Tax Reform: Companies Balk at Closing Loopholes
Business + Economy

Tax Reform: Companies Balk at Closing Loopholes

iStockphoto/The Fiscal Times

House Ways and Means Committee chairman Dave Camp, R-Mich., chose a curious set of messengers to explain how the U.S.’s highest-in-the-world corporate tax rate is retarding investment and job creation in the manufacturing sector.

First up at a hearing Thursday was Diane Dossin, chief tax office for Ford Motor Co. Ford is the only domestic manufacturer that didn’t require a bailout by the federal government. Last year it posted a robust $8.7 billion profit on $136.3 billion in sales as the automotive industry continued its remarkable rebound from a near-death experience in early 2009.

“A low rate is the single most important thing” the federal government could do to improve the business climate, she told the committee. But when pressed by Rep. Charles Rangel, D-N.Y., to name which corporate tax breaks her company would eliminate in order to lower the overall rate without reducing revenue to the federal government, she demurred. In her prepared testimony, she lauded the research and development tax credit, accelerated depreciation and the special tax break for domestic manufacturing Congress passed in 2004.

“Ford understands that, in the current fiscal climate, achieving a lower corporate income tax rate is probably only possible if the tax base is broadened,” she said. “We also understand that base broadening does not come without attendant costs – costs that must be weighed against the relative value of a lower rate.”

Ford paid a grand total of $592 million in federal
and state taxes on $18.4 billion in pre-tax earnings,
which is an effective rate of 3.2 percent.

While manufacturers have been on the front lines of calling for lower corporate tax rates – the National Association of Manufacturers issued another statement Thursday calling for a revamped tax code that led to lower rates – the fact is that manufacturers are among the biggest beneficiaries of the exemptions and tax breaks in the current code. For decades, the fight to preserve and widen those exemptions has frustrated efforts at reform even as manufacturing employment lost ground.

Ford’s most recent Securities and Exchange Commission filing reveals the extent to which one company can benefit from the current code. The company paid no income taxes last year at either the federal or state level despite nearly $9 billion in earnings. In fact, it enhanced its balance sheet by an additional $11.5 billion from previous losses that gave the company an effective tax rate of negative 141 percent.

The taxman’s take doesn’t improve if one looks back three years, all of them profitable for Ford. The company paid a grand total of $592 million in federal and state taxes on $18.4 billion in pre-tax earnings, which is an effective rate of 3.2 percent. That is well below the 39.2 percent tax rate highlighted by Camp in his opening statement (a 35 percent federal rate plus a blended state rate of 4.2 percent).

Looking ahead, it will probably be at least two more years before Ford pays taxes. Buried in the SEC document footnotes, the company reported it still has nearly $21 billion in deferred tax credits on its books. ”From a cash standpoint, for the next few years, Ford will continue to offset its U.S. taxable income with losses sustained and tax credits earned in the last decade,” Dossin wrote in her prepared testimony. “However, the day is fast approaching when Ford will make substantial cash payments to meet its corporate income tax obligations in the U.S. – at the world’s highest statutory rate.”

Next up was Henry W. Gjersdal, vice president for tax at 3M. “We support the chairman’s proposal to reduce the rate to 25 percent; a rate which is more in line with other developed countries,” he said. However, 3M also wouldn’t benefit from lowering the rate, since the new combined federal and state rate of 29.2 percent would exceed the 28.3 percent in taxes 3M paid last year on its $6 billion in corporate earnings, according to its annual report filed with the SEC.

Corning Inc. from upstate New York was the final big company to testify. Vice president Susan Ford echoed her colleagues’ claim that “a substantial reduction in the statutory tax rate is critical . . . A significant rate cut accompanied by a review of existing, often inefficient, tax benefits is in order.”

She also remained silent when the panel was pressed by Rangel to name which inefficient tax breaks to eliminate. Corning paid an effective tax rate of 12.7 percent last year after earning $3.2 billion on $7.9 billion in sales. Its tax rate in 2010 was 7.5 percent on $3.8 billion in profits. And in 2009, the company paid no taxes at all on $1.9 billion in earnings and even carried forward $74 million in unused tax credits.

There was also testimony from two small business owners who file as S-corporations, which requires the sole proprietor to pay taxes on the business at individual rates. While those rates are currently the same as the corporate rate (35 percent), they will revert to 39.6 percent in 2013 if the Bush-era tax cuts expire or President Obama gets reelected and succeeds in eliminating the decade-old tax reductions for families earning over $250,000 annually.

“It would directly impact investment; it would be negative for us,” said Ralph Hardt, president of Jagemann Stamping Co., a 300-employee firm based in Manitowoc, Wis. “There’s a lot of noise in Washington right now about only raising taxes on the ‘wealthy’ to pay for social programs and hopefully balance our federal budget. However, as a small business, we may report $250,000 or more in profit but few manufacturers take those profits home – they are overwhelmingly reinvested in our business.”

While 70 percent of manufacturers in the U.S. are structured as S-corporations, very few earn over $250,000 a year.  Only 2.5 percent of small business owners and 7.9 percent of filers with any income from small businesses that employ people are taxed at the two top rates in the code, according to a new study by the Center for Budget and Policy Priorities. If one raises the bar to $1 million annually to reflect the president’s latest proposal, the higher tax would hit only ½ of 1 percent of small businesses and 3.3 percent of filers with any income from small businesses that employ people.

So who would benefit from a large rate reduction? On the corporate side, it would be major companies without overseas earnings or tax shelters, large depreciation costs and few research and development activities.

Walmart, for instance, last year paid $7.9 billion in federal and state taxes on $24.4 billion in profits, an effective tax rate of 32.4 percent. UnitedHealth, the nation’s largest health insurer, paid a 35 percent effective tax rate after sending the taxman $2.8 billion from its $8.0 billion in earnings.

On the individual and “small business” side, the vast majority of the benefits from lower rates on S-corporations would flow to pass-through entities that have been created to sell personal services, collect royalties and rents or passively invest in other businesses or real estate ventures. “The definition (of small business) is so broad, in fact, that under it, both President Obama and Governor Romney would count as small business owners – as would 237 of the nation’s 400 wealthiest people,” the CBPP study said.

U.S. manufacturers need a boost. There was no evidence offered at the Ways and Means Committee hearing Thursday to suggest that the tax code is the way to do it.