Is President Obama Breaking his Promise of Tax Cuts for 95 Percent of Individuals by Eliminating Corporate Income Tax Breaks?

The title of this column may seem like a strange question. After all, how are individuals affected if President Obama cracks down on corporate tax havens? Isn’t it time companies paid their fair share? Although the corporate income tax rate in the United States is very high, tax breaks and shelters make the effective tax rate much lower – so isn’t it time to crack down? The President said the tax code is “full of corporate loopholes that make it perfectly legal for ‘companies’ to avoid paying their fair share.” (1)

Let’s focus on the term “companies” first. Who is President Obama referring to when he says companies haven’t paid their fair share? Another silly question…the answer is companies, of course! Who else would he be talking about?! This question is far more complex than what it appears to be on the surface. One may ask “if companies don’t pay the tax, then who does?” The answer is INDIVIDUALS. Apparently, the President and most people in Congress don’t know the correct answer to this question.

One may ask “how on Earth does an individual pay corporate income tax?” Ofttimes, when people think of corporations, a vision comes to mind of greedy men in blue pinstripe suits laughing and counting their money. When elected officials say they are going to tax the corporations and make “them” pay their fair share, this rhetoric brings instant populist satisfaction, as people can now envision a cartoon of Uncle Sam turning these men upside down and shaking them until all of their money falls from their pockets. However, let’s back up for a moment. It’s also common knowledge that a corporation is an entity – not a person. Therefore, do the men in blue pinstripe suits pay the tax? Does the entity pay the tax? How can an entity be taxed if it’s not a person?

The answers to these questions are as follows: 1) the men in blue pinstripe suits do NOT pay the tax – or at least not in the way the populist perception leads; and 2) the entity is taxed, however, the tax becomes a cost of doing business and is embedded into several components – the three largest being: a) price of the product, b) employee hires/salaries and c) future opportunities for expansion.

If you buy products, then you pay corporate income tax. No business can survive without a budget and pricing models. When the corporate income tax is raised, companies must determine how to allocate that cost. The elasticity of demand for a product is the dependent variable which determines how much of this cost can be allocated to the price of the product. In other words, if a product is in demand regardless of price and economic conditions (inelastic), this means that the company has the option to bury the tax completely in the price of the product. President Obama stated repeatedly that 95 percent of the country will not see their taxes raised one dime. What he didn’t tell you is how your taxes will be raised through “back-door” methods.

The previous example outlined a scenario for inelastic products. What happens if a company sells elastic products? Does the individual still pay the tax? If the company cannot pass all of the tax through the product itself, then it must reduce costs in other areas. What is the biggest cost that a company endures? Employees! Therefore, when the government imposes higher taxes on companies, employees are paid less as a result. This works the same as payroll taxes – all of which comes at the expense of one’s compensation. For example, one of the biggest misconceptions is that a company pays half of an employee’s FICA (social security) tax. On paper, it does; but, in reality, the EMPLOYEE pays the tax at the expense of his/her SALARY. The same concept is true for any type of business tax.

Finally, and perhaps, the most damaging aspect of higher business taxes is the fact that increased tax burdens stifle future growth. Payments to Uncle Sam come at the expense of future opportunity. Companies have fewer dollars to invest in new ventures that can lead to job creation and growth. In addition, large tax burdens induce companies to close their headquarters in the United States and set up shop in more tax-friendly environments overseas. For example, many jobs in the information technology sector have moved to Ireland and Poland whose corporate income tax rates are currently 12.5 and 19 percent respectively. The current corporate income tax rate in the United States is 35 percent – the second highest among OECD countries.

Now that it is clear who pays corporate income tax, what is the best solution going forward? President Obama says “I want to see our companies remain the most competitive in the world.” “But the way to make sure that happens is not to reward our companies for moving jobs off our shores or transferring profits to overseas tax havens.” (1)

President Obama, will all due respect, your logic is backwards. The reason why companies have been moving jobs off of our shores is to ESCAPE the U.S. tax burden. There is no other way businesses could remain competitive otherwise in a global environment. There are many costs of doing business that companies cannot avoid. However, tax burdens are an avoidable/reducible cost. Countries overseas understand this and would gladly allow our businesses to set up shop there and take advantage. If the President eliminates these “loopholes,” the end result will not be business relocating to the United States. Companies have other options – one being to move ALL of their operations out of the United States.

Perhaps it is time for President Obama to abandon the age-old political rhetoric on this topic and keep the promise he made on the campaign trail. This would be a practical decision because corporate income tax affects low and middle income folks the most – the very groups he claims to “protect.” So why not cut taxes for these people Mr. Obama and bring our corporate tax rate in line with the rest of the world?

(1) http://news.yahoo.com/s/bloomberg/20090504/pl_bloomberg/ahoduslldk8_1