Economics
Tax reform
The devil's in the details (and the politics)
Feb 22nd 2012, 21:46 by G.I. | WASHINGTON
LIKE the weather, American politicians talk a lot about tax reform but do nothing about it. Which is a pity, because while Americans have been talking, other countries have been doing; since the late 1980s, top corporate tax rates around the world have dropped to a point that America’s, once below the international average, is now well above.
As this has happened, American-based multinational companies have shifted more activity offshore; their foreign employment steadily rose over the last decade as domestic employment fell. This is mostly because of the appeal of cheap labour and growing markets in the emerging world, but business groups and many economists think America’s tax rate is also to blame. Liberal analysts blame the tax code for a different reason: it allows multinationals to stash income in foreign havens and indefinitely defer taxes on it, encouraging the outsourcing of jobs.
Barack Obama claims to be ready to do something about it. Calling the present tax code “outdated, unfair, and inefficient”, he proposed on February 22nd a reduction of the top corporate rate to 28% from 35% (39% including state and local taxes). Previous analysis suggests such a cut would cost more than $700 billion (or 0.4% of GDP) over the next decade. Mr Obama would add to the price tag by making permanent a variety of tax provisions, such as the credit for research and development, that are on course to cost $250 billion over the next decade.
Mr Obama, however, pledged that he would pay for these provisions by eliminating enough tax breaks so that the overall plan would not add to the deficit. In theory this is ideal: lower corporate rates levied on a broader base would distort the allocation of capital less and provide less incentive for wasteful and tax avoidance.
But deciding whose tax breaks get closed is what makes tax reform hard. Mr Obama has called for, and proposed budgets that include, eradication of a dog’s dinner of loopholes covering inventory accounting, oil and gas production, corporate life-insurance policies, hedge-fund profits, and corporate jets. He would impose a minimum tax rate on foreign-source income. But this still leaves a lot of money that must be raised through other means. On the remainder Mr Obama sadly but predictably grows vague: curbing depreciation, the deductibility of interest, and the use of non-corporate business forms, such as “S corporations”, partnerships, and LLCs, should all be “considered”.
The single biggest corporate tax breaks are for depreciation and expensing of capital equipment, and a tax deduction for American-based production. But, awkwardly, among the greatest beneficiaries of these benefits are manufacturers whose cause Mr Obama now loudly champions. Rather than eliminate those tax breaks altogether, Mr Obama would preserve them for manufacturers so that their effective tax rate would drop a bit, to 25% from 26% currently. (The effective tax rate equals taxes, after all deductions, as a share of income. It’s a better measure of the tax burden than the top corporate rate.)
Mr Obama’s proposal is better than what America already has, but not by much. His well-intentioned goal of broadening the tax base is betrayed by the preferences he insists on maintaining for manufacturing and “green” energy whose economic merits have been questioned, even by former members of his own administration. By maintaining many of the current tax breaks but apportioning them more variably, the tax code would become more complex rather than less so.
Mr Obama’s reform should bolster the case for manufacturing at home, but not by much. Alex Brill of the American Enterprise Institute dryly notes America’s top rate would go from the OECD’s highest to third-highest (once Japan enacts a planned cut); its effective rate would still be above the international average.
Then there are the devilish politics. Marty Sullivan, an independent tax analyst, says high-technology and pharmaceutical multinationals such as Apple and Merck that have benefited from low taxes on foreign-source intellectual-property income would be losers, as would utilities and telecommunications companies with significant interest and depreciation charges. They are unlikely to accept a tax hike quietly.
In theory, Republicans should be receptive as they, too, have been calling for corporate tax reform. All four Republican presidential candidates would drop the rate to 25% or lower. Dave Camp, the chairman of the tax-writing committee in the House of Representatives, last fall proposed lowering the corporate rate to 25% and exempting most foreign-source income from tax altogether. However, he is even less precise than Mr Obama on how the lost revenue would be made up. It is over such details that tax reform lives or, more often, dies.
(Photo credit: Office White House Photo by Pete Souza)
In this blog, our correspondents consider the fluctuations in the world economy and the policies intended to produce more booms than busts. Adam Smith argued that in a free exchange both parties benefit, and this blog's aim is to encourage a free exchange of views on economic matters.
