It is hard to be optimistic about the prospects for corporate tax reform. It was difficult in 1986 and the conditions for corporate tax reform were much more favorable in 1986 then they are now. In the second half of the 1980s our deficit was under control and the economy was growing. We had a popular second term president with a good working relationship with Congress.
In 1986 Congress reduced the corporate tax rate 12 percentage points—from 46 to 34 percent. What almost everybody forgets is that the 1986 rate reduction was paid for mostly by repeal of the investment tax credit. That credit reduced corporate tax revenues by approximately 25 percent—about $100 billion annually in today's terms. There is no one big corporate tax expenditure out there right now whose repeal can pay for major rate reduction.
On the contrary, repeal of the current top three corporate tax expenditures—accelerated depreciation, the deduction for domestic production, and the research credit—could only pay for a rate reduction to about 30 percent. And total repeal is highly unlikely given all three have strong support. Furthermore, the beneficiaries of the big three corporate tax expenditures are mainly in the manufacturing sector. Therefore, the main thrust of any revenue-neutral corporate reform effort would be a tax increase on the manufacturing sector offset by a tax cut for other sectors like retail and finance. Revenue-neutral corporate reform will create large winners and losers that will undo the corporate coalition currently supporting reform.
Not surprisingly, given the lack of attractive options, American business wants Congress to pursue corporate tax reform that is not revenue neutral. Speaking for the Business Roundtable, Robert McDonald, Procter & Gamble CEO, spoke of his concern with revenue-neutral corporate reform when he testified before the House Ways and Means Committee revenue on January 20th of this year. (For a more recent expression of corporate dissatisfaction with revenue-neutrality, see Richard Rubin, “Manufacturers Resist ‘False Choice’ in Corporate Tax Overhaul,” Bloomberg, November 10, 2011.)
But whose ox will be gored to pay for a corporate rate reduction? If we want a 25 percent corporate rate or even a 30 percent corporate rate, it is almost certain that Congress will have to extract revenue from outside the corporate sector. Here are some possible revenue sources to pay for the lower corporate rate:
--a carbon tax (as in the United Kingdom where a “climate change levy” was introduced in 2001or Australia whose Australian parliament earlier this month approved a new carbon tax)
--a value added tax (The United Kingdom increased its rate of value-added tax from 17.5 to 20 percent on January 4, 2011. In Japan, Prime Minister Yoshihiko Noda has pledged to global leaders to gradually increase the Japan value-added tax rate from its present 5 percent to 10 percent by the mid-2010s.)
--limiting the deduction on corporate debt (as in Germany, or as proposed under the "The Bipartisan Tax Fairness and Simplification Act of 2011," sponsored by U.S. Senators Ron Wyden (D-Ore.) and Dan Coats (R-Ind.))
--increasing taxes on individuals, most likely on dividends and capital gains. (On June 23, 2010 the U.K. government raised the capital gains rate for top earners from 18 to 28 percent. Under the Weyden-Coats tax reform plan the tax rate on capital gains and dividends would increase from 15 percent to 22.75 percent.)
No, I wasn't born yesterday. Yes, I understand these are considered non-starters in today's political environment. But if members of Congress want to talk about a revenue-neutral cut in the corporate rate to 25 percent, these are options that must be considered. To get to a 25 percent corporate tax rate Congress must begin to think outside the box.