Reality Check on Corporate Taxes

Are you hearing that U.S. corporations are taxed much more than their international competitors, making it harder for them to compete in global markets? Those who think so want policymakers to substantially cut corporate income taxes, protect corporate tax loopholes or both. But that claim is highly misleading to begin with, as this recent Wall Street Journal analysis of pharmaceutical giant Pfizer's accounting methods illustrates.

First, some background. The U.S. federal corporate tax rate is 35 percent, and that "statutory" rate is what corporate tax critics cite most often. Additional state corporate taxes bump the overall number up closer to 40 percent.

The statutory rate, however, doesn't reflect the write-offs in the tax code (so-called tax expenditures) that reduce the "effective rate" on corporate profits – that is, what corporations actually pay in taxes as a share of their profits. Indeed, while the U.S. statutory rate is about 14 points higher than the average among industrialized countries, the effective rate differential is much smaller, a Congressional Research Service analysis found.

One of the largest corporate tax expenditures – and the one that's central to the Pfizer situation – is "deferral of income from controlled foreign corporations," which allows multinationals to delay paying U.S. tax on their foreign profits. Companies get a credit against their U.S. taxes for the taxes they pay to other countries, and they pay no U.S. taxes on the profits they earn in other countries that they haven't yet "repatriated" (that is, brought back) to the United States.

In 2014, Pfizer reported $3.1 billion of tax obligations worldwide and an effective tax rate of 25.5 percent. That's well below the U.S. statutory rate, but Pfizer actually paid less than $1 billion in taxes for an effective rate of just 7.5 percent. The difference between its tax obligations and tax payments lies in the profits Pfizer has not yet repatriated – and may never repatriate – and hence profits on which they haven't paid taxes.

To be clear, Pfizer isn't doing anything illegal. As the Journal's analysis notes, the company is following accounting rules that require it to book those tax obligations unless they declare that they'll reinvest abroad, permanently or indefinitely, the profits on which they're based. Most companies with foreign profits seem to make such a declaration, and hence would report higher earnings and an even lower effective tax rate than Pfizer's under the same circumstances.

Those who want to cut corporate tax rates are uninformed or disingenuous to point to statutory rates or artificially high effective rates like Pfizer's to argue that corporate taxes are too high. As my Center on Budget and Policy Priorities colleague Chye-Ching Huang says here, the big problem with taxing multinationals today is "stateless income": profits that aren't taxed anywhere. Cutting the corporate rate doesn't bring that income into the U.S. tax base or greatly reduce multinationals' search for "tax havens" (countries with very low or zero corporate tax rates); it mostly just costs public revenue on the profits that the government would otherwise tax.

The tax cutters also like to propose a "repatriation tax holiday," giving corporations with lots of profits that they hold abroad a window of time to bring them back to the United States and pay much lower tax rates on them. That's a tried and failed approach.

The repatriation holiday that President Bush and Congress enacted in 2004 didn't produce any of the promised economic benefits, such as boosting jobs or domestic investment, according to a wide range of studies. A second repatriation holiday would boost federal revenues during the holiday period as companies rushed to capitalize on the temporary low rate, but it would lose revenues thereafter. Moreover, a second holiday would encourage companies to shift more profits and investments overseas in anticipation of more tax holidays, thus avoiding taxes in the meantime.

Sound corporate tax reform should raise revenues and reduce incentives for tax avoidance. Efforts to cut corporate tax rates while retaining current write-offs or to enact another repatriation holiday do neither.