Advertisement
Money talks audio
- Analects | China
- Americas view | The Americas
- Babbage | Science and technology
- Bagehot's notebook | British politics
- Banyan | Asia
- Baobab | Africa
- Blighty | Britain
- Buttonwood's notebook | Financial markets
- Charlemagne's notebook | European politics
- Clausewitz | Defence, security and diplomacy
- Democracy in America | American politics
- Eastern approaches | Ex-communist Europe
- Elysée | France’s presidential election
- Free exchange | Economics
- Game theory | Sports
- Graphic detail | Charts, maps and infographics
- Gulliver | Business travel
- Johnson | Language
- Leviathan | Public policy
- Lexington's notebook | American politics
- Newsbook | News analysis
- Prospero | Books, arts and culture
- Schumpeter | Business and management
Most commented
- The euro crisis: The Greek run
- Brazil’s economy: A bull diminished
- Gay marriage: North Carolina begs the question too
- Russia and NATO: Rethink the reset
- Foreigners in China: Barbarians at the gate, again
- Nationalism online: Backfired
- Greek politics: Slouching towards the drachma
- Greece and the euro: Exodus, chapter 1
- The euro in crisis: Groping towards Grexit
- Renouncing citizenship: Did Eduardo Saverin do anything wrong?
Over the past five days
Most recommended
- The euro crisis: The Greek run
- Renouncing citizenship: Did Eduardo Saverin do anything wrong?
- Greek politics: Slouching towards the drachma
- Brazil’s economy: A bull diminished
- The euro in crisis: Groping towards Grexit
- The euro crisis: Going, going, gone?
- Rival versions of capitalism: The endangered public company
- Jacob Zuma: Portrait of a president
- Daily chart: The German motor
- Facebook goes public: Not top of the pops
Over the past seven days
Advertisement
Readers' comments
The Economist welcomes your views. Please stay on topic and be respectful of other readers. Review our comments policy.
Sort:
Oh no, we're loosing the race to the bottom!
"The devil's in the details"
I prefer what Ludwig Mies van der Rohe liked to say: "God is in the details."
As a small business owner, I find it interesting how the government states that my ability to write off the money I spend on equipment a "loophole". If I spend $200K on a piece of equipment that is necessary for my business, why shouldn't I be able to write it off? Instead, I have to pay taxes on 83% of it, but since I spent that money, I have to pay taxes with money I no longer have. I have to pay the taxes for this out of income that I already paid taxes on. This makes my effective tax rate much higher than the nominal tax rate.
Actually, why should you be able to "write off" anything. The infinite "write offs" is why the tax code is a mess. How about lowering your rate and getting rid of precious write offs so capital is deployed based on merit and not tax purposes.
Paying taxes on gross sales rather than profits is an unusual method. Industries that run on thin margins would likely put out of business.
Or be willing to pay less for inputs, which would now be cheaper because they had a lower tax burden.
Taxes: how much they raise costs depends on elasticity, not just tax rates.
You guys sound like you work for the government. I'm not sure what they are teaching in economics classes these days, but you can't pay taxes on money you don't have.
Bear in mind that, under your scheme, a manufacturer also has to pay taxes on gross sales rather than profit. If his profit margin is 10% under the current regime, your plan would bankrupt him, unless you set tax rates at well below 10%. He would have to raise prices. Not to mention that his suppliers would have to do the same thing.
How would a grocery store, whose margins are on the order of 1%, survive at all?
The only way a business owner would be able to survive would be to squeeze wages, since workers have, in essence, a profit margin of 100%. You might argue that this is OK because tax rates are lower, but I have never seen anyone who is happy with a pay cut.
"he proposed on February 22nd a reduction of the top corporate rate to 28% from 35% "
Would such a huge reduction of taxes increase the unfairness of the rich and the poor? If the deduction of the revenue lead to the reduction of the expenditures of other welfares such as health care, would citizens agree the publication of the new tax act?
the tax is a sensitive topic
What is the role of banks, government and corporations within a democracy? In the United States they seem to be a power unto themselves, answerable only to shareholders, banks, other financial institutions and investors. Were we ever a democracy of the people, or just a source of profit? America, the best government money can buy.
Indeed.
If the Obama people could come up with a credible plan that lowered marginal company rates, they ought to be able to use it as a stick to beat opponents.
Deficits don't matter as much to the US but you ought not take this for granted as a permanent state of affairs.
"However, he is even less precise than Mr Obama on how the lost revenue would be made up."
A wee bit Victorian, G.I.?
Per Dick Cheney, Reagan showed us that deficits don't matter. :)
Why, the Communist Party of China works just like the Vatican. The Vatican packs the electorate cardinals with Italian fossils to perpetuate their own. The similarity between the 2 institutions is providential. They must have the same god, mammon.
simple solution: NO TAXES.
but then u might ask, "How will the government operate?"
Before 1913 (I might be off by a few years), the US government operated fine without taxing the income of its citizens.
"Well," you respond, "This is the 21st century. Things are different?"
