Thursday, October 30, 2008

Putting Some Taxes Into Perspective

So, Exxon Mobil announced its third quarter earnings today, which were a record $14.8 billion for the quarter. And with it comes accusations from politicians that big oil isn't paying its "fair share" of taxes. From all the political noise you would think that oil companies don't pay any taxes at all. Well this couldn't be farther from the truth. The untold story that gets lost in all this corporate bashing is that along with that $14.8 billion in earnings, Exxon Mobil also paid a record $11.3 billion in income taxes. For the past year, the company has paid $49.1 billion in income taxes.

To put this in perspective, the bottom 50 percent of income earners in the US will have paid an estimated total of $35.5 billion in 2008 (estimated from 2006 data, the most recent available), and this number does not include the rebate checks earlier this year. The effective tax rate for Exxon Mobil was 44.4 percent over this past year while the average rate for the lowest 50 percent of income earners was 3.0 percent in 2006. Keep in mind also that this is only Exxon Mobil's income tax; it does not include royalties, property taxes or their share of the sales tax. So this one company pays more in income taxes then half of the country's working population. So is Exxon Mobil really not paying its "fair share"?

Furthermore, and very importantly, corporate taxes are not really paid by corporations; they only collect them. Corporations are just legal entities for organization. The actual cost or incidence of the corporate tax is really paid for by people as it it gets carried over as a business expense. Workers pay them through lower wages, consumers pay them through higher prices, and investors pay them through lower returns. The corporate tax allows politicians to tax people without them knowing it.



As a point of concurrence, I would not argue that Exxon has not paid its "fair share." But I would also like to add that I think the amount of taxes it has paid (and everyone in the top 1% has paid) is entirely reasonable. EJB rightly points out that Exxon paid more in taxes than the bottom 50% of income owners. However, to be fair, it should be noted that the actual income difference between these two entities is enormous. To qualify for the dubious distinction of being in the bottom 50% of income owners, one must make less than $31,987 a year. The average tax rate for a person in this bracket (per EJB's website stats) was 3.01%...roughly $960. That left your average Joe Bottom-Fifty-Percent with about 31k a year (less state tax and all that jazz). Now, Exxon, this year, had a net income (after taxes) of $43,643,000,000 (about 45 billion). Its gross profit was around $200 billion, with total revenue equaling $404 billion.

Forty-five billion dollars. That's ONE company. I was unable to find any detailed information about the salaries of Exxon execs. However, in 2006, Exxon parted ways with its former CEO, Lee Raymond, and granted him a mind-boggling "retirement package" of $400 million dollars. In addition, he received two years of free home security, use of the corporate jet, a $1 million consulting deal and a car and driver. This is unconscionable. After hearing stories like this, I find it hard to believe that anyone could argue that a tax rate of 22.79% for the upper 1% is too much. Now I know that not everyone at Exxon (or in the 1%, for that matter) receives 9-figure "golden parachutes." But that's not the point...the point is to illustrate the copious amounts of wealth that is undeniably present in Exxon - and in many of the larger, more successful corporations. My point here is that it makes sense to tax the bottom 50% less because the $30k they are left with is far more important to them than the billions which are spread amongst Exxon's managers, directors and shareholders. It is an essential fairness and undoubtedly just.

Furthermore, as the abstract to this article states: Individual income taxes and payroll taxes now account for nearly 80 percent of federal revenue and corporate income tax revenue makes up about two-thirds of the rest. Thus, corporate income tax only accounts for two-thirds of 20% of the federal revenue - roughly 14%. If you consider that the top 1% paid about 40% of all income taxes paid to the United States, this means that approximately 54% of federal revenue is coming from the top 1% (assuming that the set of people within the top 1% and the set of people who pay substantial amounts of corporate tax are the same or nearly the same). I think I can live with the idea of the top 1% paying around 50% of the federal revenue - especially considering that the income cutoff for the bottom half is under $32,000.

I would also urge everyone to read the article that EJB cites. This one. I don't think it fully supports the conclusion that the actual cost of the corporate tax is covered by the people. Instead, after citing previous historical theories on where the burden of the corporate tax falls, the article states:
Modern economic opinion is divided on the incidence of the corporate income tax, but few economists today believe its burden falls entirely on the owners of capital.

