Corporate Tax Code Proves Hard to Change

By BINYAMIN APPELBAUM                 

Published: January 27, 2011

WASHINGTON — Large trucking companies paid the government more than 30 percent of their income in 2009. Biotechnology companies paid less than 5 percent.

Such yawning gaps among industries have become a defining feature of the nation’s corporate tax code, an unwieldy accretion of rules and exceptions that amount to a reward for some kinds of businesses and a rebuke for others.

President Obama on Tuesday added his name to the long list of politicians who have called for an overhaul of those rules, so that companies of all kinds pay the federal government a roughly equal share of their annual profits.

“It makes no sense, and it has to change,” Mr. Obama said in his State of the Union address. “Get rid of the loopholes. Level the playing field. And use the savings to lower the corporate tax rate for the first time in 25 years — without adding to our deficit. It can be done.”

But recent efforts to rationalize the code all have failed, and some members of both parties express skepticism that this time will be different. The problem, in a nutshell, is that the popular step of lowering taxes for industries like trucking requires the unpopular step of raising taxes for industries like biotech.

The very idea is already drawing howls from the corporate sector.

Moreover, many of the individual exceptions that allow corporations to shield profits from taxation actually enjoy broad popularity, like tax breaks to support domestic manufacturing, low-income housing and green energy.

There is also the chance of political gridlock. Senate Democrats and House Republicans are both holding hearings on tax reform. Both declare the subject a priority. But it is hardly clear that the two parties are talking about the same thing.

Many conservatives want Congress to cut the overall amount collected from corporations to spur economic growth.

Representative Paul D. Ryan, the Wisconsin Republican who gave the party’s response to the president’s State of the Union address on Tuesday night, has proposed eliminating the corporate income tax. Mr. Ryan instead would impose a smaller 8.5 percent tax on business “consumption” — a measure of income that excludes investment, meaning that the government would collect a much smaller share of a much smaller tax base.

Many liberal groups, meanwhile, see increasing corporate taxation by closing loopholes as a relatively painless way to reduce the federal deficit.

“It doesn’t make a lot of sense to say that we’re going to close loopholes and then give all the money back to corporations,” said Steve Wamhoff of Citizens for Tax Justice, a nonprofit group that favors increased corporate taxation. “This would be one deficit reduction measure that would get the most support from the public.”

The United States imposes a top corporate tax rate of 35 percent. It is almost entirely a theoretical exercise. Various government and private studies have found that the average corporation generally pays about 25 percent of its income, thanks to a mix of deductions and ever-more-sophisticated tax avoidance strategies.

Google, saluted by the president on Tuesday as a paragon of American innovation, paid the government 22 percent of its income in 2009, according to its reports. The company reduced its tax bill by more than $1 billion, claiming deductions for research and investment and exploiting a popular corporate strategy by routing a large share of its income through Ireland.

Even more striking are the differences among industries. Aswath Damodaran, a finance professor at New York University who has researched the issue, said young high-tech companies often pay less than 10 percent of income in taxes, while old-line firms like railroads and utilities often pay more than 25 percent.

This inequality is one of the administration’s major arguments for tax reform. But the idea is widely supported by economists and other academics for a different reason — the concern that the current rules encourage companies to make bad choices.

The ability to deduct interest payments, for example, leads companies to borrow more money than they need. The rules governing real estate have long spurred new construction that would not be profitable without tax benefits.

“The tax code makes bad investments into good ones,” Professor Damodaran said. “Changing the tax code is going to create economically better decisions.”

A major stumbling block is that Congress — often at the urging of presidents including Mr. Obama — has regularly tinkered with the tax code to effect policies. On Tuesday, Mr. Obama charged that “a parade of lobbyists has rigged the tax code to benefit particular companies and industries.”

But many of the largest loopholes were designed by the government. A tax break to encourage domestic manufacturing costs will reduce tax collections by $10 billion this year, according to the Office of Management and Budget. Tax breaks to support research will cost about $8 billion. A tax break for companies that invest in low-income housing will cost about $6 billion.

