Friday, April 12, 2019

Issues posed by Senator Warren's Real Corporate Profits Tax

Here is a list of some of the main issues that I see as being posed by Senator Warren's Real Corporate Profits Tax (RCPT) proposal:

1) How high should the overall effective corporate tax rate be? - Adopting the proposal, against the steady state background of current US. corporate income tax law, would affect the overall effective U.S. tax rate faced by companies subject to the tax. Included in this are the effective tax rate on U.S. companies' foreign source income (outbound), and on foreign corporations investing in the U.S. (inbound, insofar as the provision applies to them). These aspects are of course distinguishable from each other, at least in principle.

Broadly speaking, any overall effective tax rate on any of these aspects could be accomplished with or without the RCPT.  (Of course, exactly who and what will pay how much inevitably depends on the mix that is employed between the existing corporate tax and the new proposed instrument.) But while the pure structural question is simply what use to make of each instrument, given one's overall target effective rates, in practice, and at least in the short run, adopting the RCPT would result in particular levels for everything given the background set of institutions.

2) Big companies versus small companies - With its zero bracket up to a given amount ($100 million of profits in the current proposal), this introduces a kind of rate graduation to the corporate tax. It's often agreed that the corporate tax rate ought to have a flat rate, since marginal utility isn't really an issue at the entity level (it pertains to individuals, who can own stock in either large or small companies). But there are a couple of rationales for having a higher tax rate for very large companies. One is that they are likely to be better at tax avoidance than small companies, so this might tend to level the playing field, albeit via the imposition of a somewhat arbitrary line. A second is that these companies might tend to have more rents and monopoly power than the smaller companies, justifying a higher tax rate (although, again, the sieve being used is imperfect) on efficiency grounds.

3) Public companies versus private companies - The RCPT's application to non-publicly traded companies is limited by the zero bracket. But for private companies that are big enough to be subject to it - and might one need consolidation rules to ensure that commonly controlled siblings are treated as the same company? - reported profits can still be given a coherent meaning, but may be significantly less of a constraint than it is for public companies with managerial agency costs.

4) Managerial incentives issue - Clearly one of the proposal's main virtues is what I called its metaphorically "Madisonian" character in my Georgetown Law Review piece on taxable income and financial accounting income. Madison wanted to set one distortionary interest against another in order to prevent the polity's being captured by any of them. Here, it's different incentives of the same people: the corporate managers who want to lower taxable income while raising financial accounting income. They face an internal contradiction in accomplishing all their aims, rather than being set against someone else, but in an optimistic view the benignity of the result might be the same.

But it's certainly not the ideal to have financial accounting decisions affect tax liability. It's a second-best kind of argument that one is making here, and  there are certainly settings in which managerial incentives might be worse given the proposal than without it.

5) Political incentives issue - One of the RCPT's virtues is its taking part of the effective corporate tax base out of Congress's direct control - if Congress is willing to let things stay like that! But obviously the concern is that it will either start monkeying with financial accounting itself, or that it will start enacting RCPT exceptions from treating financial accounting income as taxable. The former risks harm to the information that public capital markets use, and the latter risks unwinding the RCPT, much as the corporate alternative minimum tax enacted in 1986 (partly based on the hope that it would lack the tax preferences in the regular corporate tax base) unwound as exceptions to it were enacted. It's fundamentally hard to overcome our having a flawed political system in which public understanding and accountability are so low, and in which interest group politics frequently drives the bus.

6) Integration between the systems - I'm glad that the RCPT is simply an add-on tax rather than a minimum tax (like the corporate AMT, or the BEAT in international tax). Minimum taxes tend to create unneeded complications that aren't worth the candle. But one could argue against my view that a minimum tax structure would tend to level the playing field so far as big companies paying different regular tax effective rates was concerned.

7) Other structural issues within the RCPT - As I noted in my prior post on the topic, there is the question of how to treat companies with fluctuating reported profits. Even apart from the issue of reported losses in one year and profits in another, what about "wasting" space in the zero bracket because one falls short of it some years while going above in others? There are doubtless more structural issues lurking here as well.

To repeat where I stand, I consider the RCPT a very interesting proposal that is potentially worth adopting, except we don't really know for sure just yet (and of course we'll never know with high confidence, other than perhaps if it is adopted and we get to observe its trajectory). Hopefully it will be debated by thoughtful people over the next year-plus, with the effect of improving our understanding of whether to do it, and if so how.

3 comments:

Andrew said...

A couple of additional issues from a longtime occasional commenter (been reading your blog since I was a law student in the mid 2000's (!))

1) GAAP tends to result in lower reported profits relative to economic profits in fast-growing/tech-heavy industries, such as subscription businesses investing heavily in customer acquisition, or tech firms investing heavily in R&D (generally expensed under GAAP though often capitalized under IFRS). Might not want to introduce a system that discriminates among industries that are disproportionately hit by GAAP inconsistencies.

2) One of the nice things about GAAP is that it is generally a conservative but realistic reporting system. There are areas where it is arguably "too punitive" (e.g., expensing of certain costs that arguably should be capitalized like I alluded to above), but it is relatively rare that GAAP results in income overreporting. If you start introducing incentives to suppress GAAP profitability further, you arguably start to undermine the public good of widely available "conservative but realistic" financial disclosure. #4 alludes to this but it's not just distortion of incentives, its the value of financial reporting as an analysis tool.

As many have pointed out, wouldn't it be a lot simpler (and raise comparable revenue) to simply raise the statutory rate a couple of points where we'd still be below the OECD median, or just broaden the base a little?

This reads like an attention stunt meant to grab a news cycle and distract from Warren's prpfound challenges in the polls (which is unfortunate as she is certainly brilliant and probably the most thoughtful of the candidates). Feels like she missed her window/political career started too late.

Jeff said...

There is a good bit of evidence that under the BURP, in the late 1980s, firms simply manipulated their income to avoid tax. See the papers here:
http://www.jeffreyhoopes.com/taxingbookincome.htm
And that was the 1980s where firms had far fewer channels with which to convey non-GAAP income to investors. It seems pretty easy to understate book income, and signal some other way. GAAP loses its relevance, and we have a much less regulated financial accounting system.

Daniel Shaviro said...

Thanks, Jeff. All that is of interest & I'll be reading those items.