Not exactly a ringing endorsement of the view that "
the actual cost or incidence of the corporate tax is really paid for by people as it it gets carried over as a business expense." If anything, the article suggests that this could be the case, or is, at most, a popular contemporary economic theory. But again, empirical proof it is not. Corporations, after all, are not simply "legal entities for organization," they are reified by most courts in what has been termed a "useful legal fiction." EJB, like many economists, views the corporation as a network of contracts and organizations - this explains the definition he uses in his post. But like I said, the legal world does not hold such a view. Personally, I agree with EJB's definition and hope that one day courts will drop the unnecessary, confusing and often problematic viewpoint of corporation as "legal person."

Finally, because I am not well-versed enough in economics or tax law (next year...can't wait...), I can only post a brief bit of the previously cited article to muster a defense of the corporate tax:

The arguments in favor of leaving the corporate income tax alone are politically compelling. For one thing, the tax has a proven ability to raise revenue, an important consideration for a nation that has run chronic budget deficits. For another, the old aphorism that “an old tax is a good tax” has some validity. Any major change in the tax code changes expectations and imposes new costs and complications during the transition period. But the most compelling rationale for the corporate income tax is the difficulty in assessing its incidence. Since no political constituency sees itself as the primary payer of the tax, none is willing to lobby aggressively for change. Indeed, the art of taxation, as seventeenth-century French administrator Jean-Baptiste Colbert reportedly said, “consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.” Judged solely by this standard, the corporate income tax has worked well.



A few things.
On Equating the Bottom 50% of Earners to Exxon Mobil
It is true that as JSK states that from a legal standpoint, corporations are defined as people. However, as he acknowledges for all practical purposes it is an association of contracts for the purpose of organizing labor and capital for the purpose of production. However, despite this practical acknowledgement, he continues to treat Exxon Mobil as an individual in his comparisons. He states, "However, to be fair, it should be noted that the actual income difference between these two entities [bottom 50 percent and Exxon Mobil] is enormous." He compared the income of the median individual, one piece of the group aggregate with the total income of the entire company. But just as the bottom 50 percent of earners is a collection of many individuals, Exxon Mobil is just a collection of over 100,000 employees and tens if not hundreds of millions of individual share holders. If he is going to use the entire income of the company, he has to compare it to the entire income of the bottom 50 percent, or has to compare the income per shareholder (data is not available). So the total before-tax income of Exxon Mobil over the past year was $110.6 billion (I'm not sure where JSK is getting his 200 billion number from). In comparison, the bottom 50 percent of earners in aggregate had wages of $1,016 billion. Clearly the company pays a much higher rate of taxes then individuals in this group.

Side Note: It is true that I used the bottom 50 percent of earners because this was what data was available, but understand what that is exactly. As JSK states, technically the cutoff for this group is about $32,000 per year. However, this includes part time workers and people who didn't work all year. The 50 percent cutoff for people who work full time all year around is about $41,000 and the median household income is about $51,000. Also note that this only includes wages, and not compensation through fringe benefits, which are increasingly becoming a larger portion of total compensation. Also this number does not include income from sources including interest, dividends, capital gains, rents or government transfer payments.

On CEO Pay and the Wealth of Exxon Mobil
Similarly in JSK's discussion about executives, he continues to use the framework of the company being like one person. He insinuates the absurdity of just one company earning 45 billion dollars. But once again, this is money that is divided amongst a huge amount of shareholders. Large companies tend to have more holders then small ones. Though this number is often good for press stories and political attacks, what is more important in analyzing the profitability of a company is not the raw amount of earnings but rather the rate of return on investment. The company's average market capitalization (the total value of its shares) averaged about $410 billion over the last year. Therefore the rate of return on devoting ones money to investment is 45 billion/ 410 billion or about 11 percent. In other words for every 100 dollars a shareholder gives up, he or she received 11 dollars this year in earnings. This is really not that absurd considering the stock market as a whole, for both large and small companies averages about ten percent growth per year. One has to look at proportions, not raw numbers. Just as in comparing the national incomes of differnt countries where we look at it in per-capita terms, one has to look at corporate profits in per-capita terms as well.

