Tax Analysts Blog

Top 10 Reasons There Is No Corporate Tax Reform

Posted on Feb 3, 2014

On January 29 the American Enterprise Institute and the business group known as the Alliance for Competitive Taxation held a conference in Washington on corporate tax reform. Alan Viard, an outstanding tax economist, was nice enough to ask me to be on a panel with NYU law professor Daniel Shaviro and Laura Tyson, a former top economic adviser to President Clinton. It was a lively and frank discussion, and you can watch it here.

I was asked to kick things off. After some textbook comments about the evils of the corporate tax and the pressing need to reform it—ideally by integrating it with individual taxes so corporate profits are taxed only once or, second best, by reducing the current 35 percent statutory rate--I listed the obstacles to corporate reform with a Letterman-like top 10 list. Here it is in written form. I hope readers find it a useful summary.

10. Not Enough 'Loopholes' to Close

Republicans repeatedly say that the corporate tax rate must be reduced to 25 percent. But if tax reform is to be revenue neutral, as Republicans also want, the revenue lost from rate reduction must be offset by cuts in corporate tax breaks. Even in the extreme case, if Congress were able to repeal all domestic corporate tax breaks in the tax expenditure budget, it would only provide enough revenue to reduce the rate to 28 or 29 percent. That means that in order to reach 25 percent, Congress must consider raising taxes on multinationals’ foreign-source income (Republicans generally want to move in the opposite direction), adopting some of President Obama’s unconventional revenue raisers, like limiting interest deductions and taxing large passthrough business, or adopting revenue raisers suggested by Senate Finance Committee Chair Max Baucus. The Baucus revenue raisers include requiring advertising and research expenses to be capitalized. At this time, all these options are political non-starters.

9. Corporate Tax Reform Hurts Manufacturing

At a time when all of official Washington wants to boost U.S. manufacturing, conventional revenue-neutral reform would almost certainly raise taxes on manufacturing. Why? Because the “big three” corporate tax expenditures—accelerated depreciation, the deduction for domestic production, and the research credit—disproportionately benefit manufacturing. Manufacturers would lose more from base broadening than they would gain from rate cuts. This uneven effect of base-broadening reform also means it will be politically difficult for corporate America to keep a unified front on reform.

8. Partisan Disagreement Over Overall Revenue Goals

One of the biggest myths propagated in the media is that there is bipartisan agreement on the need for corporate tax reform. Every Republican is insisting that tax reform, if not a tax cut, be revenue neutral. The overwhelming majority of Democrats are insisting that tax reform raise revenue. Republicans want to close loopholes to lower rates. Democrats want to close loopholes to raise revenue. Until there is some truce or agreement on this fundamental point, no progress can be made.

7. Tax Reform Hurts Research-Intensive Tech Sectors

One continuing theme on Capitol Hill is the need for government to support research and high tech. In order to preserve revenue, it is widely recognized that any effort to reform the U.S. international tax system—for example, by moving to a territorial system that would exempt most active-business foreign profits from U.S. tax—must be accompanied by tough antiabuse rules that prevent U.S. multinationals from parking profits in tax havens. Patent-rich high-tech companies-- including Google, Microsoft, Apple, Cisco, and Oracle -- do very well under current law and would likely suffer the most in any international tax reform effort. This would be a tax change that would hurt domestic research spending.

6. Conventional Economic Arguments Aren't Favorable to Reform

This point may be difficult for non-economist to grasp. (And who cares what economists think anyway?) But it is important to know that if you put a standard tax reform that broadens the base and lowers the rates into a conventional economic model, it is likely to show declines in investment and job creation,particularly in the short run. That's because rate cuts reduce tax on income from new and existing capital, while the burden of base broadening is entirely on new capital. Cutting taxes on old capital is a windfall that provides no incentive for new business activity. New capital is where you want to target your tax cuts, but under standard tax reform new capital gets a net tax increase. I believe these old models miss a lot of the positive effect of reform in the modern economy, but it will be very hard for tax reformers to swim against the tide of what has been conventional economic wisdom for the last 50 years.

5. Corporate Reform Must Be Linked to Individual Reform

Conservatives are insisting that individual reform be linked to corporate reform. For example, if the corporate rate is reduced to 25 percent, they want the top individual rate to be 25 percent also. Corporate tax reform is hard to do, but individual reform is a much steeper political climb. The problem for tax reformers is that under the current code, tax breaks like the mortgage interest deduction and the deduction for state and local taxes disproportionately (that is, as a percentage of income) benefit the middle class. This was hammered home during the 2012 president campaign when Mitt Romney’s proposed tax reform was shown to be possible only if taxes were increased on the middle class.

