Playing to antibusiness sentiment, the group of the world's most advanced economies—the Organization for Economic Cooperation and Development (OECD)—has been campaigning against corporate "tax abuse." According to a senior OECD official, "The goal of the action plan is to close down the avenues [for abusive tax planning] that we have left open." The targets of the OECD campaign are multinational corporations that lower their global tax bills by reporting intellectual property income (patents, copyrights, and trademarks) in low-tax jurisdictions like Ireland, Switzerland, and Bermuda. The OECD's action plan was endorsed two weeks ago at the G-20 finance ministers meeting in Moscow, and they promised to implement it over the next two years.
Almost by definition, "tax abuse" seems equivalent to "child abuse." But if we correctly name the behavior at issue by substituting "tax avoidance" for "tax abuse," the door can be opened to reasoned debate. Every household and company is entitled to study the tax code to minimize its tax burden. That's garden variety "tax avoidance," practiced every year by millions of households and companies. The public policy question is whether corporate tax planning is so extreme and leads to such low tax payments that it deserves to be characterized as "abuse."
Individual examples of corporate tax planning can be so convoluted, leading to such low effective rates, that the "abuse" label seems well deserved. But the label seems far less appropriate when the entire system of corporate taxation is examined. The OECD campaign fails to highlight the fact that, in most countries (including the United States), corporate profits are taxed twice—first at the corporate level, then at the shareholder level. The result is a combined effective tax rate that often exceeds 40 percent. In the United States, the combined rate exceeds 50 percent.
The answer to burdensome taxation that depresses corporate investment outlays is to reduce the corporate tax rate—particularly in high-tax countries like the United States and Japan—in the same legislation that closes down avenues for abusive tax planning. President Barack Obama took a step in the right direction on July 30 with his announcement that he would agree to cut corporate tax rates in return for a commitment from Republicans to invest in middle-class jobs.
The OECD campaign also fails to highlight two other broad features of corporate taxation that lead to severe misallocation of capital. One is the general deductibility of interest expense, a feature that clearly encourages debt rather than equity financing. Greater parity between debt and equity would require some deduction of dividend payments and some inclusion of interest payments in the corporate tax base. The other broad feature is the growth of "pass-through" entities, particularly in the United States. These entities, such as cooperatives and master limited partnerships, including many prominent private equity firms, pay no corporate tax and thereby enjoy a tremendous tax advantage over normal Subchapter C corporations. Thirty years ago, in the United States, "pass-through" entities accounted for less than 20 percent of business activity. Now they account for more than 50 percent.
Anyone following press accounts cannot help but notice repeated denunciations of iconic US corporations—Apple, Google, Starbucks, Amazon, and others. This is no accident. US-based multinationals face the highest statutory corporate tax rates in the world and are most exposed to home-country taxation of income earned abroad. It is no wonder they use creative tax planning to bring their global effective corporate rate closer to the level faced by competitors headquartered in the United Kingdom, Germany, Canada, and other home-base countries. Treasury Secretary Jacob Lew will severely hamper US-based multinationals unless he pairs "antiabuse" measures with rate cuts and other reforms that do a much better job of matching US tax burdens with contemporary burdens abroad.