Corporate Tax Reform

Corporate Tax Reform

March 31, 2011

Corporate tax reform is on the agendas of both political parties in Congress.

The Senate tax-writing committee has started holding weekly hearings on tax reform, but it is hard to see a bill being enacted before the next elections in November 2012.

Business groups have been pressing for a lower tax rate. The US statutory tax rate of 35% is reportedly the highest among the 34 OECD countries, assuming Japan implements a planned rate reduction. According to PricewaterhouseCoopers, adding state and local taxes brought the US corporate income tax rate to 39.2% in 2010, 14 percentage points higher than the average rate of 25.1% within the OECD.

Comparisons of effective rates—or the rates at which companies actually pay taxes—are harder to find.

Any major tax reform probably needs to be revenue neutral because of the huge federal budget deficit. The Bush Treasury Department showed in a report in December 2007 why this will be a challenge. The Treasury estimated that eliminating all business tax incentives other than accelerated depreciation would allow the corporate income tax rate to drop 4 percentage points to 31%. Eliminating accelerated depreciation would take it down to 28%.

Capital-intensive industries, like manufacturers, power companies, airlines, railroads and truckers, would be worse off from such an exchange. Retailers and financial firms would benefit the most. This will make it hard for major trade associations, like the US Chamber of Commerce, that cut across industries to support reforms.

In addition to rate reduction, US multinational corporations would like the US to move to a “territorial” system where they are taxed only on income earned in the United States. The current system of taxing US companies on worldwide income discourages them from repatriating earnings from subsidiaries in other countries that remain parked outside the US tax net in offshore holding companies. Any move to a territorial system would make US multinational corporations more competitive in foreign markets, but it could be perceived as making it easier to redeploy capital and move jobs abroad.

Meanwhile, the US tax laws have become less anchored. More and more tax provisions that reduce tax collections have sunset clauses. The first time the Joint Committee on Taxation published a list in 1998 of provisions that were scheduled to expire in the next three years, the list had 19 items. In 2010, there were 181.

Keith Martin