Hard to see point of Obama’s tax plan

The Financial Review

PUBLISHED: 03 Mar 2012

Anna Bernasek, New York

At the end of February, President Barack Obama announced a new plan for corporate tax reform. His key initiative is to cut the top marginal corporate tax rate sharply while closing loopholes and subsidies. It seems reasonable. After all, who wouldn’t want a simpler, more efficient tax system and lower tax rates?

But the more you think about it, the more questions arise. While the US has many problems, corporate taxes aren’t one of them. Strong corporate profits have been the exceptional feature of the post-housing bubble economy.

Unfortunately, that’s had little effect on hiring, which really is a problem. What’s more, it’s hard to identify any industry hurting because of taxes – the car industry wasn’t in trouble. Nor the financial industry. In fact, except for The Wall Street Journal’s editors, corporate tax reform is the last thing most Americans think about.

But first let’s take Obama’s plan at face value. He said he’d cut the top marginal corporate tax rate from 35 per cent to 28 per cent and pay for it by closing loopholes, subsidies and exemptions. Specifically, he’d end subsidies to the oil and gas industry but give manufacturing a bigger tax break by capping its top marginal rate at 25 per cent.

Obama also wants to introduce a new minimum tax on foreign earnings of US companies while, at the same time, simplifying and cutting taxes for small business. Overall, he promises to deliver corporate tax reform without any impact on the federal deficit – revenue losses from lower tax rates would be offset by gains from closing loopholes, subsidies and exemptions and revenue gains from a new foreign earnings tax. So, in effect, whatever one company gains, others will lose.

Why do this? Obama says his corporate tax plan will make US companies more competitive, promote growth and promote fairness. On competitiveness, it’s hard to believe US companies aren’t able to compete with foreign companies because of the taxes they pay at home. For one thing, we haven’t got much evidence that corporate taxes make US companies uncompetitive. In practice, they’re doing OK.

While the top marginal corporate tax rate of 35 per cent is one of the highest in the world, few companies ever pay that. The US Treasury has calculated that the effective tax rate, the amount companies actually pay, is in line with other major countries. In particular, the current treatment of interest payments reduces the headline rate significantly.

Simplifying the rules so that companies don’t have to spend on finding loopholes, subsidies and exemptions would be a good thing. But can Obama take on every interest group with a tax break and win? That would be remarkable even if Congress were in Democratic hands. Which it’s not.

As for promoting jobs, the corporate sector already has more cash than it knows what to do with. For several years now, most companies have been sitting on record cash piles, refusing to hire or invest. Giving companies even more cash doesn’t look like a great way to create jobs. Then there’s the deficit. With so much pressure from Republicans to reduce deficits, this plan seems to take an eventual rise in corporate taxes off the table. Maybe that’s the right policy, but it’s not a great way to negotiate.

As for fairness, that’s in the eye of the beholder. Levelling the playing field seems laudable, but this proposal only goes part-way. Manufacturers may appreciate the special treatment, but the service sector could see things differently. After all, the big issue of fairness in the US isn’t between companies but individuals. Income inequality is at unprecedented levels.

On that front, a major culprit is tax on investment gains, far lower than taxes on wages. Yet Obama has said nothing about changing capital gains taxes. He’s made vague remarks that high-income Americans need to pay their share of taxes but has not promised to overhaul taxes for individuals.

He is not wrong to want to improve the corporate tax system. But his plan seems out of place given his promise to focus on jobs. It’s reminiscent of the healthcare reform he introduced earlier in his presidency. Both were originally Republican ideas, and both only address issues at the margins. They essentially preserve the status quo without fundamental change. What’s more, they don’t seem likely to satisfy anyone.

A more cynical interpretation of Obama’s plan is that it is custom-made to generate campaign contributions. By signalling that corporate taxes are in play, and providing an opening gambit about what he would do, he is inviting those concerned to step forward and make their positions known. Will anyone be surprised if firms curry favour by contributing?

If Obama wins the election, his plan will probably end in one of two ways. Either companies will get a big tax cut, as it proves difficult to convince Congress to close all those loopholes, exemptions and subsidies. Or some firms will gain while others lose. We won’t find out until after November. But rest assured, the lobbying has begun.

Anna Bernasek writes on financial markets, the economy, Wall Street and public policy from New York. She is the author of The Economics of Integrity.