By Edward Alden and Rebecca Strauss
FORTUNE -- The U.S. system for taxing corporate profits is outdated, ineffective at raising revenue, and creates perverse incentives for companies to shelter profits overseas. It is also, for most U.S. companies most of the time, a pretty good deal, which is one of the big reasons why any serious overhaul will be so difficult to achieve.
The quick opposition that greeted the ambitious reform plan released a month ago by Republican Ways & Means Committee chairman Dave Camp, who last week announced he would retire from Congress, was chalked up to the usual array of special interests. But the broader problem is that U.S. companies, particularly those that compete in international markets, have adapted remarkably well to the current tax system. Indeed, the tax burden on U.S. corporations has fallen over the three decades since the last major tax overhaul, in 1986, even as corporate profits have been rising to record levels.
This is contrary to most of what we hear in the tax debate. Much of the attention is on the U.S. statutory tax rate, which at 39% combined federal and state average, is now the highest in the advanced industrial world. Most other countries have been aggressively lowering their statutory rates in an effort to attract investments.
But 39% is a highly misleading number. The average U.S. corporation actually pays roughly 27%, on par with what other corporations pay in similarly sized advanced economies, and this effective rate has been steadily declining since the 1980s. Part of the reason is that Congress has sweetened corporate tax breaks for specific industries, including deductions or credits for domestic production, capital investments, and research and development.
The biggest reason most U.S. companies are not disadvantaged is the way in which the U.S. taxes -- or mostly does not tax -- the overseas earnings of its corporations. Foreign profits now account for more than 20% of total U.S. corporate profits -- double the figure of two decades ago, and that percentage is much higher for big multinationals that drive the debate over corporate tax. In practice, U.S. corporations rarely pay much in U.S. taxes on foreign profits because they receive credit for taxes paid to foreign governments, and are allowed to avoid any U.S. tax payments as long as those profits are retained abroad. Companies are also increasingly adept at sheltering profits in tax havens that collect little or no tax on corporate profits.
The best available estimate suggests U.S. corporations face an effective tax rate (including all foreign and U.S. taxes) of just 15.7% on foreign profits. Of that, the U.S. Treasury actually collects only 3.3%, since most profits are never repatriated. U.S. companies are currently holding about $2 trillion offshore, in large part to avoid tax liabilities.
U.S.-based companies often complain that the U.S. system, which in theory requires companies to pay taxes on their profits "worldwide," is a big competitive disadvantage. Most European countries have a "territorial" tax system, which taxes only domestically earned profits. But according to one study that calculated the global tax burden of the largest 200 European- and U.S.-based multinational corporations, U.S. corporations on average faced similar or lower effective tax rates than their European counterparts, though it varied by industry sector .
There are big problems in the corporate tax system, to be sure. Companies pay highly uneven effective tax rates depending on whether they qualify for tax breaks; research-intensive multinational companies like GE (GE), for example, usually face tax rates in the single digits, while retailers like Target (TGT) that depend on domestic sales pay close to the statutory rate. Companies with intangible assets like patents and trademarks, such as Apple (AAPL) or Pfizer (PFE), are more easily able to book profits in tax haven countries like Bermuda or Ireland. The largest tax havens account for 24% of reported foreign profits by U.S. multinationals, even though they represent just 1% of the global economy.
Deferral on foreign profits also creates incentives for companies to keep those profits offshore rather than re-invest them in the U.S., which is generating pressure in Congress for another "tax holiday" to encourage repatriation. Research suggests that deferral encourages corporations to invest more abroad than they otherwise would, though the effect is small. Other factors like lower wages, proximity to fast-growing markets, and government investment incentives matter much more for corporate investment decisions. Still, no country wants a tax system that in any way encourages foreign over domestic investments.
The prospects for a corporate tax reform that lowers the statutory rate and addresses some of these problems would seem brighter than they have in years. Both Republicans and Democrats have now developed comprehensive proposals that lay out the arithmetic for adopting different trade-off options in any agreement. But unfortunately the arithmetic may show that, for all their complaints, most U.S. companies -- and particularly those competing in foreign markets -- are doing pretty well under the current system. That is probably not a recipe for change.
