StanCollender'sCapitalGainsandGames Washington, Wall Street and Everything in Between



Low-Rate Corporate Tax Reform – Easier Said Than Done

28 Sep 2012
Posted by Clint Stretch
A year ago, I casually decided to hike every trail in the North District of the Shenandoah National Park.  How hard could that be?  There are only about 150 miles of these trails.  Well, it turns out that since a lot of the trails are hikes down from the Skyline Drive and climbing back up, hiking them all requires about 225 miles of trudging up and down really steep hills. 
 
Congress seems to have decided to take on the well-meaning hike of corporate tax reform.  This is a good idea, but it is bound to be a longer journey and a tougher climb than the current dialogue suggests. 

The Committee for a Responsible Federal Budget (CRFB) has published a report that succinctly makes the case for corporate tax reform, identifies major policy considerations and reviews the options presented by policymakers to date.  As Congress takes on this arduous climb, the business community will be watching closely since they have varying objectives and goals for the effort. In particular, businesses will care deeply about which companies benefit from reform and which will pay for those benefits.   Below, I outline five of the major fault lines along which the business community could divide as tax reform progresses. 
 
The definition of a “low enough” corporate tax rate varies widely. 
 
The CRFB created a nifty corporate tax reform calculator to accompany its report.  Extrapolating from Joint Committee on Taxation Data, the CRFB calculator lets the user pick and choose between corporate reform options and watch as the corporate tax rate goes up or down in response.  Admittedly, the numbers are not precise, but they do give users a good feel for the orders of magnitude involved.  Here’s the bad news for those expecting a rate in the 25 percent range.  Making every change to current corporate tax expenditures identified by the CRFB would lower the current 35 percent rate only to just below 27 percent, if international rules were reformed on a revenue neutral basis.   The CRFB identifies additional reforms that go beyond reducing or eliminating tax expenditures.  Adopting all of these would yield a rate of 24.4 percent.  Before you imagine such a result is possible, go and look at those suggested reforms. 
 
A tax reform that results in a 26 or 27 percent rate would be an astonishing achievement.  Unfortunately, it also would make the U.S. only “average” when it comes to corporate tax rates around the globe.  If a less aggressive reform resulted in a rate of 28 or 30 percent, some corporations would question whether the rate reduction was worth losing tax benefits like the R&D credit and accelerated depreciation. In contrast, many corporations in the services, health insurance, retail or other industries that have higher effective tax rates, could see such a reform as a clear win. 
 
Sole proprietors and pass-through businesses are not interested in paying for corporate rate reductions.
 
Business tax expenditures benefit both incorporated and unincorporated businesses.  According to the CRFB calculator, in a revenue neutral reform, the corporate tax rate could be lowered by an additional 1.4 points, if accelerated depreciation and the production activity deduction were repealed for all business taxpayers rather than only for corporations.  For these unincorporated business owners, however, this would mean accepting a tax increase through lost deductions, without any reward in the form of lower rates.  In addition, they would have lost valuable corporate allies in the fight for a more generally applicable reform.  Asking sole proprietorships and partnerships to pay for corporate relief likely would be a non-starter.
 
Cash strapped companies have a different interest from those that worry about their book income
 
The largest revenue raising element identified in the CRFB’s calculator is the repeal of accelerated depreciation.  This one change, applied only to corporations, would produce a rate reduction of between 2.9 and 4.3 percentage points depending on what other reforms are included.
 
Deprecation addresses when the cost of capital equipment is recovered not whether it will be recovered.  For public companies and other firms that worry about financial statement measures of success more than they do about cash, repealing accelerated depreciation shifts a tax expense from a deferred expense to a current expense.  It does not change the financial statement bottom line in most circumstances.  In contrast, for a company financing capital investment on the strength of its after-tax cash flow, stretching out tax recoveries of investments could create a significant barrier to expansion.  
 
Not all international business is the same
 
If international tax reform were crafted so that U.S. business activities pay for changing the treatment of foreign source income, then in the trade-offs to achieve revenue neutrality within that international sector, some U.S.-based multinationals would experience tax increases while others would see reductions in their taxes.  A major fault line in this area exists between those companies that have significant intellectual property that has been considered in their international tax planning and those that do not.  Similarly, attitudes toward repatriation of pre-reform earnings (whether elective or mandatory) could differ between companies that have invested deferred earnings in plant and equipment abroad and those that are holding cash abroad.  Finally, relatively new entrants to the international business world likely will have less interest in transition rules than long-established multinational firms. 
 
Equity financing is not an option for every company
 
Economists like to discuss a bias in the U.S. tax system that favors debt-financing.  Simply put, they note that interest on corporate debt is deductible and dividends on equity are not.  This observation often leads to a proposal to limit interest deductions on corporate debt.  Many firms, however, do not have a stock pile of cash or an easy choice of issuing stock rather than borrowing.  For them, any tax reform that limits the interest deduction on their capital financing would increase the cost of the only capital available to them. 

An extra 75 miles of hiking steep trails to complete my objective of hiking all the trails made for sore feet and tired muscles, but my desired outcome was never in doubt.  In corporate tax reform, the desired outcomes vary dramatically between businesses, making the journey particularly difficult and the climb towards reform terribly steep.    

Corporate tax rate

We must reduce the rate to attempt to be competitive in the world. If necessary we could raise effective tax rate on dividends to compensate.


Dividend Tax

Looked at one way, raising the dividend tax to reduce the corporate tax favors overseas equity investors in US companies over individual US-citizen investors (except in 401(k) retirement funds). Of course, these 2 types of investor are treated differently now. But it's not clear to me that sharpening the difference is a good thing.

Looked at another way, dividends taxes aren't the most reliable revenue source. Corporations can go to debt issuance, or no dividends, and investors who really don't want to pay tax on dividends can avoid dividend paying companies. Also, the following pay no dividends tax, or a reduced one: all non-US taxpayers, US corporations, charities/endowments of any kind, pension/retirement plans, and in limited cases employer health care plans.


whom to tax

sounds like a game of capital flight whack a mole




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