Corporate tax rates have been creeping up, but so have tax breaks. So which to change—rates or preferences?
During the waning days of every presidency, administrations always try to squeak through a few goodies near and dear to their hearts. For the Bush administration, lowering corporate taxes—with Treasury Secretary Henry M. Paulson carrying the water—appears to be high on the agenda. In a briefing paper last month, Paulson wrote that in the Organization for Economic Cooperation and Development (OECD), not only is the U.S. statutory corporate tax rate of 39% higher than all other nations, save Japan, but the relative situation is getting worse as other OECD countries continue to cut rates.
While business may need and certainly want the help, they can’t count on any from the current lame duck commander-in-chief. Says William Beach, a senior fellow in economics at the Heritage Foundation, a conservative think tank, “this president is in no position to begin a tax-reform push,” given his approval ratings, which have been the lowest of any president in a generation.
The irony is that economists in influential Washington think tanks left, right and center all agree that reforming the corporate profits tax—and lowering it—is, in fact, a good idea. They just don’t think it’s going to happen any time soon. “The economics are pretty straightforward,” explains economist Beach. “Whether you are a conservative or a liberal, people agree that corporate taxes affect investment decisions and also countrywide capital costs. If you lower corporate taxes, it’s good for economic growth.”
Eric Toder, a senior fellow at the liberal-leaning Tax Policy Center, agrees. “There needs to be a basic rethink of corporate taxation,” he says, “but I don’t think it will happen in the next two years. Democrats won’t vote for anything that even looks like a lower burden for corporations.”
In the paper Paulson presented at July’s treasury conference on business taxation and global competitiveness, the treasury secretary noted that “double or triple taxation of corporate profits” as practiced in the U.S. “distorts financing choices by taxing interest earned on corporate bonds less heavily than corporate profits.” It also distorts distribution policy by taxing dividends more heavily than retained earnings and “discourages investment in corporations in favor of less heavily taxed forms of business.”
Paulson was especially critical of the welter of tax incentives that, over the years, have been enacted in response to corporate lobbying—tax breaks that can reduce taxes significantly for some companies and industries and shift the burden to the remaining, less politically connected businesses. As the treasury secretary notes, “It is estimated that these special corporate tax provisions narrow the corporate tax base by roughly 25%. If the tax base were broadened by removing these special provisions, the top corporate tax rate of 39% could be reduced to 27%, or, as an alternative, about 40% of investment costs could be written off immediately (i.e., expensed) by all businesses.”
Perhaps surprisingly, given all the lobbying for preferences, some companies admit to not liking them. For example, technology solutions provider Oracle Corp. has opposed the R&D tax credit “for years,” despite the fact that as a high-tech business it makes extensive use of that very incentive—the company spent in excess of $2.2 billion on R&D last year alone. Says Robert Hoffman, Oracle’s vice president for government affairs, “we’d be happy to see that tax break eliminated, if it meant our overall tax rate could be lowered by the same amount. As much as I love lobbying for the R&D credit, there are lots of other things I could be doing for this company.”
Mark Prysock, general counsel for the Financial Executives Institute (FEI), agrees that preferences have had a corrosive effect on U.S. corporate performance. “I’m sure most executives would prefer not to spend so much of their time working on maximizing tax benefits,” he says. “Your typical executive rues the time they spend lobbying for tax preferences, but they’re realistic enough to know that Congress isn’t going to eliminate preferences and lower the overall rate, so they have to lobby for their preferences.” He notes that beyond the lobbying, companies also “expend a lot of resources preparing their tax strategies to be eligible for those preferences.”
“I’ve always wondered why corporate executives don’t get angry at having to spend so much time on tax planning and lobbying,” laughs Leonard Burman, an economist at the liberal Urban Institute. “You’d think CFOs and CEOs would want to have simpler taxes and a level playing field so they could focus on running their businesses better, but it’s not happening.”
On the other hand, politicians definitely like preferences—or at least the lobbying for them. “Members of Congress look at corporate tax lobbyists as their own personal ATM machines,” says one lobbyist who asked to remain unidentified. “They go to that well over and over to cover the costs of getting reelected. They’re not going to shut these machines down.” If anything, according to Heritage’s Beach, the number of preferences has been steadily growing and will continue to.
Without the elimination of preferences, there probably can be no rate cuts—given the current increasingly larger revenue shortfalls facing the nation. And these pressures are only expected to grow. “The overwhelming issue, which is going to swamp corporate tax reform, is the serious need for more revenue,” says Max Sawicky, an economist with the Economic Policy Institute. “Once the baby boomers start to retire, there will need to be an increase in federal revenues of 5% to 6% to fund Social Security and Medicare, which will mean huge demands for more corporate taxes, not lower corporate taxes.” He predicts that the demand for more federal revenue will “simply overwhelm” questions about the design of corporate tax policy.
FEI’s Prysock agrees, “I think that longer term, there are going to be a lot of pressures for more corporate taxation to help fund increased retirement and healthcare costs.” Another irony, when it comes to taxes: The best chance for tax reform, according to American Enterprise Institute economist Alan Viard, could be the election of a Democratic president and Congress in 2009. “It is a little like Nixon opening up U.S. relations with China,” he observes.