BEYOND THE NUMBERS
The President’s Council on Jobs and Competitiveness, a group consisting mostly of business executives that advises the President on ways to strengthen the economy, released its year-end report this week. That report included a section on corporate tax reform, an issue that has generated significant attention in recent months and that Congress may consider this year.
While the report is obviously not a full proposal, it’s worth examining whether the Council is heading in the right direction on some of the key tests for corporate tax reform proposals that we outlined here. Below is how we would grade the report in four key areas:
- Raising additional revenue. The United States is on an unsustainable fiscal path and will face wrenching policy choices in the coming years. In addition to restraining health costs and other spending, we will need to raise taxes. Unfortunately, the Council largely ignores this harsh reality, merely observing in a “final word” at the end of the report that the retirement of the baby boomers will “affect the role of revenues.” Grade: Fail
- Encouraging investment in the United States. The Council calls for lowering the corporate tax rate, arguing that this would help American businesses and workers. At the same time, however, some members sent strong signals that they would move to a “territorial” international tax system, under which foreign profits of U.S. multinationals would face a zero tax rate. (The report does not make a final recommendation, noting that its members were divided on this point.)
Giving foreign profits a massive and permanent tax advantage over domestic profits would create a strong incentive for multinationals to move investment and profits offshore. And, given budget constraints, eliminating taxes on overseas profits would create pressure to set taxes on domestic investments higher than they would otherwise be. Grade: Incomplete
- Reducing the tax code’s bias toward debt financing. The report observes that “because interest is a deductible business expense, the corporate tax system favors debt financing over equity financing.” Encouraging corporations to rely excessively on debt poses risks for both the firms and the broader economy, as the recent financial crisis highlighted. A key priority of any corporate tax reform should therefore be to reduce tax subsidies for debt. The Council’s report highlights the bias in the current system stemming from the full deductibility of interest. Grade: Pass
- Broadening the corporate tax base by reexamining the boundary between corporate and non-corporate taxation. The Council’s report highlights that, despite its high statutory corporate tax rate, the United States collects little in corporate income taxes relative to other members of the Organisation for Economic Co-operation and Development. We rank 25th, out of the 29 OECD members for which such data are available, in corporate taxes as a share of the economy.
The report points out that a major reason is that about half of business income is not even subject to the corporate income tax. A growing number of business owners have opted to organize their firms as partnerships and S corporations, which means the firm’s profits are “passed through” to the owners. These owners benefit from the same tax deductions and credits as corporations do but pay taxes only at the individual level.
Reining in this arbitrary tax preference needs to be a major focus of tax reform. While the report made no final recommendation on this point, the Council draws attention to this important issue. Grade: Pass