Corporate Tax Reform: Where's the Beef?

By :: January 31st, 2011

One of the biggest applause lines in the President’s State of the Union speech came from his promise to reform and simplify the corporate income tax:

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. 

That sounds straightforward.   We did this, after all, in 1986.  Congress lowered the top corporate tax rate from 46 percent to 34 percent (since raised to 35 percent), while closing many business tax preferences and raising more corporate revenue.  What are the chances that we can do this again?

To get a rough idea, I added up the cost of business tax expenditures reported in last year’s budget.  In all, they total about $640 billion between 2011 and 2015.  About $506 billion of these losses (just under 80 percent) come from corporate taxpayers.  Businesses organized as “flow-through enterprises”(S corporations, partnerships, sole proprietors) benefit from many of the same provisions as taxpaying corporations. Their owners would also pay more tax if we eliminate business tax preferences.  So, any revenue-neutral combination of lower corporate rates and reduced business tax preferences would lower corporate tax receipts and increase individual tax receipts.

Over the 5-year period, estimated business tax expenditures add up to about a third of projected corporate receipts.  If wiping them all out permitted proportionately lower rates, the top corporate rate could fall to 23 percent without any loss in overall revenue.  But the actual potential rate cut would be different because of interactions among the various tax expenditures, interactions between the corporate tax rate and some tax expenditures, and behavioral responses.   For one thing, the revenue gain from closing corporate preferences would be smaller at a lower corporate tax rate.

Now, look closer at these tax expenditures.  It turns out that the ten most costly provisions benefiting business investment account for about 92 percent of the five-year revenue losses.  How likely is it that these costly provisions would be repealed?

The largest estimated loss ($169 billion) over five years comes from deferral of foreign source income of U.S. multinationals.  In the past, the revenue gain from eliminating deferral has been estimated as much smaller than the ongoing revenue cost under current law.  And the corporate leaders now advising the President are likely pushing him to move in the opposite direction, following our major trading partners, who exempt foreign-source income.   The second largest, accelerated depreciation of machinery and equipment, costs an estimated $147 billion.  But this tax expenditure, which broadly subsidizes domestic investment for a wide range of business firms, has just been increased, with the support of the Administration, by allowing full expensing for investments made in 2011.  The President has endorsed making the research credit permanent (scored at $13 billion over 5 years last year, but since increased because Congress extended it) and no one would even consider eliminating expensing of research and experimentation activities ($32 billion over 5 years).  Other items among the ten costliest provisions that seem unlikely to get chopped include the credit for low-income housing ($36 billion), accelerated depreciation on rental housing ($41 billion), and exclusion of interest on hospital construction bonds ($21 billion).  Adding up all these items reduces the potential saving from $640 billion over 5 years to just $180 billion, or less than 10 percent of 5-year corporate revenues.  And even getting this far would require eliminating alcohol fuel credits –think, Iowa primary --($32 billion), the deduction for domestic production activities ($77 billion), preferential tax rates for small corporations ($16 billion), and all tax incentives for renewable energy ($26 billion, excluding alcohol fuels).    The only tax breaks the President proposed removing in his speech were tax breaks for fossil fuels – a mere $14 billion over 5 years.

Enforcing a corporate tax is no doubt challenging in a global economy, where corporations can shift profits to low-tax jurisdictions.  And many companies have legally escaped most of the corporate tax.    The Administration may have new ideas on how to limit avoidance or to increase corporate receipts in ways their official tax expenditure list doesn’t show (such as revising inventory rules or limiting interest deductions).  If it comes up with other good ideas, or proposes some of the items I dismissed as long shots, I would be pleasantly surprised.  But, to paraphrase Willie Sutton, if we are going to broaden the corporate tax base enough to pay for a meaningful rate cut, we need to go where the money is.   And from what I have seen so far, we aren’t there yet.

16Comments

  1. Corporate Tax Reform: Where’s the Beef? | Tax Information  ::  6:42 pm on January 31st, 2011:

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  2. Sid F.  ::  7:39 pm on January 31st, 2011:

    We all agree that nothing will happen with Corporate or Individual Tax Reform. Heck, it will take all of the resources of the Executive and Congressional branches just to reach an accord on spending and keep the Federal Government in business in 2011.

    We need to concentrate on what will or can happen. There are two great issues in taxes that require attention. The first will be whether or not to extend the tax provisions that expire at the end of 2011 into 2012 and beyond, particularly the payroll tax reduction and full expensing of capital spending. Republicans will push for an extension, causing Obama to decide whether or not to campaign in 2012 on raising taxes for working people and business or being responsible for continued $1.5 trillion deficits.

    The second issue will be with respect to tax provisions expiring at the end of 2012. The question here is will that be decided prior to the election, after the election in a lame duck session of Congress on with the new Congress in 2013. Since Republicans will almost certainly take control of the Senate in 2013 and add to the House Majority, they will likely force postponing the vote until the 2013 Congress is seated. At that time they can pass legislation making all of these cuts permanent, and setting the stage to reduce government spending to 15-18% of GDP, essentially leaving the government operating only defense, Social Security, Medicare, Government Pensions, Treasury, Justice, Immigration and a few leftover programs.