Edward Alden is a senior fellow specializing in U.S. economic competitiveness at the Council on Foreign Relations. Rebecca Strauss is associate director of CFR's Renewing America publications series. This article draws on research for the CFR report "Standard Deductions: U.S. Corporate Tax Policy."
As governments coordinate to fix international tax laws on overseas earnings, companies may have to pay more taxes.
By Jack T. Ciesielski
FORTUNE -- Costless stock options. Lending to subprime borrowers. The irrelevance of earnings and cash flow for Internet companies because they can always tap capital markets. Those are some of the good ideas gone bad on Wall Street, all seemingly foolproof at first. Costless stock options warped earnings and MOREMar 31, 2014 1:14 PM ET
Unlike many previous Republican proposals to cut taxes, the Michigan congressman specifies how government would pay for them. This is critical, but it's not pretty.
By William Gale
FORTUNE – On Wednesday, U.S. Rep. Dave Camp (R-Mich.), chairman of the House Ways and Means Committee, unveiled an ambitious plan to overhaul America's complicated tax code. This is both a technical and a political feat. The number of changes is immense -- MOREFeb 27, 2014 2:41 PM ET
Corporate America needs to step up and pay its fair share, instead of using shareholder value as an excuse to dodge taxes.
FORTUNE -- At first glance, you would think that the CEOs of taxophobic U.S. corporations and our less-than-stellar leaders in Washington have nothing in common. But you'd be wrong. What they share is a lack of shame and an excess of narrow thinking.
The similarity between C-suite tax avoiders and MOREAllan Sloan, senior editor-at-large - Oct 30, 2013 5:00 AM ET
Oracle, Google, and Amazon are just a few of the hundreds of large companies that have cut confidential deals with the IRS to help lower their tax bills, and critics want the agency to disclose the details of these complex pacts.
By Lynnley Browning
FORTUNE -- When Oracle reported its latest quarterly earnings last month, most investors focused on the fact that its dividend doubled. The number that got less notice MOREJul 22, 2013 5:00 AM ET
Tax writers have announced a "blank slate" approach to the tax code overhaul.
By Tory Newmyer, writer
FORTUNE -- Corporate tax lobbyists should cancel any vacations they planned to take next month. That's the upshot of a letter the Senate's two leading tax writers sent their colleagues today to put them on notice that their overhaul of the code is starting from scratch. In other words, every corporate carve-out -- for MOREJun 27, 2013 12:52 PM ET
More energy companies are converting to a tax-free status that was once reserved for a small segment of the industry.
FORTUNE -- More and more of the companies benefiting from new technologies that are fueling America's recent energy boom are paying little or no taxes.
In early May, Emerge Energy Services sold $127 million in shares in an initial public offering. Emerge (EMES) supplies sand to oil and gas drillers for blasting MOREStephen Gandel, senior editor - May 28, 2013 9:19 AM ET
Tax avoidance works beautifully -- and legally -- for Apple and other multinationals. Why not make it work for you?
FORTUNE -- It's faddish -- and fun -- these days to talk about the income taxes that Apple does or doesn't pay. Hey, as we learned this week from a Senate report and hearings, Apple's tax strategems are even slicker than its products are. Many of them involve the "intellectual property" MOREAllan Sloan, senior editor-at-large - May 23, 2013 5:00 AM ET
Businesses organized as partnerships account for 35% of all sales. So why are we taxing them at higher rates than other corporations?
By Stephen Chipman and Doreen Griffith
FORTUNE -- The top concern for certain business entities seeking to compete on a level playing field through tax reform has not yet been addressed.
Ways and Means Chairman Dave Camp has released a tax reform discussion draft that would simplify the tax rules for MOREMay 14, 2013 12:44 PM ET
A lower corporate tax rate won't deter companies from playing tax and accounting games. Just look at Apple's math.
FORTUNE -- There's a widely shared idea that if the U.S. reduced its corporate income tax rate to 25% from the current 35%, big corporations would stop playing tax games. They would then pour all their attention into profit-making rather than allocating a ton of talent to tax avoidance, and we would MOREAllan Sloan, senior editor-at-large - Apr 26, 2013 5:00 AM ET
|GM's recalled Cobalt was a failure from the start|
|Pope Francis challenges the free market - The Buzz|
|Why you should pay off your car loan ASAP|
|Americans have fallen in love with real estate once again|
|How young tech millionaires invest|