As some of you may be aware, I report average effective tax rates for US companies, by sector, at the start of every year. Yesterday, that data was picked up by the New York Times and has got plenty of publicity since.
http://www.nytimes.com/2011/01/28/us/politics/28tax.html?_r=1
Today, I have heard from both sides of the debate. from tax lobbyists that feel that the low tax rates reported for some sectors do not reflect reality and also from those who believe that companies in the US don't pay their fair share.
Before I dive in, I want to be clear that the tax rates on my website were never intended for a tax policy debate. My interests are more mundane - computing cost of capital and value - and tax rates are raw material that I use to these numbers. Here is how I compute the averages. I compute the effective tax rate for a company by dividing its taxes paid by the taxable income; if the company is losing money and pays no taxes, I set its tax rate to zero. For my purposes, I need an average tax rate for all companies in a sector, money making as well as losing, to compare valuation multiples and costs of capital across sectors. That is the number (a simple average of effective tax rates for all firms in a sector) that was reported on my site and picked up by others.
However, that average may not be an indicator of what a profitable firm in that sector pays as taxes, especially if there are large numbers of money losing firms (as is the case with the biotechnology sector). To remedy this, I have decided to expand my tax rate table to include an additional statistic - an average tax rate for only money making firms. If you get a chance, you can see the data here and download it.
http://www.stern.nyu.edu/~adamodar/pc/datasets/taxrate.xls
Note that these tax rates are much higher than the original averages. The average tax rate across companies that have taxable income is more than 29%, whereas the overall average across all firms (including the money losers) is just above 15%.
You can draw your own conclusions from the data, but here is my reading:
1. The average US company pays its "fair share" of taxes: I know that there will be many who disagree with me on this premise but the facts back me up. I computed the average effective tax rate for companies globally and here is what I got:
The average money-making firm in the US pays about 29% of its taxable income in taxes, which is higher than the tax rate paid by most European, Asian or Latin American companies. Only Japanese companies have higher effective tax rates.To be fair, the taxable income may be lower in the United States than in other countries because of sundry deductions, but here is a comparison that dispenses with this problem. The average US company pays 3% of revenues in taxes, roughly similar to what companies in other countries pay.
2. There is much higher variance in tax rates across companies in the US than in other countries: Here is where I think our excessively complicated tax code has an effect. There is much higher variance across the tax rates paid by companies in the US, as companies in some sectors are given tax deductions and credits and others are not. I will wager that US companies spend more on tax lawyers and consultants than companies elsewhere.
3. There is a much bigger difference between the effective and marginal tax rate in the US than in other countries. Note that the average effective tax rate across companies is less than 30% whereas the marginal tax rate in the US is close to 40% (with state and local taxes). The difference is far smaller in countries with simpler tax codes. In Japan, for instance, the marginal tax rate is 41% but the average effective tax rate is 38%.
Having laid that data question to rest, here are my thoughts on the tax policy questions, for what they are worth.
1. Investment decisions should be driven by economics and not the tax code: The more complexities (and goodies) that we build into the tax code, the more we risk having investment decisions determined by tax law and not by economics. I would rather have all companies pay a 25% tax rate on taxable income, with no special deductions and credits, than have an average tax rate of 25% with wide variations across investments and companies.
2. Borrowing decisions are driven by marginal tax rates: Decisions by firms on how much to borrow are driven by the marginal tax rate and having a high marginal tax rate will induce more borrowing across the board. If you use load the tax code with deductions and credits, you have to raise the marginal tax rate to compensate and with it, you raise the amount of debt that companies will carry. If we truly want to bring down financial leverage at US companies, we have to start by making the marginal tax rate lower.
Do I think that this latest move to simplify the tax code and lower tax rates will work? I am not hopeful and here is why. To keep that change revenue-neutral, we also have to start stripping the tax code of some of the deductions and credits. Unfortunately, that will make it a zero-sum game, at least in the short term, where some sectors will have to pay more in taxes while others will save. In the long term, I believe it will make the economy stronger, but who has the patience of the long run, when it comes to taxes?
http://www.nytimes.com/2011/01/28/us/politics/28tax.html?_r=1
Today, I have heard from both sides of the debate. from tax lobbyists that feel that the low tax rates reported for some sectors do not reflect reality and also from those who believe that companies in the US don't pay their fair share.
