The most courageous odd couple in Congress – Sen. Max Baucus (D-Mont.) and Rep. Dave Camp (R-Mich.) – is determined to pass comprehensive tax reform, which would eliminate tax preferences in order to reduce tax rates. The novelty of having two committee chairmen from different parties working toward the same goal makes reform a real possibility. But deciphering who comes out ahead in such a complex equation can be difficult.
That’s why tax reform should be viewed through the lens of effective tax rates, the amount that businesses actually pay. Our new group, the Coalition for Fair Effective Tax Rates, represents businesses both large and small and believes the current tax system is broken and needs to apply in an even-handed way across all industries.
The National Federation of Independent Business, representing some of the smallest businesses in the country, and the Retail Industry Leaders Association, representing some of the largest, have found common ground in tax reform. Both agree that a level playing field is needed to fix the current system and achieve meaningful tax reform.
And why? Because comprehensive tax reform that lowers rates and eliminates distorting tax preferences increases fairness and promotes economic growth and job creation.
Various groups angling for advantage in the tax reform debate want the public to focus on their own favorite parts of the income tax system. Some want us to look at the rate. Others want to single out particular deductions. But true tax reform of the kind that Baucus and Camp support is a blending of the two that can only be assessed by looking at the bottom line.
That’s the effective tax rate, which is literally the percentage of an entity’s income that’s paid in federal taxes.
With a single number, the effective tax rate can measure the impact of the many moving parts of reform. A company can be large or small, or organized as a corporation or as a pass-through entity that pays taxes on the individual tax rate system. The effective tax rate for all of them is the best and clearest way to judge whether tax reform is helping or hurting.
Effective rates also explain why reform is such a good idea in the first place. Study after study has shown that U.S.-based companies shoulder one of the highest effective tax rates among developed nations. The respected Tax Foundation recently calculated that the average U.S. effective tax rate was 27 percent, roughly seven percentage points higher than companies in the other countries in the Organization for Economic Co-operation and Development.
The fact that U.S.-based companies pay significantly more in taxes than their major competitors abroad is a strong argument by itself for the kind of comprehensive reform that Baucus and Camp prefer – one that lowers America’s high effective tax rate for businesses whether they are corporations or pass-throughs. Clearly, our ability to compete in the world marketplace – and to create the economic conditions that open the way for more hiring – is at stake here.
Another argument for reform is the sometimes large disparity in effective tax rates among industries in the U.S. For example, the retail industry, the second largest private-sector employer in the U.S., is taxed at an effective tax rate that is significantly higher than other industries. Some retailers, even the largest of them, tend to have effective tax rates in the 30s. This contrasts sharply with other industries whose effective tax rates are often in the teens or lower.
Why do some industries have effective rates that are twice as high as others?
Under the current tax system, some companies are able to take advantage of tax preferences in the code while others are not. As a result, S&P Capital IQ has reported that the effective tax rates paid to all governments by companies in the S&P 500 range widely – some paying nearly the maximum statutory rate, while some pay close to zero.
As congressional tax-writers led by Baucus and Camp begin to repair that problem, let’s keep our eye on the bottom line. Effective tax rates – the amount actually paid in taxes – is the right way to assess the progress of tax reform.
Danner is president of the National Federation of Independent Business. Hughes is senior vice president of the Retail Industry Leaders Association. They co-chair the Coalition for Fair Effective Tax Rates.