Thursday, November 6, 2014

Reforming U.S. Corporate Taxation: On the Virtue of Simplification

As the Republican Party assumed control of the U.S. Senate, and thus of Congress itself, since they would continue in the majority in the U.S. House, Republican Congressional  leaders and President Obama all emphasized policy areas where common ground could be found. Suddenly, the day after the midterm election of 2014, talk of bipartisanship was in the air. In this essay, I discuss the domain of corporate taxation in order to suggest that the common ground can be deeper than typically thought.

With the stars aligned, previously untouched proposals were poised to see the light of day. According to The New York Times, “The Treasury Department under Mr. Obama . . .  [had] proposed a detailed plan to broadly overhaul the corporate tax code and bring down the corporate income tax rate to 28 percent from 35 percent. Mr. Obama [also] proposed a novel deal to Republicans: simplify the corporate tax code and allow multinational corporations a one-time low tax rate to bring home billions of dollars in profits parked overseas, but use the windfall from that ‘tax holiday’ for infrastructure spending.”[1] To be sure, a lower tax rate does not translate into a lower tax bill if loopholes are removed in the simplification. Furthermore, a one-time low tax rate could be seen as a gimmick—to insignificant in itself to move corporations back to the U.S. that have fled for tax purposes. That the new president of the European Commission, Jean Claude Juncker, had been the prime minister of the tax-haven Luxembourg suggests that corporations would still have enticing alternatives.

For their parts, the newly re-elected House Speaker and the presumptive majority leader in the U.S. Senate, Mitch McConnell, wrote at the time of “the insanely complex tax code that is driving American jobs overseas.”[2] Of course, the complexity also translates into loopholes that cadres of corporate lawyers have been able to use to minimize the U.S. taxes that corporations actually pay. Would a simpler tax code bring them back if it meant higher taxes (i.e., fewer loopholes)—especially if the tax rate changes by only 7 percent? 

Moreover—and my point is precisely moreover—would incremental tax reform be worth all the legislative fuss? In other words, would minor adjustments trigger major corporate moves that would make a dent in the structural unemployment, keep capital in the U.S., and significantly contribute to lowering the U.S. Government's deficits? The incremental approach itself is vulnerable to the onslaught of corporate lobbyists, each of whom can slip in a very specific provision as the legislation is tweaked as a myriad of clauses are adjusted. That many points of access exist in the Congressional system of lawmaking makes this all the more likely.  To be solid, tax reform must be bold enough to have a positive impact above and beyond the inevitable imprint of the vested interests that offer huge sums to lawmakers in exchange for favors, which one by one undermine the point of the reform.

For example, rather than dropping the corporate tax rate 7 percent and only moderately simplifying the tax code, members of Congress could write legislation putting the rate at, say, 10 percent and allowing only basic expenses as deductions. Better yet, re-frame the tax as one based on revenue and forget about deductions. The same approach could be applied to individuals’ income tax. Any income could be taxed at, say 10 percent, without deductions and thus tax returns. I submit that in both cases, the U.S. Treasury would collect more tax revenue.

As a starker example to make my point, the U.S. Government could do away with corporate taxation altogether. Corporate earnings that are paid to stockholders as dividends would of course be taxed as personal income. Taxing such funds as corporate income would be to tax them twice. Corporate income that is reinvested rather than distributed can be viewed as merely one part of a seamless cycle of capital investment; selecting a point at which to tax would be rather artificial in this sense. Furthermore, at no point in the cycle do human beings use the funds for consumption and thus pleasure. In short, corporate income taxation can be viewed as arbitrary and artificial in nature. Companies would have a disincentive to go off-shore, and foreign companies would be inclined to invest in the States.[3] My point is that the paradigm of the status quo need not be the limit to the common ground between the Democratic and Republican parties; such ground goes deeper than superficial incrementalism.

To be sure, the powerful interests are wealthy as things are, and so the gravity of the status quo would have to be countered as we drill. Tax reform can be painted with a broad brush, however, without intricacies that can be exploited by lobbyists together with the members of Congress who are already thinking ahead to their next election.  “We are all dirty,” Barak Obama admitted to the press a month or so before the 2014 midterm election. Campaigns cost so much that "we have to take the money," and “that obligates us,” he said. Hence, in spite of being unpopular in Kentucky, Sen. Mitch McConnell (who stood to assume the powerful position of majority leader and thus "repay" contributors) handily defeated his opponent. This is a tough nut to crack.

However, Congress (i.e., collective action within each chamber) can effectively make a policy domain difficult for favors. Reform as incremental change is like thick grass to the python snakes in Florida’s Everglades. If the tall grass is cut incredibly short to begin with, those sneaky, slithering snakes would be seen and perhaps captured, so they would naturally avoid that area. Similarly, even the corporations that have “bought” members of Congress or the president would be hard pressed to ask for a favored tax exemption or deduction if there is no corporate income tax! Even a tax rate of 10 percent with no deductions would have little shade wherein the snakes could lay their eggs. 

[1] Jonathan Weisman, “As Power Shifts in Washington, Some See Chance for Tax and Fiscal Deals,” The New York Times, November 6, 2014.
[2] John Boehner and Mitch McConnell, “Now We Can Get Congress Going,” The Wall Street Journal, November 5, 2014.
[3] I am assuming that foreign companies would not be allowed to simply have a scant presence in the U.S. in order to avoid taxes in their respective home countries. The U.S. would not have many allies otherwise.