Business Taxes: Not What You Think

As the federal government deteriorates its finances and there is talk in Congress about even more deficit spending, it is not far-fetched that they also start talking about raising taxes. There was no shortage of proposals in the Democrat presidential primaries to raise the corporate income tax, with bold proposals dating as far back as to the fall of 2019. One of the staples of the Biden administration’s tax policy is to get the corporate income tax back up to 28 percent.

Nobody should be fooled into believing that the Democrats would abandon their tax-hike plan simply because they can print money instead. It is, in fact, a staple of Modern Monetary Theory (a theory I explain in Cayman Financial Review, October 2018 and in a Special Report here on this blog) that Congress will use taxes actively as a “balancing act” when excessive money printing causes inflation to accelerate. When inflation increases, government raises taxes to pull money out of the economy and thereby take heat out of the inflationary balloon.

There are many problems with this theory, one of which is that taxes themselves drive inflation. They also discourage productive activity, adding to the problems that coalesce into monetary inflation in the first place. Nevertheless, the deeper the Biden administration and Congress dig themselves into deficit monetization, the greater the risk for disruptive tax increases once they realize that inflation is actually ticking up. Therefore, it is essential to dispel some myths regarding tax hikes.

One of those myths is that America’s businesses have been left virtually without any tax burden after the Trump tax reform. The following numbers, all from the Bureau of Economic Analysis, report taxes on gross operating surplus in the second year of the Trump tax reform. They are compared to the tax burden as it applied in 2016, the last year of the Obama administration.

Table 1: Taxes on production as share of gross operating surplus; AER = Arts, Entertainment and Recreation

 20162019
Private industries18.7%18.7%
Agriculture, forestry, fishing, and hunting9.1%9.6%
Mining35.6%25.4%
Utilities37.7%35.3%
Construction3.8%3.8%
Manufacturing8.5%7.9%
Wholesale trade51.7%64.8%
Retail trade92.3%95.5%
Transportation and warehousing18.3%18.7%
Information9.7%9.2%
Finance and insurance13.0%8.2%
Real estate and rental and leasing13.8%13.2%
Professional and business services9.9%9.8%
Educational services19.1%19.6%
Health care and social assistance12.8%13.5%
AER47.0%48.8%
Other services, except government27.1%25.3%

For clarity: this is a more comprehensive measurement of taxation on industries than the corporate income tax. Not all businesses are corporations to begin with, and not all taxes on businesses – corporations and others – are income taxes. In 2019, total federal, state and local government revenue from the corporate income tax amounted to approximately $300 billion. This number is to be compared to $1.5 trillion, which is the the total taxes reported in the raw data underlying Table 1.

The remarkable stability in taxation from 2016 to 2019 suggests that the Trump tax reform did not have nearly the tax-cutting effect on businesses that is sometimes suggested in the public discourse. However, individual numbers could point in that direction, such as the tax rate on minerals which appears to have fallen from 35.6 percent to 25.4 percent. However, this industry, which is heavily volatile in its production volume and value, delivers tax revenue with an even greater volatility (given how taxes are constructed). Figure 1 reports the tax ratios from Table 1 for the minerals industry back to 1998:

Figure 1

Source of raw data: Bureau of Economic Analysis

There are also striking variations in how taxes affect industries. The following snippets report disaggregated numbers from Table 1; first out is the minerals industry, where taxes strike very differently depending on what part of the industry we are looking at:

        Mining25.4%
                Oil and gas extraction29.3%
                Mining, except oil and gas17.5%
                Support activities for mining13.6%

Next up is minerals, where the overall tax rate is less than eight percent but some specific industries are hit hard:

        Manufacturing7.9%
            Durable goods6.1%
            Nondurable goods9.7%
                Food and beverage and tobacco products23.4%
                Textile mills and textile product mills14.3%
                Apparel and leather and allied products23.1%
                Paper products6.9%
                Printing and related support activities6.2%
                Petroleum and coal products3.3%
                Chemical products7.2%
                Plastics and rubber products8.0%

Under the category “Transportation and warehousing”, air transportation stands out as hit particularly hard:

        Transportation and warehousing18.7%
            Air transportation49.2%
            Rail transportation10.8%
            Water transportation19.7%
            Truck transportation7.9%
            Transit and ground passenger transportation8.8%
            Pipeline transportation9.7%
            Other transportation and support activities9.3%
            Warehousing and storage10.8%

Our hospitals are another hidden source of tax revenue. They are often levied by states and local governments for the purposes of subsidies – to hospitals:

            Health care and social assistance13.5%
                Ambulatory health care services6.2%
                Hospitals and nursing and residential care facilities27.2%
                Social assistance22.1%

Last out is the AER industry, where football, baseball and the Museum of Post Modern Art get away leniently while casinos, restaurants and hotels are taken for almost everything they’ve got:

            Arts, entertainment, and recreation26.1%
                Performing arts, spectator sports, museums, and related activities14.2%
                Amusements, gambling, and recreation industries62.6%
            Accommodation and food services62.0%
                Accommodation54.0%
                Food services and drinking places67.3%

One of the counter-arguments to these tax rates is that businesses also get subsides. That is true, but there is a significant misconception floating around out there as to what a “subsidy” actually is. A tax reduction, even if selective, is not a subsidy. It is a rebate on the price of government. A subsidy is a cash payment to a business for the purposes of contributing toward its operating costs. Table 2 reports the share of these subsidies, where they apply, as share of gross operating surplus:

Table 2

Source of raw data: Bureau of Economic Analysis

Discretionary payouts of economic-development money counts as subsidies, but they are not significant enough to register in our national accounts. Neither subsides nor economic development is desirable from an economic viewpoint, but – again – it is important to separate the two in terms of their impact on the economy. The distortionary effect of economic-development spending is found in how it affects business investments, especially their geographic allocation.