Cutting Corporate Taxes Would Stimulate Economy

In the tax battle of the fiscal cliff, there’s one area of agreement: lower corporate tax rates.

President Obama and the House Republicans have both proposed lowering corporate tax rates. Last week the White House told Republicans that corporate tax reform was on the table, based on the president’s February proposal, which would lower the corporate tax rate to 28%.

While some call for eliminating corporate tax deductions to solve America’s fiscal problems, reducing corporate taxes would bring in more investment from abroad — together with additional revenue. Read Rex Nutting’s column "Why isn’t Obama demanding corporate welfare cuts?"

America’s corporate tax rates are far higher than our Organisation for Economic Co-operation and Development, or OECD, competitors, and we tax income on a worldwide rather than territorial basis. Corporations are holding $1.7 trillion offshore, and some would come back with a more competitive tax structure.

So, rather than the power struggle of two titans over individual rates, House Speaker John Boehner and Obama could start with corporate tax reform, upon which there is far greater concurrence than individual tax reform.

Even Senate Democrats are on board. Senate Finance Committee Chairman Max Baucus said that in response to globalization, other countries have modernized their tax laws, but America has not. As a result, we’re losing investments to other countries. "When it comes to international tax rules, we seem to have the worst of all worlds. We haven’t kept up, and it’s time to change," said Baucus last summer. Read Chairman Baucus’s remarks here.

The politics of individual tax reform are dynamite, but the politics of corporate tax rates are less explosive.

The table compares some major provisions of current corporate tax law to Obama’s proposals and those of House Ways and Means Committee Chair Dave Camp. To be sure, the plans are very different — but the fact that both call for reductions in the tax rate suggests that perhaps the parties can find agreement.

The current top corporate tax rate is 35%. Obama has proposed reducing the rate to 28%, and Camp to 25%. Obama would keep the current system of worldwide taxation, and Camp would move to a territorial system, with 95% of foreign profits exempt from tax. Obama would raise taxes on oil and gas companies, as well as taking away deductions for companies which move overseas.

Why are prospects for corporate tax reform brighter? Here are three reasons.

First, corporate tax issues are more complex and arcane, and so differences between the two parties’ plans are not as obvious to the general public. Proposed changes are not as simple as raising individual tax rates.

Many Americans don’t know — or care — about the difference between worldwide and territorial taxation, and probably haven’t heard of earnings stripping by expatriated entities. These don’t make very good soundbites. On the other hand, they do know whether individual taxes have gone up, gone down, or stayed the same.

Just look at the Tax Reform Act of 1986, widely viewed as a reduction in taxes, because the top individual marginal tax rate was reduced to 28%. In fact, the Act was revenue neutral, because of increases in business taxes. The vast majority of Americans are unaware of this.

Second, both Republicans and Democrats know that corporate tax rates are too high. Every year our corporate tax system becomes more of an outlier among the 34 countries that make up the OECD. In April, after Japan lowered its tax rate, the United States was left with the highest tax rate in the OECD, at 35%, with a worldwide tax system. The average corporate tax rate of the countries is 24%. Canada, our largest trading partner, has a 15% corporate tax rate, as does Germany. Both tax corporate income generated within their borders, rather than corporations’ worldwide income, as does America.

Third, another advantage of corporate tax reform is that it will probably bring in revenue, at least in a dynamic sense. Bringing U.S. corporate tax rates in line with worldwide rates will attract some investment back to America and discourage other investments from leaving.

The Senate Permanent Subcommittee on Investigations has estimated that American companies hold around $1.7 trillion of earnings offshore from foreign operations. No one knows for sure how much of this would be repatriated with a lower U.S. tax rate, but corporations would surely repatriate more of it than they do now, adding to investment and employment.

Camp has proposed exempting 95% of repatriated dividends as an inducement to corporations holding significant earnings abroad. Even if only half the funds held abroad, $850 billion, were repatriated, this would exceed the stimulus in the 2009 American Recovery and Reinvestment Act, and the federal government would get billions in tax revenues.

University of California (Berkeley) professor Laura D’Andrea Tyson, President Clinton’s former Council of Economic Advisers chair, estimated that a temporary tax holiday, also included in the Camp plan, would result in $1 trillion of repatriated earnings. After taxes, she estimates that about $950 billion would be distributed to shareholders or used for investment. Read Tyson’s paper here.

The 2004 tax repatriation holiday, which lowered the tax on repatriated earnings to 5%, resulted in $360 billion of $800 billion held offshore returning to America. According to an August 2012 Tax Foundation study, "Following the same ratio, $765 billion could be poised for return under similar conditions." Read "A Global Perspective on Territorial Taxation."

Although corporate tax reform is less toxic that individual reform, it will not be easy. One major obstacle comes from small businesses, which now file under the individual tax code at a top rate of 35% — soon to move to over 40% if America goes off the so-called fiscal cliff.

With lower corporate rates, small businesses naturally ask why their top tax rates should be higher than proposed corporate tax rates of 25% or 28%. And it’s a good question — there are problems with having business rates so far apart. Some will convert to corporations, but this has its costs, so they will not all become corporations and get taxed at the lower rate.

Another major obstacle comes from capital-intensive industries, which benefit from the deductions that are targets for elimination. Lower rates will help service and financial industries but could result in an increase in taxes on manufacturing.

Politics trumps good tax policy any day, as can be seen from the mess of the tax code, the tax provisions that crater towards extinction only to be revived at the last moment, and the Affordable Care Act, which will impose a practically impossible burden on the Internal Revenue Service come 2014.

But these days, with Obama and Boehner staring each other down in a massive game of chicken over individual rates, it might just be easier to tackle corporate tax reform first.

This piece originally appeared in WSJ's Marketwatch

This piece originally appeared in WSJ's MarketWatch