Can We Cut the Corporate Rate?
Tax experts will argue about nearly anything. But on one issue, there is something approaching a consensus: Corporate tax rates in the
President Obama’s interest in raising the top rate on wealthy individuals only increases the challenges. If we cut the corporate rate from 35 percent to, say, 25 percent but at the same time raise the top individual rate from 35 percent to something over 40 percent…well, you can see the problem. Many high earners will turn themselves into corporations to dodge the higher individual rate.
Harvard law professor and TPC scholar Dan Halperin has looked at an intriguing solution—a split rate tax system on profits. Imagine a 25 percent levy at the company level and an additional 20 percent tax on dividends distributed to shareholders. Do the math, and you’d get a combined rate of about 40 percent on distributed profits, roughly what the top individual rate would be after 2010, when the Bush tax cuts are allowed to expire for those in the top bracket. (Here’s the math: Company pays $25 on $100 in profits. Shareholder pays 20 percent on the remaining $75, or $15. $25 plus $15=$40).
Today, Dan, Peter Merrill of the accounting firm Pricewaterhouse Coopers; Michael Schler of the law firm Cravath, Swain & Moore; and TPC’s Rosanne Altshuler discussed corporate rates at the latest session in TPC’s Tax Reform 2.0 series. The panelists agreed that Dan has come up with an elegant solution to the problems of corporate tax reform. The trouble is, it is probably politically impossible.
Dan shouldn’t feel too bad, however, since so is just about every other idea. American business wants lower rates, but nobody wants to pay the cost, which Peter estimates at more than $1 trillion over 10 years.
The split rate system has its own problems. Dan would solve some tax avoidance issues and make the rate cut more equitable by limiting it to publicly traded companies. At the very least, Subchapter S corporations, partnerships, and other forms of business could be taxed at the individual rate.
He’d also tax personal service income (from, say, lawyers, accountants, and, ahem, writers) at the individual rate. And he'd do the same with passive income such as interest and dividends to discourage investors from reducing their tax liability by stashing their portfolios in corporations. All in all, said Schler, Dan has come up with “creative and theoretically correct solutions.”
But, said Michael, there is one problem: tax lawyers like him. They will inevitably figure out ways to game the lower corporate rate. He even came up with a few on the fly as Dan finished his presentation.
So, what to do? We could broaden the corporate tax base by requiring economic, rather than accelerated, depreciation on investment property or imposing more restrictive tax accounting rules on the sale of goods. Congress could raise the top individual rate even more or tinker with the brackets at which the highest rates kick in (though that would further encourage people to morph into corporations). Rosanne argued that the money might have to come from outside the income tax, perhaps through a Value-Added Tax.
Is corporate tax reform likely to happen? Nope. And the sticking point won’t just be populists who resist lower corporate rates. It also will be those businesses who paid good money for the messy tax system we have. As long as they oppose efforts to close the special interest tax benefits that so benefit their own bottom lines, the