The Truth about Corporate Taxes

The announcement on Monday of Burger King’s merger with Canadian doughnut giant Tim Hortons prompted more than the usual financial media buzz, as pundits weighed in with outrage about the naked “tax inversion” ploy, in which Burger King will relocate its headquarters to Canada to benefit from their 15% corporate tax rate, rather than the US’s 35% rate. Such tax inversions have been rising in recent years as international tax havens proliferate, prompting outrage from the left over the eroding ethic of corporate citizenship.

However, corporate apologist Megan McArdle (known for her infamous pre-review of Piketty’s Capital) offers a more charitable read of the move in a recent Bloomberg piece. The real fact of the matter, McArdle contends, is that the US corporate tax system is grossly unjust for imposing a “global tax” on US corporations, rather than the “territorial taxation” practiced by most other developed countries. This means that if Burger King makes a billion dollars at its Canadian locations and a billion in the US, it will pay not $500 million ($350 million to the US government and $150 million to the Canadian), but $700 million—the full 35% rate on all its profits everywhere. Since the basic rationale for corporate taxes is to reimburse the public for the benefits of public education, infrastructure, etc. that make a successful business possible, it makes no sense, argues McArdle, for the US to collect taxes for the benefits provided by other countries to companies doing business there. She comments sarcastically, “This is a great deal for the U.S. government, which gets to collect income tax even though it’s not providing the companies sewers or roads or courts or no-knock raids on their abodes.”

Accordingly, contends McArdle, Burger King is only reasonable in trying to escape such an oppressive system and move to an enlightened country like Canada that allows it to pay tax on a country-by-country basis, depending on where it does business and earns profits.

On the face of it, this seems like a good argument, and offers a valuable corrective to over-simplistic narratives of what “tax inversions” are about. It’s also nice to see McArdle recognizing that taxation is best understood as a way of paying back the public for the various public investments and public goods that make corporate profits possible in the first place; too many on the Right now act as if taxes are just some arbitrary penalty the government slaps on businesses just to feel powerful.

But McArdle’s argument itself oversimplifies the narrative in at least four key ways, which together make her account deeply misleading.

First, it is a well-known fact that the supposedly crushing 35% corporate tax rate in the US is only 35% on paper; it is actually so riddled with loopholes and exemptions that it works out to being roughly on par with other developed nations (see for instance Stiglitz, The Price of Inequality, pp. 92), or even lower—in 2011, the average corporate tax collected on profits from activities within the United States was just 12.6% (Reich, Beyond Outrage, p. 25).

Second, the idea that they have to pay this crushing tax on every dollar they earn overseas is also misleading. In fact, the tax is only payable when the money from foreign subsidiaries is repatriated, which can be deferred indefinitely at the company’s discretion; sometimes, even this is avoided, when lobbyists convince the government to declare a “tax holiday” on repatriated money, as Bush did as part of his 2002 stimulus package (Stiglitz, 92). By deferring taxation, the gains can be reinvested in low-tax foreign subsidiaries until such time as they can be partially cancelled out against a loss at home (i.e., after a really bad quarter), thus again working out to a real tax rate far below the paper rate.

Third, although territorial taxation does, in principle, make more sense, the reason the US tries to insist on a global tax is that multinational corporations are so adept at playing the system that they can avoid paying any territory its fair share. Multinationals set up foreign subsidiaries both in countries where they do a lot of business and in those where they do very little, but which conveniently offer low tax rates. They can then often make use of “transfer pricing,” selling goods and services between their subsidiaries at prices which ensure they run at a loss, or very little profit, in high-tax jurisdictions, and make their profits in the low- or no-tax jurisdictions (McArdle mentions this problem in passing, but then very misleadingly implies that transfer pricing is really only an issue for “a few intellectual-property-based businesses”). All of this has been documented extensively by Nicholas Shaxson in Treasure Islands: Uncovering the Damage of Offshore Banking and Tax Havens.

Fourth, even more troubling is the fact that, as Shaxson has also shown, the very creation of “tax havens” is often the product of direct pressure by large corporations, many of whom have cash flows greater than that of many nations. With such an imbalance of power, it is easy for business interests to pressure small governments to lower their taxes and loosen their regulations so they can set up subsidiaries there. This process quickly becomes a race to the bottom, as corporations can wring still further concessions or lower rates by negotiating a better deal in another tax haven and threatening to relocate there.

Accordingly, as Shaxson documents, recent years have seen a fall in corporate tax rates in many countries and US States, as each competes for the flow of capital. None of this, mind you, is some dark conspiracy theory, attributing sinister motives to businessmen; rather, it is simply the logical behavior for corporate executives who are responsible to their shareholders to maximize profits and who have come to see this responsibility as higher than national allegiance. (Many on the Right can even be found defending this proliferation of tax havens as a great picture of competition in action, reducing capital costs for all.)

In such an environment, what McArdle describes as our governments “increasingly obnoxious demands” to other countries’ financial authorities are really just attempts to get something close to a fair share of corporate taxes. She is right that a global policy of territorial taxation would be more equitable, if carefully regulated by international treaties and oversight organizations, but in a world where many corporations are more powerful than most territories, this amounts to little more than a call for corporations to self-regulate, and out of the goodness of their hearts spare a few pennies for the tax authorities.