There are some signs that Congress is willing to rethink its ways. Senator Max Baucus, the Montana Democrat who leads the Finance Committee, has been influenced in his thinking by conversations with corporate leaders who told him they would prefer the certainty of a lower tax rate to the uncertain application of various deductions. Mr. Baucus is now holding a series of hearings on the tax code.

Senator Orrin G. Hatch, the ranking Republican on the Finance Committee, said after the State of the Union address that he believed the entire tax code should be cleaned up — in part because many small businesses actually are taxed as individuals.

“The president is right that our nation’s corporate tax rate, the second-highest in the world, is an impediment to economic growth and a significant drag on our economic competitiveness,” Mr. Hatch said in a statement.

Representative Dave Camp, the Michigan Republican who is chairman of the House Ways and Means Committee, is planning a series of hearings on broader tax reform starting Thursday.

But in a sign of the disagreements lurking just beneath the surface, Mr. Camp emphasized that his hearing was focused in part on reducing “the cost burdens of the current code.” He described the president’s proposals as “a few token gestures.” READ CATHERINE RAMPELL’S BLOG “WINNER’S & LOSER’S UNDER THE NEW YORK TAX CODE”

A version of this article appeared in print on January 28, 2011, on page A22 of the New York edition.

Stuck in the Middle with our International Tax System

by Rosanne Altshuler

President Obama took aim at multinational corporations last May at a press conference on international tax policy. I’ll leave out the details here, lest I put you to sleep or explode your brain. Let’s just say that the current system is a mess that drastically needs fundamental reform.

Economists describe two contrasting “pure” approaches to taxing the income U.S. companies earn abroad. A “worldwide” approach would apply our domestic tax rules to all income (with a foreign tax credit to protect against double-taxation). In theory, that system would tax U.S. business income the same, whether it’s earned at home or overseas, so firms shouldn’t care where they invest. In contrast, under a “territorial” or “dividend exemption” system, the U.S. wouldn’t tax active business income earned overseas; American firms would pay only the taxes of the country where they earn income, just like any non-U.S. business operating there. In theory, that puts U.S. businesses that invest abroad on equal tax footing with foreign firms.

Which system do we use? We’re stuck in the middle and it’s not pretty. A 2005 Joint Committee on Taxation Report labeled the current system a “paradox of defects” and recommended that the U.S. adopt a dividend exemption system. The 2005 President’s Advisory Panel on Federal Tax Reform came to the same conclusions. Its November 2005 report said that the current system “likely distorts economic decisions to a greater extent and is more complex than a system that simply exempts active foreign business income from U.S. tax.”

In 2006, Harry Grubert of the U.S. Department of Treasury and I carefully studied three different systems for taxing the cross-border income of U.S. multinational corporations: the current hybrid system, which combines worldwide and dividend- exemption systems; a “burden neutral” variant of a worldwide system that increases the tax base by taxing all foreign source income currently but lowers the rate to keep the burden on foreign source income the same; and a dividend-exemption system. We concluded that either fundamental reform delivers a better system than the current one and recommended the “burden neutral” worldwide system over dividend exemption.

President Obama has proposed several incremental reforms to cut back on deferral—the current policy of taxing foreign earnings only when U.S. corporations bring them home.  If he’s simply looking for revenue, however, the president would do better to move in the other direction. In recent blogs, Bob Williams and I have been examining the revenue and spending options in the new CBO Budget Options report. CBO includes a dividend exemption option—indefinite deferral—that would raise $76.2 over ten years. That’s $11 billion more than the CBO option of ending deferral entirely!  Again, I’ll spare you the details. But you know a tax system is broken when not taxing a form of income raises more money than taxing it today. We definitely need serious, principled, international tax reform.

So what’s the bottom line? We’re in a mess. We’re stuck between two inconsistent systems with no obvious way to get out. We need reform and we need revenue. The two aren’t necessarily incompatible but change will be hard. Many firms benefit from the status quo — the worst of all worlds is the best of all worlds for them. Whatever we do, there will be losers everywhere.