Tax Analysts Blog

Why Obama's Corporate Tax Reform Will Fail

Posted on May 23, 2011

A large reduction in the U.S. corporate tax rate is inevitable. It can't miss when proponents have an easy-to-understand talking point: The United States will soon have the highest corporate tax rate in the world. If it weren't for the Japanese earthquake, we would already have the number one spot.

Now, corporate rate cutters are a dime a dozen on Capitol Hill. You hear a lot of talk about 25 percent, often with the words "at least" in front of it. And they'll get no flak from pesky policy analysts. Cutting the corporate rate is like exercise for an out-of-shape tax system. And there's the added bonus for the over-50 crowd: It stirs up fond memories of 1986.

Of course, the rate cut is the easy part. At a May 12 House Ways and Means Committee hearing, all four business executives on one monotonous panel pleaded for the rate to be cut. But there was no hint of how to pay for it. Not so long ago, it might have been possible for a Republican-controlled Washington to finance a big rate cut with debt. After all, they did it for an expanded Medicare prescription drug benefit in 2003. But those days are gone. We are in the opening stages of a fiscal crisis in which figures less than $100 billion are small change. Nothing will happen without money from somewhere.

One development keeps the talk of rate cutting real. It has been brought to the public's attention that big corporations take advantage of tax loopholes, and the public is not happy. A Bloomberg report about Google's offshore tax maneuvers and a New York Times article about tax strategies that let General Electric Co. "avoid taxes altogether" set off a wave of commentary about wealthy corporations not paying their fair share. The details are unimportant. Large swaths of the public now believe they pay more taxes than GE.

The impressions from the media are reinforced from official Washington. In its "The Moment of Truth" report, the Bowles-Simpson commission did not hold back: "The tax code is rife with inefficiencies, loopholes, incentives, tax earmarks, and baffling complexity." With a calculated lack of specificity, the commission suggested ridding the code of all tax breaks. Most of the revenue raised would be used to cut tax rates. The remainder would be for deficit reduction.

Even strongly antitax Tea Party types recognize the equivalence of tax subsidies and plain old cash subsidies. And in case you think cutting corporate tax breaks turns you into a RINO, remember it was Ronald Reagan who did more of it than any other president.

Lose the Battle, Win the War



Above all this stands President Obama. A few short sentences in his 2011 State of the Union address took all these crosscurrents and channeled them to his purposes:

    Over the years, a parade of lobbyists has rigged the tax code to benefit particular companies and industries. Those with accountants or lawyers to work the system can end up paying no taxes at all. But all the rest are hit with one of the highest corporate tax rates in the world. It makes no sense, and it has to change. So tonight, I'm asking Democrats and Republicans to simplify the system. Get rid of the loopholes. Level the playing field. And use the savings to lower the corporate tax rate for the first time in 25 years -- without adding to our deficit. It can be done.

For Washington insiders, there was nothing new in the substance of the president's remarks. In June 2008 candidate Obama said: "If we could eliminate loopholes in taxes, create a level playing field, then I think there's the possibility of reducing corporate rates." And in March 2009 Obama told the Business Roundtable:

    I will certainly listen to your point of view, because I want American businesses to be competitive. And by the way, at some point -- this isn't reflected in our current budget because we've already got a lot on our plate -- my interest over time in potentially lowering corporate rates in exchange for closing a lot of the loopholes that make the tax system so complex, that's a very appealing conversation to me, and I'd like to pursue it.

Two years later we have moved beyond the conversation stage -- but not by much. The White House putting corporate tax reform in the State of the Union spotlight cost nothing but gave a lot in return. Left-leaning supporters were appeased because the president was sharing their disgust with corporate loopholes. Opponents on the political right were pleased because a Democratic president was identifying with their efforts to reduce corporate tax rates. Appeasing corporate America was particularly important to the White House after the Republicans picked up 64 House seats in the midterm elections and the president was being brandished as anti-business.

The key to Obama's strategy on corporate tax reform is his insistence that reform not spread to other parts of the tax code and that it be revenue neutral. Although many can disagree, the president could hardly be subject to severe criticism for wanting to keep revenues unchanged. Competitive pressures rule out a tax increase. Budget pressures rule out a tax cut. The president is just taking a reasonable middle course.

But once the president endorses a real plan, his would-be supporters will melt away. The plan with the details filled in will not comport with their fuzzy visions of what corporate tax reform must be. Liberals who want to cut corporate tax expenditures instead of social programs will walk away. And the business community, which really means "corporate tax cut" when it says "corporate rate cut," will give the president the same cold shoulder it gave former Ways and Means Chair Charles B. Rangel, D-N.Y., in 2007 when he floated his revenue-neutral plan to cut the rate to 30.5 percent.

