How High US Corporate Tax Rates Hurt the Economy by Gary D. Halbert

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert

September 30, 2014

IN THIS ISSUE:

1.  US Gross Domestic Product Rose Healthy 4.6% in the 2Q

2.  “Tax Inversion” Increasingly Popular for US Corporations

3.  How the 35% Corporate Tax Rate Stifles the Economy

4.  Obamacare Architect: 75 Years is Long Enough to Live

Overview

The US corporate tax rate is the highest among developed nations at 35% at the federal level. Tack on state and local taxes, which can add 5-7%, and US corporations are looking at a 40%-42% income tax burden. But the US takes it even another step further, unlike any other country in the developed world.

Uncle Sam demands that American companies with offshore operations pay US taxes on all income earned abroad – if those profits are repatriated to the US – even though taxes have already been paid to the countries where the income was actually generated. Think of it as double taxation on profits.

No wonder then that more and more US corporations with offshore operations are keeping those profits outside the US in order to avoid this double taxation. It is estimated that up to $2 trillion of those foreign profits are parked outside the US. That is a ton of money which, if brought home, could result in lots of new projects that could create many new jobs.

With an obligation to their shareholders to maximize profits, large US corporations are increasingly taking additional steps to minimize taxes owed to the Treasury in a process that has been coined “tax inversion” as I will explain below. This involves US firms moving their corporate headquarters overseas to countries where the tax burden is lower.

Today, we’ll explore how the extraordinarily high US corporate tax rate hurts the economy and why more and more large American corporations are moving their headquarters offshore. And we’ll look at why the Obama administration is trying to stop it – when all it would take to fix it is the US lowering its tax burden to a more reasonable level. But no, Obama wants to raise corporate taxes even more. This should make for an interesting E-letter.

But before we get into that discussion, let’s take a quick look at last Friday’s third and final report on 2Q Gross Domestic Product.

US Gross Domestic Product Rose Healthy 4.6% in the 2Q

In its third and final estimate of 2Q GDP, the Bureau of Economic Analysis (BEA) reported last Friday that the economy expanded by 4.6% (annual rate) in the April to June quarter, up from 4.2% estimated late last month.

The gain of 4.6% is the strongest since the economic recovery began. But don’t break out the champagne just yet. Much of this growth is simply catching up from the 1Q when severe winter weather led the economy to contract at an annualized pace of 2.1%. The cold weather, it seems, led spending to be deferred a quarter, rather than canceled.

For the first half of this year, the economy expanded at an average rate of only 1.25%. That’s not only slower than the rate through most of the recovery but is also so disappointing that if it persists, it will lead to unemployment rising again. Fortunately, most forecasters expect growth of 2.5%-3.0% for the second half of the year.

All government reports have their strengths and weaknesses, as does the GDP report. Some economists prefer to look at a separate report within the GDP report called “Gross Domestic Income,” which is calculated by adding up everyone’s income, rather than everyone’s spending.

Corporate Tax Rates

 

Because every dollar that you spend also registers as income for someone else, the two measures should, in theory, yield identical estimates. But in reality, Gross Domestic Income is measured using somewhat higher-quality data, and so it tends to yield more reliable signals. Using this measure, the economy expanded 2.2% in the first half of this year, a little better than the first half GDP rate of 1.25%.

“Tax Inversion” Increasingly Popular for US Corporations

By now, you’ve probably heard the term “tax inversion.” You may have even heard President Obama criticize it as “unpatriotic” on the part of US corporations who do it. Tax inversion is the term used to describe transactions that occur when a US corporation buys or merges with a foreign entity and moves its official headquarters offshore in order to achieve more favorable taxation.

In most circumstances, the foreign company purchased is considerably smaller than the US corporation, and the larger firm’s core operations and personnel stay in the US. The tax savings on offshore profits can be substantial, and as of now tax inversion is perfectly legal.  The inversion does not affect the taxes paid on profits generated within the US.

Two of the main reasons companies undertake the inversion are to obtain the lower tax rates in the foreign country and escape the US worldwide corporate income tax.  As noted above, when state and local taxes are included, the US corporate tax rate becomes 40%-42%.  That is the highest rate of all the major world economies.

The second reason is that most other countries only tax profits that are earned inside their own borders. The US, on the other hand, applies its tax rate to corporate profits no matter where they are earned.  If corporations want to invest overseas profits back home (after taxes were already paid to a foreign government), they have to open their checkbook again to pay even more taxes to the US Treasury.

While the current administration would like to stop the tax inversion process completely, it would take new laws from Congress. Since that is not likely to occur, the Treasury Department last week announced new changes in the way it is interpreting current tax law as it pertains to inversions in an effort to make such transactions more difficult and less lucrative for US corporations. In a very aggressive stance, the new rules took effect immediately.

In effect, these aggressive new rules by the Treasury represent just another job-killing Executive Order by the president, since he no doubt approved them. As such, these new rules are almost certain to be challenged in court. Even if they stand, it remains to be seen if the new and complicated Treasury rules will work.

Most Republicans and even some Democrats agree that the reason more US corporations are  increasingly considering tax inversion is because the US corporate tax rate is simply too high. In addition, our tax code is far too complex and needs to be broadly reformed.

President Obama and liberals in Congress refuse to admit that US corporations are in business to make profits for their shareholders, and patriotism is not really an issue here, especially when inversion is perfectly legal.

The easiest way the president could stop tax inversions would be to declare a moratorium on the double taxation for overseas profits. These profits, which are estimated at up to $2 trillion, could be quickly repatriated to the US. But that is not an option for this president.

So much for the issues related to tax inversions. Now, let’s tackle the problem of the US corporate tax rate of 35% at the federal level, which is

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