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Myth:
Under the law, a corporation is a person. It has the right to buy, own, and sell property. A corporation can sue and be sued. A corporation is quite distinct from its owners; its liabilities cannot be passed on to its stockholders. In the case of Citizens United vs Federal Election Commission, the U.S. Supreme Court ruled that corporations are persons with many of the same Constitutional rights as flash-and-blood individuals.
A corporation benefits from the operation of government, receiving police and fire protection, defense against foreign invasion, roads on which to transport raw materials and finished goods, and reliable supplies of water. Multinational corporations receive benefits and protection through trade treaties negotiated by our government. Thus, a corporation is obligated to pay taxes to operate government without regard for whether its stockholders or customers pay taxes. And, in a highly competitive business environment, a corporation cannot always pass those taxes on to its customers.
Three important areas in which federal corporate taxes require reform are
A tax credit narrowly focused to benefit only one industry is a subsidy, "corporate welfare". Such credits have been found to violate international trade treaties. All such credits must be eliminated.
On the other hand, credits that are broadly applied across all businesses — such as credits to hire the handicapped or to install energy-saving equipment — should be retained. However, a corporation should not be allowed to offset more than 10% of its federal tax obligation through such credits. Excess credits should be carried forward into subsequent years.
As with corporeal persons (individuals), those businesses that prosper under our form of government must pay taxes to support our government; and those businesses that prosper disproportionately should pay disproportionately. However, while the prosperity of an individual can be measured by his or her income, corporate prosperity is measured by profitability.
Two measures of profitability are profit margin (profits divided by revenues) and return on equity (profits divided by the company's net worth). Both are usually expressed as a percentage.
No absolute percentage for either measure of profitability is a valid indicator of how prosperous a company is. Both measures must be taken relative to the profitability of other corporations. A company is considered very profitable if its profit margin or return on equity is above average. I propose that corporate income taxes be based on both relative measures.
Using data from corporate tax returns, the IRS should determine brackets for each measure of profitability: the bottom 10% of all corporations (by count), the next 20%, the middle 40%, the next 20%, and the top 10%. The tax would increase or decrease in 5% steps for corporations that are above or below the middle range according to the following chart, which assumes a tax rate of 30% for corporations with average profitability.
| Profit Margin | Return on Equity | ||||
| bottom 10% | low 20% | middle 40% | high 20% | top 10% | |
| top 10% | 30% | 35% | 40% | 45% | 50% |
| high 20% | 25% | 30% | 35% | 40% | 45% |
| middle 40% | 20% | 25% | 30% | 35% | 40% |
| low 20% | 15% | 20% | 25% | 30% | 35% |
| bottom 10% | 10% | 15% | 20% | 25% | 30% |
Note that, unlike the individual income tax rates in which the tax rate for each bracket applies only to the income in that bracket, each of these rates apply to all income for a company if that company falls within a given bracket. Losses carried forward from prior years would offset taxable profits only after the bracket is determined, thus discouraging the practice of shifting revenues or costs from one year to another for tax purposes.
This chart means that a company with a low profit margin but high return on equity (e.g., a supermarket chain) might pay the same rate as a company with a high profit margin but low return on equity (e.g., a freight railroad). Overall, this would implement the concept.
With the brackets based on year-old data, economic cycles will be moderated to an even greater extent than with personal income taxes. For example, during a recession with corporate profits falling, it might be possible that no company falls in the 50% or even 45% brackets.
Companies that pass their prosperity to their owners should get a break. Eliminate the recently enacted — and excessively confusing — reduction in taxes on dividends. Instead, a company that pays 30%-40% of its current profits to its owners as dividends should have its tax rate reduced 5%; a company that pays more than 40% of its profits as dividends should have its tax rate reduced 10%. This would mean that a company in the very top bracket might pay taxes of 40% instead of 50%; if that company paid 41% of its profits in dividends, it would keep 20% of its profits after taxes and dividends to invest in expanding its business. This rate reduction should not apply to a company in the very bottom bracket, which is performing too poorly to pay significant dividends according to both measures of profitability. (Remember: Dividends do not reduce taxable corporate profits; taxes are computed on before-dividend profits.)
Note that this structure of corporate income taxes would create incentives for companies to share their prosperity with customers (by keeping prices low) and employees (by keeping payrolls and compensation high). These tend to reduce profitability and thus the tax rate, and a slight reduction in profitability (e.g., dropping just below the top 10% in both measures) could save a corporation a significant amount of taxes.
Congressional investigations have already documented how corporations operating in more than one nation often fail to pay their fair share of federal corporate taxes. It is so very simple.
Consider the fictitious PDQ Company, with operations in the U.S., Italy, and the Philippines. The company ships raw materials to the U.S. from the Philippines, overcharging itself. This results in higher U.S. costs and thus lower U.S. profits. The company then ships finished goods from the U.S. to Italy, undercharging itself. This results in lower U.S. revenues and thus lower U.S. profits.
Add to this situation, companies incorporate in offshore "tax-shelter" nations, eliminating profits that cannot be attributed to being earned in a single nation.
California has a solution to this. Taking the ratio of in-state sales to total sales, California assesses the same ratio on total profits as being earned within the state.
The existence of luxury cruise lines basing their ships in U.S. ports without paying U.S. taxes and the move by several large, publicly-held companies to reincorporate in the West Indies are flagrant abuses of our tax laws. If companies expect to receive protection under U.S. laws, we must change taxation of world-wide corporate profits to ensure they pay for that protection in proportion to how much of their overall business occurs within the U.S., measured by the amount of sales in the U.S. For telephone, Internet, and other electronic sales, sales in the U.S. would be determined by where the purchasers are. Not only will this end the abuses of offshore companies doing business in the U.S., but it will also ensure that multinational companies incorporated in the U.S. pay a fair share of taxes on their world-wide profits.
31 March 2004
Updated 25 December 2012
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