This similarly applies to corporate pay. Though JSK may find it personally disturbing that an individual makes millions of dollars per year, it is only because the CEOs of large companies have fiduciary responsibility over a larger amount of shareholder wealth relative to smaller firms. The cost of employing the CEO per dollar of investment is no more then a smaller company paying their execs less. This is why CEOs of large companies tend to make more then CEOs of small companies.

On Who Pays the Corporate Tax
It is true that empirically, it is difficult to measure exactly the incidence of corporate taxation. This isn't because it hasn't been done, but that is it very difficult to get estimates on the elasticities of supply or more plainly the relative responsiveness that labor and capital have to changes in prices. However, logically it has to be paid in some proportion from the three areas I earlier mentioned: labor, capital, and the consumer. Unlike what is often misunderstood to be, corporate profits are not what is available for executive pay; this is the earnings of the entity after expenses including executive compensation. So in theory this is the money to now be divided amongst share holders. But if this money is taxed, then the rate of return on investment is reduced and share holders now no longer invest as much in the company, which reduces demand for labor, and reduces the production of goods, which respectively lower wages and increase the price to the consumer. So all three are hit to some degree. It is increasingly becoming generally agreed upon however that a relatively small percent actually gets paid for by those who own capital, because capital is easily movable. Investment can go to other companies, even other countries or investors may just decide to save less and spend more. Whereas workers can not as easily move to other locations to find work and work income is generally more of a necessity then investment income for most individuals. So in the end the cost of the corporate tax more heavily gets absorbed by reduced wages. This is why most developed nations in the world have recently been slashing their corporate tax rates in order to attract more investment which in turn creates wage growth. The US now has the second highest corporate tax rate in the developed world and I am more then willing to bet that it is one of the reasons why manufacturing activities are moving oversees and done so not at the expense of investors, but workers.

On Who Owns Oil Companies
But for the sake of argument, lets assume that the bulk of the corporate tax does indeed fall on capital, or investors. Well who actually owns these shares? Obviously "rich" people own more stock then poorer people, but unlike the common conception and what JSK implies through his adding the corporate tax rate to the rich 1 percent income tax rate and stating its more fair to tax shareholders, stock ownership is a lot more spread out then most think. The emergence of 401ks, IRAs and online discount brokers, has allowed the middle class to broadly participate in the stock market. As of 2005, an estimated 50.3 percent of US households owned stocks either directly or through mutual funds. The median family income for this group was $65,000 (more then the country average but by no means not in the middle class). Also, about another 15 percent of households who don't own stocks, do so indirectly through participation in pension plans. Therefore, about 65 percent of American households own stocks either directly or indirectly. Also understand that this is a snapshot in time. Young people with few assets don't own as much stock and retired people often liquidate their shares for income, so the percent of households that will have owned stock at some point in their lifetimes is even higher. To the extent that the corporate tax does fall on capital, it is more then a tax on just the rich.

Likewise, the following chart derived from a recent study breaks down oil company ownership in the US.

*All direct ownership not included in IRAs
**Mutual funds not held in IRA's, pensions, hedge funds of by other institutions
*** Among others, includes charitable trusts, university endowments, and other financial companies

Also note that due to the overlap in categories and the use of data from multiple source in the linked study, I had to make an estimate for individual investors, mutual funds, IRA's and pensions where the real percentage value could be off be a couple of percent. The data for executives and hedge funds was directly reported from the study.

Notice how small of a percent of stock ownership is in the hands of the executives, the object of resentment and perceived target of increased taxes on corporations and capital. Also this is for the entire industry; the percent for the large integrated oil and gas companies, such as Exxon Mobil is even less at 0.7 percent. Also note that the bulk of ownership fits in retirement accounts, mutual funds and pensions, all largely owned by the middle class. Many of the individual investors are also small, as it includes your average guy with an E-Trade account.

I agree with the quote that JSK cited about the art of taxation in that it, "consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing", but we derive different meaning from it. The corporate tax is good at this, because it is a hidden tax paid by people who don't even know they are paying it. So as far as raising revenue, sure its effective at JSK implies with the quote, but it comes at significant economic cost. I wonder if the mass of people who not only tolerate corporate taxes but champion them would have the same attitude if they knew they were arguing for themselves to be taxed more?