The United States' statutory corporate tax rate of 35% is the second highest rate in the world, trailing only Japan, which has a 39.54% tax rate. Many U.S. corporations, however, are able to significantly reduce their tax liabilities through foreign operations, various subsidies, credits and other legal tax loopholes. This can alter the effective tax rate for various corporations, particularly within an industry.
According to a 2011 study released by Kevin S. Markle of Dartmouth and Douglas A. Shackelford of the University of North Carolina, taxes vary more by industry within the United States than in other countries. The Congressional Budget Office takes note of this industry-specific taxation, estimating in a 2006 paper that the effective marginal corporate-level tax rate ranges from "29% on computer equipment to a negative 2.2% on petroleum and natural-gas structures."
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Aswath Damodaran, Professor of Finance at the Stern School of Business at New York University, calculated the average tax rate of various business sectors using public financial statements. Damodaran's findings, which were included in the Center on Budget and Policy Priorities publication "Six Tests for Corporate Tax Reform," indicate that corporate taxes do vary by sector. Figure 1 illustrates the disparity between the average tax rates that are paid by different sectors.
|Figure 1: Using data compiled by New York University Professor of Finance Aswath Damodaran, the chart shows the various average tax rates (by percentage) paid by different business sectors.|
|Source: Created with Microsoft Excel|
Why the Disparity?
The current tax code's preferences, including deductions and credits that corporations can legally use to reduce taxes as well as the tax handling of overseas investments, contribute greatly to the disparity. Economist Martin A. Sullivan cites the major reason for low effective tax rates for certain business sectors is the ability for some corporation to move significant portions of their profits into low-tax jurisdictions. Sullivan explained in a January 20, 2011, Congressional testimony before the Committee on Ways and Means:
"…low effective tax rates are common in industries like pharmaceuticals and computer equipment where it is easy to shift technology and manufacturing to low-tax jurisdictions. In industries where customer markets and the provision of services are largely domestic, the opportunities for reducing taxes through cross-border profit shirting are limited…Under current law, if an American corporation opens a factory in Indiana, the profits of that factory are subject to the 35% U.S. corporate tax rate. If the same corporation instead opens a similar factory in Ireland, the profits from that factory are subject to a 12.5% tax rate." (For related reading, see Do Tax Cuts Stimulate The Economy?)
Proposals are being discussed in Washington to change the way corporations are taxed, reducing the statutory rate to 25% and eliminating certain tax breaks and loopholes. It is estimated that targeted tax preferences, created by Congress to benefit specific companies and/or industries, cost the federal government $100 billion, and that creative accounting costs another $50 billion each year.
During the September 26, 2008, U.S. Presidential debate, Barack Obama said, "There are so many loopholes that have been written into the tax code...that we actually see our businesses pay effectively one of the lowest tax rates in the world." While in reality, corporations in the United States still pay higher effective tax rates than most of the world's industrialized nations, a company's effective tax rate often depends on how creative its tax department is, within what industry it lies and where its operations exist. (For related reading, see What You Need To Know About Capital Gains And Taxes.)