Ethics & Corporate Taxes

How much tax do corporations pay? Ask most people and I’m guessing they’ll say “not enough.” But seriously, how many people know what the actual corporate tax rate is? And then complicating things, there are the loopholes, those little tricks o’ the accounting trade that — as “everyone knows” — allows most big companies to pay next to nothing. Right?

For insight into these questions, see this useful piece by David Leonhardt, for the NY Times: The Paradox of Corporate Taxes.

OK, so a few answers. In the US, the federal corporate tax rate is 35%. (For comparison: in Japan it’s just over 40%, in Germany it’s 29.8%, and in Canada it’s 16.5%. In Ireland it’s just 12.5%.) So, on an international scale, the US corporate tax rate is actually fairly high. (For more, see Taxes Around the World.)

What about those loopholes? Sure enough, there are American companies that manage to dodge almost all taxes. The most egregious examples are from the cruise-line industry. As the NYT story points out, Carnival Cruise Lines is a prime example:

Over the last five years, the company has paid total corporate taxes — federal, state, local and foreign — equal to only 1.1 percent of its cumulative $11.3 billion in profits. Thanks to an obscure loophole in the tax code, Carnival can legally avoid most taxes.

That’s an extreme case, but lots of other companies manage to avoid paying anything close to the full 35% too. According to the NYT:

Over the last five years, on the other hand, Boeing paid a total tax rate of just 4.5 percent, …. Southwest Airlines paid 6.3 percent. … Yahoo paid 7 percent; Prudential Financial, 7.6 percent; General Electric, 14.3 percent.

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What’s more surprising, though, is how much tax corporations pay, in total, on average:

The average total tax rate for the 500 companies [in Standard & Poor’s stock index] over the last five years — again, including federal, state, local and foreign corporate taxes — was 32.8 percent.

So while some corporations pay very little tax, there’s also considerable variation.

From an ethical point of view, is this situation fair? Do corporations, in general, pay enough? Too much?On the face of it, that’s a basic issue of distributive justice: is 35% (or some fraction of that, after deductions) the right share of the overall tax burden for corporations (as opposed to individuals) to bear? That’s obviously a big question.

Fundamentally, corporations are a conduit, facilitating the flow of cash from consumers to employees and investors. To some, this implies a fundamental criticism of current patterns of taxation in the corporate world. Such critics point out that there’s a sense in which the money that flows through corporations is taxed twice: corporate profits are taxed, and then any dividend (i.e., a portion of after-tax profit) that is payed out to shareholders is taxed, too. In principle (as far as I can see) the same could be said about the money paid out to employees in the form of salaries (though the tax on profits is paid on the amount left over after expenses, including salaries, are paid). To the extent that I understand it, this criticism seems odd to me: after all, money flows around (and around and around) the economy, and is taxed at various points along the way (and is then injected back into the economy, of course, in the form of government spending). The point is that we (via government) levy taxes at specific points in this flow, and at specific rates, based on whether we want to encourage or discourage particular behaviours. If you tax a behaviour, then, other things being equal, people will do less of it. And if you offer a tax deduction for y, you are encouraging people to do more of it. We tax at various points in the corporate “process”, if you will, in order to encourage or discourage particular activities like investment. So in a sense, there is no “corporate share” of the tax burden — there’s just the question of whether various taxes and deductions operating in the corporate world broadly understood are effective in achieving our goals. (Although there is a question of justice regarding any difference in the way dividends are taxed as opposed to employment income.)

But again, back to the issue of loopholes as a way of reducing a corporation’s tax burden. Now, it’s worth considering the point of loopholes, from a public policy point of view. In some cases, at least, “loophole” is just the pejorative term for a tax exemption or deduction that a government has put in place to encourage or deter certain kinds of behaviour: deductions for investments in equipment or buildings are an example of this. But you don’t have to be either a tax lawyer or even a keen observer of politics to guess that some such mechanisms are astute ways for government to mould the economy, whereas others are almost certainly boondoggles resulting from savvy corporate lobbying. Then, of course, there’s also the question of gaming the system. A particular incentive (or loophole) might have been put in place for sound public-policy reasons, yet be abused by corporations as a way of dodging taxes (say, by investing in new equipment in order to reap a tax benefit and then selling the equipment off as soon as it can within the letter of the law). The most obvious ethical litmus test here is the “intent-of-the-law” test. It is prima facie unethical to misuse a tax deduction that is intended to be socially beneficial in a manner that is cynically aimed at simply minimizing corporate tax burden.

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p.s., I’m not an accountant or tax lawyer. If anyone with relevant expertise can correct any of the factual assumptions above, please do help out. Thanks.

7 comments so far

  1. Dan Wheeler on

    Carnival only pays 1.1%?!?! What kind of loophole would allow this?

    Dan
    Josephson Institute
    Business Ethics Training

  2. Jack Marshall on

    “It is prima facie unethical to misuse a tax deduction that is intended to be socially beneficial in a manner that is cynically aimed at simply minimizing corporate tax burden.”

    A spectacular example of a non-lawyer’s way of looking at things!

    I’m sympathetic, but isn’t is asking a lot to require the objects of tax laws to use them in ways that minimize poor drafting? If your quote above is true, do you also believe that it is unethical to take advantage of a tax benefit that is intended to be socially beneficial but that in fact is terrible policy and doesn’t accomplish what it supposed to accomplish? A U.S. tax lawyer will tell clients that he, she or it has a right to every legitimate tax deduction the law allows, and recommend that the client structure finances to qualify for as many of those deductions as possible. Are you really saying that is per se unethical, Chris?

  3. Chris MacDonald on

    Jack:

    Yeah, I think I’ll stand by that claim until someone shows me why not. I did throw a “prima facie” in there, just to hedge my bets a bit. The law in general provides us with many legal options, not all of which are ethically good. There are contracts that you ought not seek to have enforced, and trespasses which you ought not seek to have punished. Using deductions in ways that simply let the company avoid paying its fair share (while not doing the socially-beneficial thing the deduction was set up to promote) seems unjust to me.

    (Note that I’m not saying it’s unethical of the tax lawyer to avise their client that way — the ethical obligations that go with their job are different from the obligations of their client.)

    Chris.

  4. Wayne Norman on

    I wonder whether there is a morally relevant relation/difference between exploiting a legal market failure and exploiting a legal tax loophole…

  5. […] MacDonald, The Power of Critical Thinking, 2nd Canadian Edition, Oxford University Press, 2010. « Ethics & Corporate Taxes LikeBe the first to like this […]

  6. […] so quick. As I’ve argued before, what we commonly call “loopholes” are in most cases the result of some decision by […]

  7. […] not tax,” that’s not always quite true. And the ethics of it all is actually quite complicated. But anyway, here it is: […]


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