    People that study taxes need to focus on this possible future, not on things that will not happen.

  3. Tweets that mention TaxVox » Blog Archive » Corporate Tax Reform: Where’s the Beef? — Topsy.com  ::  9:20 am on February 1st, 2011:

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  4. Michael Bindner  ::  4:50 pm on February 3rd, 2011:

    The reason to lower the corporate rate is the lowering of the top individual rate. Currently, the top individual rate and the corporate rate are 35%. The Fiscal Commission recommends both be 28%, while the Bipartisan Policy Center (BPC) recommend 27 percent.

    Most of the base broadening will come on the individual side, at least under each proposal, although BPC also includes a VAT (even though it does not use that term).

    I question using individual loophole closing to lower rates and increase revenue and I question why it is any easier or any more equitable to cut the number of tax brackets to two, since by and large filers use the provided tax tables anyway, so the number or rates does not add any burden at all – unless I am missing something, it sounds gimmicky to me.

    I agree with the BPC on the notion of a VAT, however I would double it to 13% and tie it to discretionary spending, with a requirement that the two balance with automatic spending cuts and rate increases kicking in when there is a shortfall and the reverse when there is an excess – provided that the economy is out of recession – in which case a deficit would be permitted.

    In order to make payment of the VAT politically palatable, withholding tables would be altered to increase net pay by enough for people to pay the tax.

    The middle range of personal income tax rates, as well as individually filed pass through taxes from Schedule C and F income, as well as partnership and Chapter S income, will be shifted to an expanded business income tax – along with payroll taxes funding surivor benefits for widows under age 60, Medicare Hospital Insurance and Disability Insurance (which will be decoupled from income), as well as revenue from the current corporate income tax.

    This tax will be set to collect 27.6% of value added to cover all social service entitlements – however it will not show up on receipts because the tax will also include a refundable child tax credit to be paid to workers and the preservation of the mortgage interest exclusion. In order to account for these payouts, the statutory rate will be 33.6% The child tax credit is fully paid for by ending the home mortgage deduction and the state property and income/sales tax deductions at all levels. These deductions and credits, as well as residual Social Security payroll taxes, will be factored out before the VAT induced net pay increase is calculated.

    Payroll taxes for Old age and older survivors insurance will continue to be withheld separately, with the income cap eliminated and the employer contibution credited equally regardless of income – although the employee contribution will remain tied to income. Bend points will be ended as a result, with benefit calculations in the future tied to contributions in each year. Bend points will be phased out over time. Note that these developments are necessary in order to pursue any kind of personal account scheme – however such accounts should be limited to investments in one’s own employer rather than the casino of Wall Street, with diversification provided by having a third of employee-owned shares (which are only provided from the employer contribution) held by an insurance fund of all such companies.

    Budget balance should come from the residual income surtax, which will range from 4% for joint filers and widows making over $100,000 (or singles making over $50,000) to 28% at the $550,000/$275,000 level, with rates going up in 4% increments for each $75,000. If fewer rates are politically expedient, the tax floor could occur at 12% of all income over $200,000 and 28% for income over $475,000. Dividend income, capital gains and distributions from estates would be taxed as normal income – with an ESOP sales exclusion for estate distributions and the retention of the charitable contribution deduction.

    The income surtax would fund any deficits in the VAT or BIT in time of economic downturn, net interest payments, repayment of trust funds, including the Social Security Trust Fund, overseas military, air and marine deployments and naval sea operations.

    If taxes are inadequate, this fund may go into deficit – with the understanding that only this fund will pay back all such borrowing and that only high income taxpayers and their children will be on the hook for this. In reality, they are anyway, since the ability to run a deficit is solely provided by the ability to tax incomes and that taxing lower incomes has a Laffer problem, not because of tax avoidance but because such taxes would retard consumer spending. When this fact is really understood, the resistence to raising adequate revenue will evaporate fairly quickly, if only to save on interest costs.

  5. Michael Bindner  ::  4:56 pm on February 3rd, 2011:

    I don’t really agree with that, so all is not the right word.

  6. Tax Reform and the Revenue Problem – Swampland – TIME.com  ::  4:00 pm on February 17th, 2011:

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  10. The Largest Tax Breaks for Individuals – NYTimes.com  ::  2:49 pm on April 13th, 2011:

    […] Largest Tax Breaks for Individuals By DAVID LEONHARDT The economist Eric Toder has pointed out that the largest corporate tax loopholes also happen to be among the most politically popular. They […]

  11. Economix: The Largest Tax Breaks for Individuals  ::  4:15 am on April 14th, 2011:

    […] economist Eric Toder has pointed out that the largest corporate tax loopholes also happen to be among the most politically popular. They […]

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  15. Corporate Taxes and Apple: The Flaw Is in the Law | Wall St. Cheat Sheet  ::  9:38 am on June 1st, 2013:

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