As Senator Warren notes, recently “Amazon reported more than $10 billion in profits and paid zero federal corporate income taxes. Occidental Petroleum reported $4.1 billion in profits and paid zero federal corporate income taxes.” Under her plan, “Amazon would pay $698 million in taxes instead of paying zero. And Occidental Petroleum would pay $280 million in taxes instead of paying zero.”
Such disparities between the income and accounting measures are multicausal. Sometimes there are just timing swings between years. Also, the income tax allows net operating losses (whereby loss years can offset the tax due in gain years), as in the case where a company loses $10 billion in Year 1 and makes $10 billion in Year 2. The financial accounting measure is for worldwide income, including that earned abroad through foreign subsidiaries. But also, the managers of publicly traded companies notoriously, at least in some cases, engage in complicated maneuvers to raise financial accounting income while lowering taxable income. The latter is likely to be in the shareholders’ interest but not necessarily the country’s. The former serves managerial goals but is potentially harmful to the aims of financial accounting, which is supposed to provide the capital markets with reliable information.
I gather that the proposal may also attempt to discern and tax inbound, U.S. source profits by foreign corporations, as measured for financial accounting purposes, and subject them to the tax as well.
I have long thought that the interplay between corporate managers’ sub-optimal incentives – i.e., to inflate financial accounting income and unduly reduce taxable income (such as through aggressive tax avoidance transactions) – creates a potentially fruitful opportunity for the U.S. federal income tax system to graze two birds with one stone. If managers have difficulty doing both at the same time – e.g., if raising financial accounting income has adverse tax consequences for them – it’s possible that the overall incentives that they face will be improved. It’s true that this creates pressures on financial accounting choices that, all else equal, would be undesirable. But financial accounting experts who make this point – and they tend, in my experience, to hate proposals of this kind! – need to consider as well the fact that this bias may potentially offset an opposite bias that they know quite well is there.
In sum, while financial accounting is not inherently well-designed as an income tax base, its use in a very secondary fashion, a la the Warren proposal with its 7% rate (I might prefer 5%) and its $100 million exemption amount (which I’d consider increasing), has the virtue of offsetting existing imperfections in both systems. One danger, however, is that having tax consequences depend on financial accounting would cause interest groups, through Congress, to bring their dark arts more to bear than they have already on distorting how financial accounting income is measured.
I discuss these sorts of issues in this article, the final version of which appeared (here, but possibly behind a paywall for some readers?) in the Georgetown Law Journal.
One issue to think about in relation to the Real Corporate Profits Tax is the equivalent of income averaging. E.g., what should be the result if a company has, say, $80 million of reported profits in Year 1, $200 million in Year 2, and $80 million in Year 3. Should the company just pay $7 million (i.e., 7% of the excess over $100 million) in Year 2? Should there be an adjustment in Year 2 for Year 1? In Year 3 for Year 2?
People in the Warren campaign asked me what I thought about the proposal, and I replied as follows:
“This is a serious proposal that has a lot of merit, and that deserves further debate. It addresses several problems at once – in particular: (1) the excessive size of the unfunded corporate tax cut that Congress enacted in 2017, (2) possible under-taxation of both outbound investment by U.S. firms and inbound investment by foreign firms, and (3) the socially undesirable incentive that public companies’ managers have to overstate their companies’ book earnings.
“It also has the potential to raise revenue from the upper tier of the corporate sector without putting Congress even further into the business of picking winners and losers as between industries, and without magnifying the importance of existing distortions in the corporate tax base.”