Are they really? First of all, the pentagon sucks the bulk of the tax revenue (actually the taxes are used to service the debt.. and a chunk of that debt pays for the pentagon). Hence by reducing the size of the defense budget by, say, 60%, you reduce the need for debt by 60%. Now, I am sure that all those "no tax" republicans will jump on my bandwagon on this one.
Second, run the government like a for-profit enterprise. Eliminate the gas tax and all other stupidity, and charge people for riding the freeways (in Cali-- other states call them expressways or stateroads).
Tax consumption (especially consumption of luxury goods--- not that i have a problem with people buying expensive things .. it is simply to focus money spent on productive pursuits as opposed to consumerism).
Give small businesses a 3 year tax break.
In this dire economy, give business a tax discount for each new hire they employ... especially if such a hire is from a poor background.
Eliminate the dividend tax (double-taxation)
Levy a tax penalty on corporations for each job they send off-shore
Impose higher tarrifs on imported products (why not start a trade war while we are at it)
Finally, create a new cabinet position.. call it the "Tax Lord", and make me secretary.
thing is - may I kindly remind you all that nothing is certain apart from death and taxes...
please ponder this point before continuing to post comments.
whenever a nation wants to take a tax reform, it will meet a lot of difficulty and sacrifice some people's interest. doing sth is better than nothing,i think
Real tax reform would deprive our pols of their stock-in-trade for campaign contributions, sweetheart deals, and a cushy spot just the other side of the revolving door.
that's alot of information.
Corporations basically just buy up whatever political reform that suites them in this country, and bend the government to their will. Are all countries like this? Do we have to bow before corporate power to stay competitive as a nation? What's the alternative, if any, and how has it worked out? Would love to get a solid answer, discussion, and/or links to reading on this subject by some of the esteemed Economist commentators out there. Much obliged!
Didn't we have Tax Reform in 1986?
Just another "Leave No Lobbyist Behind" Act.
Regards
Yes indeed. I think a quarter century+ is enough time gone by for another.
According to the Office of Management and Budget, corporate tax revenue as a % of GDP was 7.2 percent back in 1945. It has dropped consistently since then and now sits at a little over 1 percent, just about the lowest in that time. So, the effective corporate tax rates in the US are actually among the lowest in the world. I'm not sure why the Economist would present this article from the viewpoint of US corporations paying too MUCH in taxes.
The US should spend less on military,otherwise it can not recover from the crisis.
Pretending to be world police is a difficult task for any country.
"I can make a firm pledge. Under my plan, no family making less than $250,000 a year will see any form of tax increase. Not your income tax, not your payroll tax, not your capital gains taxes, not any of your taxes." - Barak Obama, Dover, N.H., September 12th 2009.
Since then many many new taxes like the following have gone up on families making <$250,000
Huge Healthcare Tax/Penalty (PPACA minimum essential requirement)
Significant Bank Tax/Fees (all kinds of new bank fees)
Big Savers Tax/Penalty (Govt. choses to keep interest rates at near zero percent)
Cigerette Tax
Tanning Tax
Medicare Cuts (500 billion)
:
:
where is the tax hike??????
Honest politician oxymoron
1. http://www.youtube.com/watch?v=bg-ofjXrXio
2. http://www.politifact.com/truth-o-meter/statements/2011/feb/07/barack-ob...
USC › Title 26 (- Internal Revenue Code) › Subtitle D (- MISCELLANEOUS EXCISE TAXES)› Chapter 48 (- MAINTENANCE OF MINIMUM ESSENTIAL COVERAGE) › § 5000A ( - REQUIREMENT TO MAINTAIN MINIMUM ESSENTIAL COVERAGE)
This part of the code uses the term tax* 34 times ;)
American corporations can deduct, depreciate, amortize, or capitalize nearly everything. Additionally losses from year can be carried forward or even backwards to offset past and future gains. If you an American corporation and you are paying taxes it's time to fire your accountant.
Flat tax on income + flat tax on VAT. Keep It Simple Stupid. Get rid of all the overpaid tax laywers, tax accountants, tax bankers, tax lobbyists.
Many would argue that simplicity isn't worth the regressive nature of a flat income and VAT tax. Those taxes shift the tax burden disproportionately onto the poorest tax payers, even those who don't (read also: can't) pay taxes under our current system. Consumption (VAT) taxes are always going to land harder on people who consume the vast majority of their income, i.e. the poor.
Some of these arguments aren't don't immediately translate to corporate taxation. However, I maintain that since corporations are sophisticated entities, a degree of simplicity is desirable, but a flat tax is not the way to achieve an optimal solution.