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

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.