The New York Times published last week an article about the large amount of taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. incentives available to makers of video games, and it got me thinking more broadly about the role that such incentives play in our corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. structure. As someone who spends a significant amount of his free time playing video games, and who has friends working in the game industry, I was annoyed at the tone of some of the reactions to this story, and feared that it would become another piece of rhetorical ammunition for the anti-video game crowd.
To be clear, my intention is not to defend these tax breaks – rather, it’s to place them in the appropriate context. The top marginal corporate tax rate in the U.S. is 35%, and the combined federal and state rate exceeds 40% in 19 states – among the highest rates in the world. A common response to this fact is “That may be true, but the code has so many credits and deductions and loopholes that the effective rate is much lower.” Reasonable people disagree over the extent to which our effective corporate tax rates are competitive, and, without getting into that discussion here, I want simply to point out that this kind of argument is a clear illustration of the fact that our corporate income tax, to a great extent, structurally depends on the existence of these tax breaks in order to remain competitive with the rest of the world.
This is not a good system, and the reaction to the news that video game companies enjoy large tax breaks shows precisely why. About Electronic Arts (or E.A.), one of the biggest companies in the industry, the New York Times notes that “… one of the company’s biggest tax advantages is a tool available to all companies, a deduction related to the stock gains on options exercised by its executives,” and that its accounting “reflect[s] the standard approach used by other companies.” Most of the specific tax breaks mentioned in the article are broadly available. Yet, despite playing by the same rules as everyone else, and taking a tax deduction used by everyone else, anti-video game demagogues will nevertheless attack E.A. for cheating the government out of its fair share of revenues by using some nefarious tax loophole. Even if it’s true, as a tax professor asserts in the article, that video game production is “one of the most highly subsidized businesses in the United States,” the relevant question is not “How much are video games subsidized?,” it’s “How much more are they subsidized than other comparable industries?” The first question is impossible to answer, because it depends on your definition of what actually qualifies as a tax subsidy rather than being a structural part of the tax code. The answer to the second question is likely to be a lot less than the large numbers that get bandied about in an attempt to answer the first.
When tax deductions are a structural part of the system, it becomes much easier for people opposed to a particular company or industry (for whatever reason) to attack it as benefitting from a government subsidy. The imposition or removal of these tax breaks is an easy way for populist politicians to demagogue the bogeyman of the day. To be clear, if Congress decides, as a result of this news, to limit the executive stock option deduction for video game companies, that’s not ending a subsidy, that’s a punitive tax increase on an industry that happens to be unpopular in some quarters. (If they got rid of the deduction for everybody then it’d be a different story.) There’s a free speech issue here – the government would be enacting a punitive tax increase on an industry that some people are opposed to mainly because they dislike the violent content in its products, and it should make everyone every uncomfortable if the government starts to go around enacting punitive taxes on certain companies because certain folks don’t like what they have to say.
The obvious solution is corporate tax reform that gets rid of all of these deductions and credits and tax breaks, and lowers the currently high top marginal rate down to something that accurately reflects the today’s average effective tax burden. That way, U.S. companies can continue to pay more or less the same effective tax rate that they do today, but it will be a lot harder for demagogues to baselessly accuse them of swindling Uncle Sam.
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