of Sarajevo, which the empire then occupied.

Late that morning, the cars in their imperial procession made a wrong tum on the unfamiliar streets of Sarajevo and halted to get their bearings. At that moment, Gavrilo Princip, a young Bosnian freedom fighter (or terrorist, take your pick) stepped out of the crowd and fired two shots into the back seat of the open car carrying the Archduke and Duchess. Both died within minutes.

And Europe proceeded to come apart at the seams.

Less than six weeks later, on Aug. 3, Kaiser Wilhelm’s Germany invaded Belgium as the first step in their longstanding Schlieffen Plan to score a quick military victory over Republican France.

France had a military alliance with Tsarist Russia, which had already begun mobilizing its huge army in support of its client Balkan state of Serbia, the “spiritual leader” of occupied Balkan states like Bosnia. Serbia was being threatened with invasion by the Austro-Hungarian Empire (with the support of its German ally) for “refusing to cooperate fully” in the investigation of Archduke Ferdinand’s assassination.

Germany regarded Russian mobilization as a threat against its eastern provinces and assumed Russia’s French allies would attack from the west, so it decided to mount a preemptive invasion of France through neutral Belgium.

However, the constitutional monarch of Great Britain had guaranteed the territorial integrity of Belgium. The British declared war against rampaging Germany on Aug. 4 and began landing contingents of its small but highly trained army in France on Aug. 7 to support the French and Belgian armies.

By the middle of August, the major league lineup was basically set: The alliance of Britain, France, and Russia was at war with Germany and Austria-Hungary.

Clear? I thought not. But the parties plunged ahead with great enthusiasm into the five local wars that broke out during August in different parts of Europe. Austria-Hungary was fighting Serbia in the Balkans and Russia in southern Poland and Galicia. Russia was fighting Germany in East Prussia. France squared off against Germany in Alsace-Lorraine and Germany fought Belgium, France and Britain in Belgium and northern France.

All confidently expected the war to be over by Christmas. They got the Christmas part right, but not the year.

The unimaginable catastrophe of World War I, which would remake the world, dragged on with maximum mismanagement by all parties until November 1918. It destroyed the remains of 19th-century European society and wouldn’t really be settled until the end of World War II, when the western allies and the Soviet Union finally smashed the resurgent monster Germany had become in the wake of the 1918 Armistice and established a new Europe amid the ruins.

World War I may have been inconclusive, but its cost was staggering. All told, the 16 nations that ultimately ended up fighting spent the equivalent of some $3,000 trillion (in inflation-adjusted dollars) on the war. They mobilized 65 million troops, 12 percent of whom were killed and another 33 percent wounded.

The Austro-Hungarian Empire collapsed and was replaced by some half-a-dozen ethnically based nations, most of which were overrun by Germany in World War II and later became puppet states of the Soviet Union.

The people of Europe, having borne the brunt of the suffering, lost all confidence in the so-called “ideals of western civilization” they had taken for granted before 1914. They also lost faith in their governments, which they were convinced had persistently lied to them, protected their elites at the cost of everyone else and squandered millions of lives by mismanaging the war.

Virtually everyone, victor and vanquished alike, was left bankrupt and owing more money to the United States (which sat out most of the war and became the world’s leading creditor nation) than they could ever possibly repay.

It was quite a scorecard for a war that settled virtually nothing.

originally published: August 9, 2014

Time to make overt corporate tax inversions

Every political season brings new issues and controversies. One of the big ones this time around is “corporate tax inversions.” Unfortunately, the trend is a symptom of a bigger problem that will require the kind of long-term solution that is rarely crafted in even-numbered years.

In business terms, inversion is the restructuring of a U.S. company’s corporate form such that it becomes a foreign corporation based in a country with low corporate taxes, basically turning the corporate structure on its head. American multinational corporations undertake these transactions because the top U.S. corporate tax rate of 35 percent is higher than in many other countries and the U.S. taxes worldwide income at a time when foreign income is increasing substantially.

One example is Medtronic Inc.’s recent agreement to buy Covidien for $43 billion. The move enables Medtronic to domicile to Ireland, take advantage of low corporate tax rates and access its overseas cash without having to pay high repatriation costs.

These inversion deals allow American corporations to reduce their average combined federal and state corporate tax rate of 40 percent. This rate is one of the world’s highest, double the European average more than triple the 12.5 percent rate in Ireland. Over the past 25 years, almost all countries in the Organization for Economic Cooperation and Development except the U.S. have lowered their top corporate tax rate.

The increased number of American firms that have incorporated abroad to reduce their tax burden has prompted a series of congressional hearings, where representatives can express their frustration and anger at maximum strength about firms reducing the U.S. corporate income tax base. The Joint Committee on Taxation estimates that future deals will cost the U.S. almost $20 billion in corporate tax revenue over the next 10 years.

The flurry of inversion deals has also angered President Obama, who has said the practice is “wrong” and urged Congress to close the loophole.

High corporate tax rates are not the only problem. What is frequently overlooked in these contentious discussions is that the United States, unlike many other countries, employs a worldwide taxation system, taxing corporate foreign income at the same rate as domestic income while permitting corporations to claim limited tax credits for income taxes paid to foreign governments to mitigate the possibility of double taxation.

By anyone’s standards the U.S. has a very complex tax code. Corporate tax reforms must recognize global economic changes and resolve the fundamental contradictions in the current corporate income tax structure.

All this strongly suggests that truly solving the problems created by the current corporate tax regime requires a long-term fix and cannot be solved unilaterally by the U.S. Some second-order benefits may be gained by plugging specific loopholes, but a real long-term solution requires better international coordination of tax rules to minimize tax avoidance activities by multinational corporations.

Not too long ago, a corporation could be successful by focusing on making and selling goods and services within its national boundaries. Profits earned from exporting products were considered frosting on the cake but not really essential to corporate success. That is no longer the case, and the U.S. needs to reform its corporate tax code to reflect this new reality.

originally published: August 2, 2014