President Barack Obama’s corporate-tax framework, unveiled Wednesday, recognizes that the U.S. tax code desperately needs a spring cleaning. There are too many loopholes, deductions, subsidies, allowances and special rules.
The 35 percent statutory rate is also too high, especially because most companies have figured out how not to pay it, and most countries have dropped their rates below the U.S.’s.
We agree it’s time to lower the marginal rate, conceivably to 25 percent -- lower than Obama’s proposed 28 percent -- which is about where it stood after the last tax reform 25 years ago. Obama’s proposal goes a long way toward streamlining the code and broadening the base of tax-paying corporations, but it contains some obvious flaws and comes up short in a few areas. Luckily, there’s time to fix it.
It was 1986 when the U.S. tax system got a thorough going-over in President Ronald Reagan’s second term. In the quarter century since, Congress has been unable to resist adding new breaks and loopholes, and then having to raise rates to prevent a hemorrhaging of revenue. As a share of gross domestic product, corporate taxes now make up a mere 1.16 percent, versus more than 4 percent in 1960, according to a study released in November by Citizens for Tax Justice, a small, left-wing think tank.
Reagan created a commission in 1984 to examine the tax code after Citizens for Tax Justice noted then that many large companies were paying little or no taxes. Reagan wanted to get the subject off the table until after that year’s elections, but two years later, tax reform ended up passing.
The same dynamic may be happening again. It’s a presidential election year, and Obama’s framework is meant to get the subject off the table until after November. Citizens for Tax Justice has even come out with another report concluding that corporations again are avoiding paying taxes.
The nonprofit group, along with the Institute on Taxation and Economic Policy, looked at 280 of the biggest and most profitable U.S. companies. A quarter of them paid less than 10 percent in taxes over the three years 2008 to 2010. Thirty companies, including such familiar names as Boeing Co., Verizon Communications Inc. and Wells Fargo & Co., paid little or no taxes in at least one of the three years.
Only about a quarter of the companies studied paid close to the official 35 percent rate. The average annual tax rate for all 280 was 18.5 percent over the three years, barely half the official rate, yet they reported almost $1.4 trillion in pretax profits. (The U.S. Treasury estimates the effective U.S. marginal tax rate at 29.2 percent for all corporations.)
To address this, Obama’s blueprint, while light on details, includes several approaches we endorse. It would discourage outsourcing by imposing a minimum tax on overseas profits (sadly, without saying what the minimum would be) and eliminating breaks for moving operations abroad. The current system, in which companies can defer income taxes on foreign profits until they are repatriated, unfairly rewards companies for leaving the U.S. and robs it of revenue.
The president’s plan would also eliminate many unwarranted preferences, such as oil and gas subsidies, breaks for corporate aircraft and accounting gimmicks that allow companies to artificially lower reported earnings. Most important, it does not increase the bloated federal budget deficit.
In many ways, though, the plan is too timid and internally contradictory. It suggests, but doesn’t outright endorse, reducing the deductibility of interest on corporate debt. It’s a smart idea and, as we have said, removes some of the incentive to borrow rather than raise equity capital, and would bring in much-needed tax revenue.
Administration officials said the 28 percent rate was based on “brutal” arithmetic that lowered corporate levies without worsening the deficit. The math is complicated, but boils down to this: The plan would save $250 billion over the next decade by wiping out an abundance of loopholes and special-interest breaks, and would apply those savings to new breaks for manufacturers, research and experimentation, and clean energy. So-called advanced manufacturing, whatever that is, would get even richer tax breaks.
It’s unrealistic, we know, to expect a pure tax code in which every company pays the same rate. For example, one widely used tax break, the depreciation allowance, may need to be kept, even though it’s confusing and often abused. Companies must have a way to deal with the fact that equipment and buildings wear out and need to be replaced. And some tax breaks, such as those for clean energy and research, are largely justifiable because they benefit the entire country and are vital to the future economy.
Still, the goal should be to do away with as many preferences as possible. The Obama framework does this with one hand, and then undoes it with the other.
The Obama plan also increases the potential for tax code gamesmanship. It says, for example, that the minimum tax on overseas profits shouldn’t penalize businesses engaging in “activities which, by necessity, must occur in a foreign country.” Administration officials have in mind exemptions for things like building and operating hotels abroad, but we spy a loophole that could undermine the provision’s intent.
When all is said and done, some corporations may get a better deal and some may get a worse deal. Making corporate taxes fairer and simpler won’t be easy when reform produces as many losers as winners. But with both parties claiming tax reform as a goal, there’s no excuse not to begin an earnest discussion now.
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