Wednesday, August 20, 2008

Corporations and Taxes

Steven Malanga at RCP points out the dynamism of the American economy and takes issue with the recent media reports indicating most American corporations don't any any taxes. Malanga uses the US 2005 economic numbers to illustrate these themes. By All accounts 2005 was a great year, unemployment averaged under 5%, the economy grew at a solid pace, and overall corporate profits increased 18%.

First he examines the labor market, which added 2 million new jobs, but he notes this number masks the fact that 31 million new jobs were actually created, while 29 million jobs were eliminated. About 1.5 million business were expanding, about the same were contracting, and around 325,000 actually went out of business. So the net numbers substantially mask the rather massive true churn in these labor markets.

On the second note, the GAO report indicating that most corporations (2/3s) do not pay corporate taxes ignore the fact that most US corporations are chartered as small business S-corporations, in which the business owner receieves their profits in the form of wages and thus pay income taxes on their profits rather get taxed under the corporate rate. The reports also indicates that around a quarter of "big businesses" also pay no corporate taxes, but this ignores the fact that not all businesses make any profits that can be taxed.

"The impression one gets from corporate critics is that many are prospering but exploiting loopholes in the tax code and leaving the rest of us to pick up the tab. But that criticism is based on the mistaken notion that in robust years, such as 2005, virtually all businesses do well. Nothing could be further from the truth. Even in good times, there are plenty of losers in a dynamic economy. The BLS’ Business Dynamics Survey, for instance, shows that in 2005 there were 7.3 businesses that were contracting for every 7.6 that were expanding, including 1.3 that were closing their doors for every 1.5 that were starting up. Large businesses were hardly immune to this kind of tumult. For every 5.8 jobs added by firms with more than 500 employees, other firms that big eliminated 4.9 jobs. Among those hit hard in 2005 was General Motors, which despite $193 billion in revenues wracked up a $10.4 billion loss and cut its workforce. It shouldn’t be necessary to remind reporters and editors who cover such matters that businesses pay taxes on their profits, not sales."

Of course, this little factoid is often confused by our betters in the media, who quite often use sales revenue data rather than the net income numbers. As the author notes, many industries have extremely small margins, such the supermarket industry, which has margins around 1-2%. Even mighty Wal-mart had margins of only 3.4%, on revenues of 312 billion, for a profit of 11.7 billion after paying 5.8 billion in taxes. Of course, looking at these numbers, you also should note that the US corporate tax rate is the second highest in the world at 35% (if I recall correctly), which also has a dramatic impact on the competitiveness of US corporations overall and the ability of these businesses to hire.

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