Before I dive in, I want to be clear that the tax rates on my website were never intended for a tax policy debate. My interests are more mundane - computing cost of capital and value - and tax rates are raw material that I use to these numbers. Here is how I compute the averages. I compute the effective tax rate for a company by dividing its taxes paid by the taxable income; if the company is losing money and pays no taxes, I set its tax rate to zero. For my purposes, I need an average tax rate for all companies in a sector, money making as well as losing, to compare valuation multiples and costs of capital across sectors. That is the number (a simple average of effective tax rates for all firms in a sector) that was reported on my site and picked up by others.
However, that average may not be an indicator of what a profitable firm in that sector pays as taxes, especially if there are large numbers of money losing firms (as is the case with the biotechnology sector). To remedy this, I have decided to expand my tax rate table to include an additional statistic - an average tax rate for only money making firms. If you get a chance, you can see the data here and download it.
http://www.stern.nyu.edu/~adamodar/pc/datasets/taxrate.xls
Note that these tax rates are much higher than the original averages. The average tax rate across companies that have taxable income is more than 29%, whereas the overall average across all firms (including the money losers) is just above 15%.
You can draw your own conclusions from the data, but here is my reading:
1. The average US company pays its "fair share" of taxes: I know that there will be many who disagree with me on this premise but the facts back me up. I computed the average effective tax rate for companies globally and here is what I got:
| Global Region | Number of firms | Effective tax rate | Taxes as % of Revenues |
| Australia, NZ and Canada | 3834 | 26.65% | 3.38% |
| Developed Europe | 4818 | 28.49% | 2.51% |
| Emerging Markets | 17079 | 21.63% | 3.15% |
| Japan | 3584 | 38.30% | 2.39% |
| United States | 5472 | 29.35% | 3.01% |
| World | 34787 | 27.17% | 2.82% |
2. There is much higher variance in tax rates across companies in the US than in other countries: Here is where I think our excessively complicated tax code has an effect. There is much higher variance across the tax rates paid by companies in the US, as companies in some sectors are given tax deductions and credits and others are not. I will wager that US companies spend more on tax lawyers and consultants than companies elsewhere.
3. There is a much bigger difference between the effective and marginal tax rate in the US than in other countries. Note that the average effective tax rate across companies is less than 30% whereas the marginal tax rate in the US is close to 40% (with state and local taxes). The difference is far smaller in countries with simpler tax codes. In Japan, for instance, the marginal tax rate is 41% but the average effective tax rate is 38%.
Having laid that data question to rest, here are my thoughts on the tax policy questions, for what they are worth.
1. Investment decisions should be driven by economics and not the tax code: The more complexities (and goodies) that we build into the tax code, the more we risk having investment decisions determined by tax law and not by economics. I would rather have all companies pay a 25% tax rate on taxable income, with no special deductions and credits, than have an average tax rate of 25% with wide variations across investments and companies.
2. Borrowing decisions are driven by marginal tax rates: Decisions by firms on how much to borrow are driven by the marginal tax rate and having a high marginal tax rate will induce more borrowing across the board. If you use load the tax code with deductions and credits, you have to raise the marginal tax rate to compensate and with it, you raise the amount of debt that companies will carry. If we truly want to bring down financial leverage at US companies, we have to start by making the marginal tax rate lower.
Do I think that this latest move to simplify the tax code and lower tax rates will work? I am not hopeful and here is why. To keep that change revenue-neutral, we also have to start stripping the tax code of some of the deductions and credits. Unfortunately, that will make it a zero-sum game, at least in the short term, where some sectors will have to pay more in taxes while others will save. In the long term, I believe it will make the economy stronger, but who has the patience of the long run, when it comes to taxes?
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