US needs corporate tax reform. Does the GOP deliver it?
modes of thought
Both parties have called for a rethink of business taxes to boost global competitiveness. New House and Senate plans deliver part of the equation – lower tax rates – but stir controversy in the process.
Boston and Washington—Ask Americans what bothers them the most about taxes, and they typically don’t talk about their own tax bill. Their top complaint is that corporations are not paying their fair share.
Polls this year suggest that roughly two-thirds of Americans believe corporate taxes should go up.
So why are Republicans in the House and Senate moving full-speed ahead to do just the opposite?
As the Senate Finance Committee voted Thursday to move its tax bill to the floor, the measure was stirring controversy on several fronts – not least because it makes its tax cuts for average Americans temporary, and it uses that phaseout to help finance a permanent tax cut for corporations.
The political optics aren’t good, and the proposal could face changes when it’s taken up on the Senate floor after Thanksgiving. Yet the reality, many economists say, is that the corporate tax code needs an overhaul, and some of the Republican ideas come right out of a playbook that’s been in mainstream discussion for years.
The basic challenge: Other advanced nations tend to have lower tax rates, while some features of the US code incentivize firms to send capital and jobs overseas. While the Republican tax proposals raise questions of fairness in apportioning tax cuts between the wealthy and average Americans, leaders of both parties have long agreed on the need for tax reforms that keep more investment and jobs in the United States.
“It's a global race ... to attract global corporations,” says Richard Kaplan, a tax expert at the University of Illinois College of Law. “The nominal rate [for US corporate taxes] is 35 percent. There are very few countries at that level.”
If Republicans succeed in their current goal of getting the top corporate income-tax rate permanently down to 20 percent, that would put the US rate roughly on par with top marginal rates European nations, according to research cited by the Tax Foundation in Washington.
Growing the economy
Back in 2015, President Barack Obama was calling for efforts to lower corporate tax rates, with his budget team arguing that “the tax code needs to ensure that the United States is the most attractive place for entrepreneurship and business growth.”
It’s not necessarily that US corporations pay hugely more in taxes than firms in other nations do, Professor Kaplan and others note. Due to a maze of deductions and credits, US firms pay an effective rate somewhere in the 20s, not way off from what firms in some other developed countries pay.
Still, economists generally support the idea of lowering the nominal rate as part of broader tax reforms that could make US corporations more competitive globally and help grow the domestic economy.
“Cutting the corporate rate this substantially is going to draw some additional investment in the United States,” says Alan Viard, resident scholar at the American Enterprise Institute and former senior economist at the Federal Reserve Bank of Dallas.
US corporations will have less incentive to park their earnings offshore and foreign companies will have more reason to locate facilities here in the US.
But many economists would prefer to have corporate reforms be revenue-neutral and not add to the deficit. Instead, the House and Senate tax plans would add $1.5 trillion to the deficit over 10 years, much of that going to corporations.
While some Trump administration officials, notably Treasury Secretary Steve Mnuchin, argue that the additional revenue would create enough new economic activity to make up for adding to the federal deficit, most economists disagree.
“I think that’s very unlikely,” says Joel Slemrod, director of the Office of Tax Policy Research at the University of Michigan in Ann Arbor. “The empirical evidence is pretty clear.”
By 2027, the House tax bill would increase gross domestic product by only an additional 0.4 to 0.9 percent, according to the Penn Wharton Budget Model, and by 0.0 to 0.8 percent by 2040. One reason the impact is so small is that the resulting growth in US debt puts upward pressure on interest rates.
A broader base?
Tax reform could also make the system fairer by reducing the number of loopholes. That way, tax burdens would be more uniform across industries and the US would collect revenues from a broader base of business activities. But in closing some loopholes, both the House and Senate bills create new ones.
Republicans “have lowered the rate, but if anything, they seem to have narrowed the base,” says Kimberly Clausing, dean and economic professor at Reed College in Portland, Ore.
Taxing corporations is tricky because the money that they pay to the government would otherwise go somewhere else. Perhaps more investment in capital equipment or higher pay for workers, more dividends for shareholders, or lower prices for customers. That’s why some experts suggest that corporations not be taxed at all.
But the revenues from corporate taxes are so big, and so accepted as the norm, that Congress isn’t pitching the radical idea of reducing them to zero and taxing individual investors instead.
Instead, by reducing rates, congressional Republicans argue that they are putting money in workers’ pockets. How much money is subject to plenty of debate. A study last month by the White House Council of Economic Advisers suggested that cutting the corporate rate to 20 percent would over several years boost the average household’s income by $4,000 a year and, eventually, up to $9,000 a year.
Many economists are skeptical of that claim, predicting the gains from corporate tax cuts will be reaped by shareholders and managers more than average workers.
Indeed, the Republican bills have also come in for sharp criticism for other provisions that would benefit the rich, notably cutting the top tax rate on much “pass-through” income, by which owners of noncorporate businesses see their income taxed as individuals.
A territorial change
The House and Senate bills do include some elements of reform. Both versions make it easier to deduct new investments in one year rather than over multiple years. But those provisions phase out after five years.
The House version of the bill limits deductions for business interest expenses, which would discourage corporations from relying on debt to make new investments.
The Republicans are calling, moreover, for the US to shift its whole theory behind how multinational firms are taxed. The current system is called a “worldwide” approach, where the US Treasury seeks to levy the same tax rate on a firm no matter where it earns its income or what the tax rates are in those nations.
The rest of the world doesn’t operate that way. Other advanced nations use versions of a contrasting “territorial” approach, where firms essentially pay taxes country by country, based on the tax rates in each locality. Surcharges from the home country aren’t the rule.
Many tax experts support a territorial shift, while the Obama plan refused to do that.
A challenge under any system, however, is how to keep corporations from seeking tax shelters by creatively gaming differences among national laws.
Both Democrats and Republicans have cited the goal of bringing back some $2 trillion-plus in money that US-based firms have parked overseas, but it’s not clear that either side has realistic ways of drawing the bulk of that money into job-creating investment back home.
In 2005, the last time the US held a tax holiday so corporations could repatriate their offshore profits, researchers concluded that most of the influx went to shareholders rather than new investment or workers.
Still, some analysts see the idea of lower rates, coupled with a territorial approach, as positive shifts that would help the economy.
As Republicans gird to push a tax package through Congress, with likely the thinnest of margins, they will also face plenty of critics who say that, overall, the changes don't represent a major or lasting overhaul of the tax code.
“This is not tax reform,” says Howard Gleckman, a senior fellow at the Urban-Brookings Tax Policy Center, a Washington-based nonprofit research group. Early proposals for some big reforms were dropped in both houses, he says. “What they’re left with is a big corporate tax cut.”