Is U.S. corporate tax reform on the horizon?
With Republicans’ midterm election gains, the odds certainly improved. Then President Barack Obama added his voice to those calling for reform.
So it’s virtually a done deal, right? Not exactly. As always, the devil is in the details—and the corporate tax reform issue is nothing if not complex.
Not everyone, of course, favors a reduction in the corporate tax. Some say it would be a giveaway to rich companies, but this argument is flawed. Why? Because corporations don’t really pay taxes—the obligation is passed to shareholders (through lower returns on capital), workers (through lower wages) and customers (through higher prices).
Reducing the corporate tax would benefit all of them—and not through the lower rate alone. It also would make U.S. corporations more competitive globally. The federal corporate tax rate is 35 percent (and 39 percent when factoring in the average state corporate tax), compared with an average of 25 percent for other industrial nations.
To make matters worse, the way we tax U.S. companies’ foreign profits increases their competitive disadvantage. Switching to the “territorial” system most other industrial nations use would eliminate the added tax U.S. firms pay when they repatriate foreign profits and would remove the incentive to leave profits overseas, to be invested in foreign operations.
With these facts arguing in favor of reform, what could stand in the way? Here’s one big stumbling block: the loopholes that riddle the U.S. corporate tax. These special breaks allow many companies to pay a rate much lower than 35 percent and give them a strong incentive to resist change. (How low? Biotech, drug and Internet firms all have effective tax rates of less than 6 percent.)
In part because of these loopholes, some say the real reform needed is elimination of the corporate tax. But chances of this happening are slim, because it would cause a big drop in federal tax revenues.
With rare political alignment on the need for some reform, this moment should not be wasted. Reducing the tax rate, eliminating some of the most egregious loopholes and ending the penalty on foreign profits—these three steps should be achievable and would provide a strong boost to the economy now and in the future.
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