A game not worth playing. KIRILL KUDRYAVTSEV/AFP/GettyImages
A game not worth playing. KIRILL KUDRYAVTSEV/AFP/GettyImages

You can think of corporate taxation as a sort of long chess match: The government makes a move. Corporations move in response -- sometimes literally, to another country where the tax burden is less onerous. This upsets the government greatly, and the Barack Obama administration in particular. Treasury Secretary Jack Lew has written a letter to Congress, urging it to make it stop by passing rules that make it harder to execute these “inversions.”

I’ve got a better idea: What if we made our tax system so attractive to corporations that they would have no interest in moving themselves abroad?

Tax Inversion

The problem with this extended chess game is that every move is very costly. First, it adds to the complexity of the tax code. With every new rule -- no matter how earnestly said rule attempts to close a “loophole” -- it becomes harder to know whether you are in compliance with the law. This is true on both sides; corporate tax law has now passed well beyond the point where it is possible for a single expert to be familiar with its ins and outs. This makes it harder to plan business expansions, harder to forecast government revenue, and it requires both sides to hire more experts in order to determine whether corporations are compliant. It also means more lawsuits, and longer ones, as both sides wrangle over how this morass of laws should be applied to real-world situations.

You can think of it this way: Every new law has possible intersections with every other tax law in existence. As the number of laws grows, the number of possible intersections grows even faster. And each of those intersections represents both a possible way to avoid taxes and a potential for unintended consequences that inadvertently outlaw something Congress never intended to touch. This growing complexity makes it more and more difficult for either companies or lawmakers to forecast the ultimate effects of new tax laws. That’s bad. It’s also expensive.

Then there’s the immense amount of time, money and human talent wasted structuring business activity to minimize tax bills -- up to, and including, moving your headquarters to another country. This is a total loss to the economy: All the resources used to structure those transactions could instead have been employed doing something useful, or at least not actively harmful.

You can argue that corporations shouldn’t do this, but this is rather like arguing that people shouldn’t waste so much water on hot, luxurious baths when they’re on vacation. All the incentives run in the wrong direction, and moral suasion isn’t going to get many bath lovers to take stingy showers -- or many corporations to give the government a cent more than they are legally required to fork over.

You can also argue that the government should crack down on all this structuring. But this is precisely backward. Those armies of tax lawyers were raised because of all the earlier attempts to close the loopholes, which made more laws for them to study and exploit. Yet our response is always the same: even more laws to change the earlier laws that aren’t working.

I know what you’re thinking. You want a simple tax code that raises a bunch of money by closing the loopholes. Many people think this because they think that taxing income is simple, so “loopholes” must be illicit backdoors placed in the tax code at the behest of greedy corporations.

And to be sure, the tax code contains plenty of senseless giveaways to corporations. But these are small beer. Most of the “loopholes” that we argue about are not a result of congressional pandering, or even sharp lawyers who bend sensible rules. They’re an artifact of the fact that calculating corporate income is really hard.

Why is it so hard? Because unlike with the personal income tax, calculating corporate income tax requires taking account of a corporation’s expenses. The Internal Revenue Service basically ignores most personal expenses because it can assume that the operating costs are the same from person to person. You may think that a BMW and a pied-a-terre in Gstaad are basic survival equipment, but the IRS doesn’t care. Everyone gets the same standard deduction; if they itemize, they can only itemize select big-ticket expenses -- children, excessive medical costs, mortgage interest and so forth.

But that won’t work for a corporation because basic living expenses can vary wildly, from tech firms whose only assets are a few computers and a handful of programmers to airlines and aluminum mills that run huge workforces and buy lots of heavy equipment meant to last decades. If you ignore expenses and just tax revenue, you’ll either end up giving the tech firms a hell of a deal or handing low-margin businesses such as grocery stores a tax bill for 800 percent of their profits.

Once you’ve decided to tax profits instead of gross revenue, you’re going to spend a huge amount of time arguing over what constitutes a legitimate expense (say, flying to Vegas for a major trade show: If you say yes, you’ll ensure that trade shows and conventions are held in a lot of prime vacation slots so business owners can catch a little tax-deductible R&R on the side; if you say no, you may have just outlawed the trade show), when revenue and expenses are recognized, and whether particular transactions have a genuine business purpose. This is not because businesses are all engaged in a nonstop tax scam on the public. It’s because -- as you may know from your own interactions with the IRS -- it’s possible to have legitimate differences of opinion from the government.

Take two of the “loopholes” most frequently cited by the Obama administration: the carried-interest deduction and the depreciation of corporate jets. Most people believe that these are special deals inserted into the law at the behest of nefarious lobbyists. In fact, “carried interest” is a long-standing feature of partnership taxation, and it wasn’t designed to let hedge-fund managers have a special, low rate of tax; it was designed to equalize the treatment of partners who contribute equity and partners who contribute labor. You can argue that it’s not worth the cost, and maybe I’d agree (though the cost is really trivial, on the scale of federal taxation). But if you change the law, you will also be privileging partners with money to invest over partners with ideas to invest, which benefits the relatively wealthy. These sorts of trade-offs are exactly why tax policy is hard.

Depreciation of corporate jets, meanwhile, is not some special loophole. All assets depreciate, which is to say they become less valuable over time as they become outdated and suffer wear and tear. Both financial accounting and the tax code recognize this. Depreciation is how the tax code handles investment expenses; if you disallow this, you would be essentially levying extra-heavy taxes on capital-intensive businesses.

The Obama administration liked to talk about loopholes for corporate jets, but all it was talking about was depreciation. And it wasn't saying that the jets shouldn’t be depreciated; it just wanted to lengthen the time period over which companies took the depreciation allowance, meaning they’d take a smaller deduction for more years. Ultimately, the net effect on tax collections is negligible: You get more now, less later. Which is not to say that the administration is wrong; I have no opinion at all about the proper schedule for depreciating an aircraft. But these are not the easy questions that the administration made them out to be -- and they are not special favors to businesses that own jets.

All of which is to say that there is no such thing as a fair, simple corporate tax code that can’t be gamed. And the harder we try to squeeze them for each extra dime, the harder -- and more expensively -- they will resist. So here’s my proposal: Let’s not try. Let’s eliminate the corporate income tax, or at least lower the rate so far that they won’t spend so much time and energy trying to avoid it.

There are two possible objections to this. One is that corporations won’t be paying “their fair share” and the other is that giving up the corporate income tax would be very expensive.

The first objection is not a good reason to keep trying to pummel more money out of American companies. Now, I know you’re getting all red in the neck, but hear me out. The truth is that you can’t tax a corporation at all. All “corporate taxes” ultimately come out of the pocket of some person: an owner, a manager, a customer, an employee. A corporation can’t pay its “fair share” because, in the end, a person is paying.

And the corporate income tax is not a particularly good way to ensure that those individuals are paying their fair share. It’s a blunt instrument that falls equally on all owners -- from filthy-rich hedge-fund managers to lonely widows sitting on a few hundred shares of AT&T.

But while I don’t agree that we need to make corporations pay their “fair share,” I do agree that jettisoning the corporate income tax would be expensive. So here’s my proposal: Eliminate the corporate income tax and take the money from people. That’s what you’re doing anyway, so do it in a simpler, fairer and more progressive way, by raising income taxes on the wealthy and taxing capital income (dividends plus capital gains) more like ordinary income. And stop wasting everyone’s time and money on this insane, unwinnable chess game.

To contact the writer of this article: Megan McArdle at mmcardle3@bloomberg.net.

To contact the editor responsible for this article: Brooke Sample at bsample1@bloomberg.net.