Tax reform: The devil’s in the details (and the politics)
Feb 22nd 2012, 21:46 by G.I. | WASHINGTON
[Greg Ip] LIKE the weather, American politicians talk a lot about tax reform but do nothing about it. Which is a pity, because while Americans have been talking, other countries have been doing; since the late 1980s, top corporate tax rates around the world have dropped to a point that America’s, once below the international average, is now well above.
As this has happened, American-based multinational companies have shifted more activity offshore; their foreign employment steadily rose over the last decade as domestic employment fell. This is mostly because of the appeal of cheap labour and growing markets in the emerging world, but business groups and many economists think America’s tax rate is also to blame. Liberal analysts blame the tax code for a different reason: it allows multinationals to stash income in foreign havens and indefinitely defer taxes on it, encouraging the outsourcing of jobs.
Barack Obama claims to be ready to do something about it. Calling the present tax code “outdated, unfair, and inefficient”, he proposed on February 22nd a reduction of the top corporate rate to 28% from 35% (39% including state and local taxes). Previous analysis suggests such a cut would cost more than $700 billion (or 0.4% of GDP) over the next decade. Mr Obama would add to the price tag by making permanent a variety of tax provisions, such as the credit for research and development, that are on course to cost $250 billion over the next decade.
Mr Obama, however, pledged that he would pay for these provisions by eliminating enough tax breaks so that the overall plan would not add to the deficit. In theory this is ideal: lower corporate rates levied on a broader base would distort the allocation of capital less and provide less incentive for wasteful and tax avoidance.
But deciding whose tax breaks get closed is what makes tax reform hard. Mr Obama has called for, and proposed budgets that include, eradication of a dog’s dinner of loopholes covering inventory accounting, oil and gas production, corporate life-insurance policies, hedge-fund profits, and corporate jets. He would impose a minimum tax rate on foreign-source income. But this still leaves a lot of money that must be raised through other means. On the remainder Mr Obama sadly but predictably grows vague: curbing depreciation, the deductibility of interest, and the use of non-corporate business forms, such as “S corporations”, partnerships, and LLCs, should all be “considered”.
The single biggest corporate tax breaks are for depreciation and expensing of capital equipment, and a tax deduction for American-based production. But, awkwardly, among the greatest beneficiaries of these benefits are manufacturers whose cause Mr Obama now loudly champions. Rather than eliminate those tax breaks altogether, Mr Obama would preserve them for manufacturers so that their effective tax rate would drop a bit, to 25% from 26% currently. (The effective tax rate equals taxes, after all deductions, as a share of income. It’s a better measure of the tax burden than the top corporate rate.)
Mr Obama’s proposal is better than what America already has, but not by much. His well-intentioned goal of broadening the tax base is betrayed by the preferences he insists on maintaining for manufacturing and “green” energy whose economic merits have been questioned, even by former members of his own administration. By maintaining many of the current tax breaks but apportioning them more variably, the tax code would become more complex rather than less so.
Mr Obama’s reform should bolster the case for manufacturing at home, but not by much. Alex Brill of the American Enterprise Institute dryly notes America’s top rate would go from the OECD’s highest to third-highest (once Japan enacts a planned cut); its effective rate would still be above the international average.
Then there are the devilish politics. Marty Sullivan, an independent tax analyst, says high-technology and pharmaceutical multinationals such as Apple and Merck that have benefited from low taxes on foreign-source intellectual-property income would be losers, as would utilities and telecommunications companies with significant interest and depreciation charges. They are unlikely to accept a tax hike quietly.
In theory, Republicans should be receptive as they, too, have been calling for corporate tax reform. All four Republican presidential candidates would drop the rate to 25% or lower. Dave Camp, the chairman of the tax-writing committee in the House of Representatives, last fall proposed lowering the corporate rate to 25% and exempting most foreign-source income from tax altogether. However, he is even less precise than Mr Obama on how the lost revenue would be made up. It is over such details that tax reform lives or, more often, dies.
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