4. The United States Isn't Like Other Countries

Ever since Japan lowered its corporate tax rate, the United States (when average state corporate taxes are included) has had the highest statutory rate in the world. How can this happen in a country that, compared with the rest of the world, is so pro-business and antitax? Answer: To pay for rate cuts, other countries have used tax increases that are off the table in the United States. For example, the United Kingdom, whose corporate tax rate will soon be down to 20 percent, raised its value added tax, imposed special taxes on banks, and raised its carbon tax to pay for corporate rate cuts. If the United States won't consider raising less economically damaging revenue sources like these, it is probably doomed to remain a country with high corporate taxes.

3. This Ain’t 1986

In current discussions of tax reform, you often hear this argument: “Before 1986, everybody said tax reform was impossible, but then it happened. So when you hear skeptics say tax reform is impossible now, don’t listen to them.” The problem with this line of thinking is that there were many factors favorable to tax reform then that don't exist now. For example, in the 1980s there was much less partisanship, and tax reform almost certainly needs to be a bipartisan effort.

Even more daunting are the numbers. In the five years before the 1986 tax reform, the corporate tax with a 46 percent rate tax raised 1.4 percent of GDP. In the five years before the 2008 recession a 35 percent corporate tax rate raised 2.1 percent of GDP. If a lower rate raises more revenue now than it did back in the 1980s, this suggests the corporate tax had a lot more loopholes to close then than it does now. And that is in fact true. Before the 1986 reform, the investment tax credit reduced corporate tax revenue by a third. President Reagan’s proposed repeal of the investment tax credit raised the lion’s share of the revenue that made a large corporate rate cut possible. There are no large, juicy revenue raisers like that now.

2. Long-Term Revenue Problems

Three of the largest likely revenue raisers for tax reform—repeal of accelerated depreciation, repeal of the last-in, first-out method of accounting, and taxation of the stock of unrepatriated foreign earnings—produce large amounts of revenue in the short term but much less after the standard 10-year revenue window. As hard as it is to achieve revenue neutrality in the standard 10-year time frame (see point 10 above), it will be much harder to achieve it over the long term. Boosters of tax reform like to gloss over this. If we did tax reform that is revenue-neutral only in the ten-year window, corporate tax reform would start to be a big revenue loser just as projected deficits begin to rise again to problematic levels. Once the potential of corporate tax reform to cause long-term deficit problems is widely understood, it is unlikely that Congress, the president, the public, and the bond rating agencies would allow that to happen.

1. No Presidential Leadership

Republicans are much more devoted to tax reform than Democrats. That is not meant to be a partisan statement, but a good-faith assessment of the historical record. Clinton was totally uninterested in it and in fact added dozens of tax breaks to the code. To his credit, Obama has endorsed lowering the corporate rate and broadening the base. But his unwillingness to lead on tax reform demonstrates that it is only a talking point to show that he is not in conflict with business on the issue. Tax reform requires real commitment from the administration, like what Reagan and his Treasury Department provided in 1984 and in 1985. For this reason, tax reform is unlikely to get the attention it deserves before 2017. And that is only if a Republican is elected president.

Read Comments (4)

niclas virinFeb 6, 2014

The best company tax reform is the abolition of company tax.

John LeeFeb 10, 2014

We may do federal corporate tax reform at 10-28% with simple 3 tax brackets
instead of the existing 8 tax brackets (62.5% reduction). You may check the wet
at www.rigeltechcorp.com/federal_corp_tax

or the paper of The U.S. Personal Income Tax Reform: Linear and Gradual Tax
Simplifications, Academy of Economics and Finance Journal, 2013(4) 47-55
(Robert Kao and John Lee)

Terry ScottFeb 10, 2014

Who cares if there's 3,6,9,12, or 24 brackets? That's easy to understand and
plug into any software program which will figure it out to a penny. It's the
rest of he tax code that's confusing.

Jose OyolaFeb 21, 2014

There is an 11th reason why corporate tax reform is not in the horizon: the
$1.7 trillion accumulated foreign profits of US MNEs are already back into the
US, and is mostly invested in US financial securities.

The means used to achieve this feat without triggering a US tax liability are
analyzed in the congressional study on the same subject, found in
http://www.hsgac.senate.gov/subcommittees/investigations.

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