President Joe Biden's plan to spend $2 trillion on infrastructure was noteworthy not for proposing trillions of dollars in new spending—that's now par for the course in Washington—but for proposing commensurate tax hikes as well. The corporate taxes that Biden laid out are likely to be popular among Americans constantly bombarded by stories about large businesses with low tax burdens. But the increases will do real damage to the economy.
Whenever a new story comes out about "profitable" corporations not paying taxes, it almost invariably can be traced back to the Institution on Taxation and Economic Policy (ITEP). This is the advocacy group that launched that round of articles about Amazon paying zero federal income taxes a couple years back, and it just put out a report declaring that 55 large American corporations with "pre-tax profits" are getting away with paying no federal income tax.
A corporation's book profits are actually an unhelpful metric when it comes to assessing what its tax liability should be. While the tax code is far from perfect, many deductions and credits that reduce liabilities serve an important purpose and help make the tax code fairer. Calculating a corporation's income before factoring these in makes as much sense as complaining that a kid with a summer job gets to avoid paying regular income taxes because of the "standard deduction loophole."
For example, consider net operating loss (NOL) carryforwards and carrybacks, one of the most common culprits behind these sensational headlines. These are normal features of a smart policy that allows corporations to pay taxes based on a realistic view of their cash flow over time.
Imagine a start-up business that spends two years developing its feature product, only to release it in the next year. If that business ran a deficit of $2 million the previous two years, then made a $1 million profit the third year, it has not actually made a profit in the long term. Disallowing NOL deductions from being carried forward would mean that the business would face corporate income tax liability despite having, thus far, lost money.
Failing to understand this simple calculation has led to a lot of confusion. Last year's Coronavirus Aid, Relief, and Economic Security (CARES) Act undid a limitation on carrybacks that was included in the 2017 tax reform law to make the tax reform bill's budget math work for reconciliation. The New York Times quickly blasted the CARES Act provision as a "bonanza for rich real estate investors."
Democrats had also included language in many bills expanding the use of net operating losses. That didn't stop dozens of Democratic legislators from trying to rile up their base with a letter to Speaker Nancy Pelosi (D–Calif.) calling these changes "giveaways" and "gimmicks."
NOL carryforwards were one reason Amazon had no federal tax liability when those articles appeared a couple years back. Another was the research and development (R&D) tax credit, long a bipartisan favorite. The Obama administration in 2012 identified the R&D credit as a crucial element of business tax reform, claiming that businesses undervalue R&D in the absence of the credit as the social benefit is far greater. It's deeply disingenuous to incentivize R&D, then wag your finger when businesses respond to the incentives the R&D credit provides.
Then there's accelerated depreciation. One of the most positive changes in the 2017 tax reform law was the introduction of full expensing of capital investments, which allowed businesses to bypass the complicated system of asset depreciation that requires them to recoup the value of capital investments over timelines as long as decades. Huffing and puffing that businesses use full expensing to zero out their tax liabilities is absurd, because it merely accelerates tax deductions businesses would receive anyway. In other words, the long-term "cost" of accelerated depreciation in terms of revenue reduction is zero. The difference is that businesses, which prefer cash on hand to cash down the line, are then able to reinvest the value of the deduction immediately rather than waiting years to receive the tax benefit.
Any company that receives a tax benefit for capital investments is by definition engaging in the type of business activity liberals say they want to see. If corporations follow the tax code's incentives, they get hit for not paying enough taxes; if they don't, they get slammed for not contributing to economic growth.
The purpose of these reports is to lay the groundwork for corporate tax increases, as we are seeing with Biden's infrastructure plan. Corporate taxes are popular because many voters don't believe corporate taxes affect them, but they are mistaken. Corporate tax rates are directly linked to wage growth, and labor bears 70 percent or more of the cost of the corporate tax through lower paychecks.
Biden's corporate tax changes would also work against efforts to make the American tax code more competitive. Not only would he make the combined federal and state corporate tax rate the highest in the industrialized world, but he would undo the 2017 tax reform law's efforts to bring the U.S. in line with other countries' tax treatment of foreign corporate tax income. Returning to an antiquated "global" tax system would only encourage more companies to shift their headquarters to another, more business-friendly nation.
Americans shouldn't be fooled by this full-court media press. The case for these tax hikes is built on a flimsy understanding of tax policy, and the increases would end up hurting American workers.