Obama's Corporate Tax Cut Could Be a Tax Hike

The tax cut must not be a disguised effort to increase corporate dollars’ flow into the U.S. Treasury.

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In an otherwise largely forgettable State of the Union address, President Barack Obama surprisingly called for a cut in the U.S. corporate income tax rate.

“Over the years, a parade of lobbyists has rigged the tax code to benefit particular companies and industries. Those with accountants or lawyers to work the system can end up paying no taxes at all. But all the rest are hit with one of the highest corporate tax rates in the world. It makes no sense, and it has to change,” Obama said. “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.” [Check out a roundup of political cartoons on Obama.]

The key phrase here is “without adding to our deficit.” While it was startling to hear a liberal Democrat like Obama concede that the corporate income tax rate in the United States is the highest in the developed world, it is almost certain that the plan he has in mind will cause the effective tax rate—what corporations actually pay—to go up rather than down.

In Washington, where spending more money on a government program in one year than was spent in the previous year can be called “a cut” with a straight face, it is easy to see how a call for a tax cut could actually result in a tax increase. If Obama is serious, if he wants to restructure the corporate tax in ways that promote savings and investment, research and development, and economic growth, then he has to come with a plan to keep more money in the system rather than pull it out in the form of increased tax payments. [Check out a roundup of political cartoons on Democrats.]

Americans for Tax Reform, the nonpartisan, pro-taxpayer organization headed by Grover G. Norquist, has put forward a series of principles for the White House to follow if it wants its corporate tax cut to have a stimulating effect on the U.S. economy:

1. The rate needs to come down—way down. Our 40 percent rate is much higher than the average European rate of 25 percent. Ideally, we'd want to be under that in order to attract jobs and capital from the rest of the world

2. Don't raise taxes. The President has argued this should be a tax revenue-neutral exercise. While we would prefer a net tax cut (at least on paper in a static score), revenue-neutrality should be the worst revenue case. This should not be an excuse to raise net taxes (like the President's Debt Commission did).

3. Move from "worldwide" to "territorial" taxation. As part of reform, the corporate tax system should migrate away from "worldwide" taxation (where all income of U.S. companies from all around the world is liable to be taxed by the IRS) to "territorial" taxation (where only U.S.-source income is taxed). This is what the rest of the world by and large does, and would make all the international deferrals and credits unnecessary.

4. Resist the temptation to lengthen depreciation lives. The proper tax treatment of business purchases is immediate expensing (as was contained in the December tax deal). Going in the other direction by lengthening depreciation lives will only bias toward consumption and away from productive investment. It's the government picking winners and losers, and hurting economic growth in the process.

5. Remember that the corporate income tax is only the first act of a two-act play. After-tax corporate profits distributed to shareholders are double-taxed as dividends. After-tax corporate profits retained by firms eventually come out in the wash as taxable capital gains to shareholders. An integration of both bites at the apple would truly be a pro-growth and comprehensive tax reform effort on the corporate side.

6. Don't forget about corporate capital gains and dividends received. Unlike individuals, corporations don't have a preferential rate on capital gains, and cannot exclude all the dividends received from other corporations. Dealing with the capital stock and portfolio income of corporations is a necessary component to reform.

7. Don't pick winners and losers. President Obama seems to have a particular vitriol reserved for energy companies, as exemplified (again) in his SOTU speech. This hatred should not cause this sector to suffer more base-broadening than other sectors. Conversely, favored companies should not get light treatment. Rather, the goal of a revenue-neutral corporate tax reform (as opposed to a simple rate cut, which remains ATR's preference) should be to broaden the base as much as possible in order to lower the rates as much as possible. How individual companies or sectors do is not particularly relevant.

The principles are sound. The tax cut the White House is going to propose must be real, rather than a disguised effort to increase the flow of corporate dollars into the U.S. Treasury.