Obama’s Tax Reform: Corporate, Individual, or Both?

By :: January 25th, 2011

If President Obama says much in his State of the Union address tonight about tax reform, he’s likely to focus on revising corporate taxes, and leave the chore of fixing the individual income tax for another day.

He’ll probably say that corporate reform is important to achieve international competitiveness. He won’t say that his real reason for focusing on the corporate side is that White House strategists feel it is better politics. It puts pressure on both congressional Republicans and the (largely-Republican) business community to try to build consensus for a plan among their own widely divergent interests.  If they can’t, Democrats will happily blame them for the collapse of the initiative.

Even better, focusing on corporate taxes allows the President to dodge the nastier political minefields of individual reform. After all, it is so much easier to talk about closing corporate loopholes than curbing the mortgage interest deduction.

Regardless of the politics, does it make sense to split corporate and individual reform? I don’t think so. Here are two reasons why:

The revenue problem. Given a national debt that exceeds $14 trillion and is rising each year, one goal of tax reform ought to be to raise more money. Any responsible deficit reduction plan would include both spending cuts and new tax revenues. But Obama seems to favor a new corporate tax code that raises the same amount of money as it does today. And that’s not good enough for business execs who are already urging Congress to cut corporate taxes even as they reform the law. They want lower rates--and an exemption from U.S. tax on their foreign earnings. Oh, and they'd also like to save many of their targeted tax breaks that are already on the books.

Perhaps Obama could hold the line and keep reform from draining even more revenue, although given his inability to restrain last December’s tax cuts that’s hard to imagine. But let’s get wildly optimistic and say corporate reform will end up, in Washington-parlance, revenue-neutral.

Then what happens? We’ll still have a debt that will exceed $15 trillion by the end of this year. Will Obama and the Democrats then try to balance the budget entirely through individual tax hikes and whatever spending cuts they can settle on? That’s not very likely. Will they instead immediately turn back to the corporate community with the following offer: “Remember that top rate of 25 percent you got in 2011, well now we are going to bump it back up to 30 percent to cut the deficit.” Hard to see that flying.

Most businesses are indifferent to changes in corporate taxes. The vast majority of businesses pay at individual rates, not corporate rates. Remember the big fight Washington had last December about how raising top individual tax rates would crush “small business?” As bogus as that debate was, it pointed up the reality of business taxation: To avoid the double tax on corporate profits, most firms organize themselves so their owners pay tax on their individual returns. The Tax Policy Center estimates that 20 million businesses file this way. By contrast, only about 7 million firms file corporate returns.

Corporate filers are usually bigger—generating greater economic activity and employing more workers—and many are multinationals and thus have much more interest in how foreign sales are taxed.  

Still, most businesses won’t care about corporate tax reform. Sure, some firms might pay lower taxes if Washington cut the corporate rate enough, and they'd reorganize themselves to take advantage of the change. That would increase corporate tax revenues some and reduce individual tax revenues more, but otherwise please only the lawyers who’d get to do all the extra paperwork. For the most part, American businesses care much more about individual taxes since that is how most of them file. Indeed, when it comes to taxes, the issues business owners often care most about are capital gains and dividends. And they are opart of the individual tax code.          

I understand why Obama wants to focus on corporate reform, but I’m not sold.

3Comments

  1. Michael Bindner  ::  4:34 pm on January 25th, 2011:

    Ideally, corporate tax reform and the taxation of business and farm income on personal returns would be reformed together and filed in the same way as part of comprehensive reform. Part of this reform would be to shift payment of disability insurance, hospital insurance and personal income taxaton funding Medicare and Medicaid to a single tax, with offsets for providing health insurance or care for both current workers and retired former workers. This tax could be programmed to increase with health care costs, giving the system an incentive to restrain them.

    If the funding of higher education is moved from individuals to employers (an emerging trend) then offsets for employer provided education could also be included.

    If comprehensive tax reform included replacing tax collection on the middle class with a VAT, then tax credits for children and workers could be shifted to the business income tax as well.

    Of course, the reform I am suggesting would require adding payroll to the tax base of the business income tax and would all but require repeal of personal income taxes on all but the top 20% of earners – if not the top 10%. It would also end the need to assign tax liability to employees, report it to employees or pay them a bonus over their net income that is then sent to the IRS to pay the tax – although the net would go up so that the VAT can be afforded.

    Nothing short of this will short circuit the complaint that people are “taxed enough already.” It is not the financial bite that worries them, its the reporting and the feeling that they are entitled to every cent they earn. Those who think that are unware of how much of their output their employers take in profit. It dwarves what is sent to the IRS in their name.

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  3. Wonkbook: So much State of the Union | Daringminds.com  ::  7:47 am on January 26th, 2011:

    […] on corporate tax reform has political, not policy, merit, writes Howard Gleckman: “His real reason for focusing on the corporate side is that White House […]