According to a 2007 Treasury study, the corporate tax rate could be cut to 28 percent if all corporate tax expenditures, except those relating to foreign-source income, were cut. That list of tax expenditures includes some -- like the research credit and the deduction for charitable contributions -- that have no chance of being eliminated. And others -- like accelerated depreciation for equipment -- are considered such a positive inducement to capital formation and competitiveness that it would leave many legitimately questioning if there are actually any economic benefits to revenue-neutral reform. The bottom line: With Obama's revenue constraints, it is nearly impossible to formulate a politically acceptable reform that gets the rate to 30 percent.

That makes tax reform unattractive to conservative legislators who do not want to go through holy hell only to end up with a modest rate reduction. They would give Obama a political victory on their favorite issue. And they would lose the wonderful talking point about the United States having the highest corporate rate in the world.

Adding to the political baggage is poor distribution of the goodies. Corporate tax reform would create winners and losers in the business community, and it would split powerful groups like the Business Roundtable and the U.S. Chamber of Commerce. The lion's share of tax expenditures favor manufacturers. Non-manufacturing businesses like retail and finance would benefit at their expense. Revenue-neutral tax reform would mean a tax increase on American manufacturing. That would be as politically popular as cutting food rations for the troops.

The word around town now is that the Treasury Department has a revenue-neutral corporate reform plan with a rate of 26 percent. To get the rate that low, Treasury will have to look beyond the list of tax expenditures it compiled for the Bush administration in 2007. One probable revenue raiser is a provision to prevent large businesses from escaping taxable subchapter C status. But that won't yield nearly enough revenue to get the rate to 26 percent. Another possibility would be to put some limitations on the deductibility of interest, like the German government did when it cut its corporate tax rate.

But most likely the new source of revenue in any Obama corporate reform with a 26 percent rate will be a tightening of international tax rules. There is no doubt that the White House has lost a lot of enthusiasm for attacking multinationals' offshore operations since the heady days of 2008 when it was an effective campaign issue. On the other hand, there is no indication that the White House is ready to totally capitulate.

The bipartisan Wyden-Coats tax reform bill adopts a rate-cut-with-repeal-of-deferral approach. That legislation would get the corporate rate down to 24 percent and entirely eliminate deferral of U.S. tax on foreign-source income. The basic sales pitch is that with the corporate rate so low, the business community will be willing to give up tax benefits for foreign income.

That's a good enough argument for the public, but it will never fly with the business community. On international tax reform multinational corporations are dead set on moving 100 percent in the opposite direction: total exemption of active foreign-source income from U.S. tax. And corporate tax reform will never pass without their support.

This all spells defeat for the Obama approach to corporate tax reform. But that is perfectly fine with the White House. The business community will ultimately split with Obama, but it cannot attack him. The president did sign up the CEO of GE to advise him on competitiveness, and after all, he did address the issue that that company made the center of its public relations campaign: The United States must not have the world's highest corporate tax rate.

Waiting for 2013



Everybody says the big issue is jobs. Yes, but truth be told, there is little any president can do to reduce unemployment. And now it looks like in time the economy will take care of itself. The federal budget is the real central issue in Washington now. We have heard those words before, but there is no precedent for our situation.

We are driving toward the fiscal precipice in the dark. Avoiding disaster is not just about numbers but about the fundamental role of government. Will the government give priority to assisting its aging society or to improving business conditions for U.S. companies competing in world markets?

If you do the math, it is clear that returning the government to a sound fiscal footing without fundamentally cutting benefits to senior citizens is impossible without significant tax increases. And allowing the Bush tax cuts to expire for families with incomes of more than $250,000 will not be enough. If Obama is elected to a second term, he will propose major new tax increases -- perhaps even a VAT (but it won't be called a VAT). It would be political suicide to even hint at that before November 2012.

So it is critically important for Obama to delay answering the ultimate question of how he will put federal finances on a sustainable path. He needs placeholders. He needs to distract attention. He needs to appear to be addressing key fiscal issues: "Thank you, corporate America, for making such a big deal out of your taxes. I've already put two blue-ribbon commissions to work on tax reform and gotten their recommendations. I was wondering how I could keep stalling. Now I'll have the Treasury staff make a big study of corporate tax reform. Or even better, I'll wait for your recommendations that I know will never come because you cannot agree among yourselves."

A large reduction in the U.S. corporate tax rate is inevitable. But it will not be part of a revenue-neutral corporate reform. It will come after 2012 as a sweetener to buy business support for the big tax increase needed to bring the deficit under control.

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