Obama Likely to Pursue Corporate-Tax Cut

by David Wessel
Wednesday, December 29, 2010 by The Wall Street Journal

All signs point to President Barack Obama pursuing far-reaching changes to the corporate income tax, seeking to lower one of the highest statutory corporate-tax rates in the world by eliminating deductions, credits and loopholes.

If he proceeds, the administration will insist that any changes raise as much revenue as the existing, 35% corporate tax. That's to constrain those who want to lighten the business-tax burden and those who want to get more money from business. But the constraint means that for every company that saves a dollar, another will pay a dollar more.

The White House says no decisions have been made and that the president has yet to have a session with his economic team devoted to corporate taxes. But Treasury tax technicians are sifting through options, CEOs are buzzing and the president has voiced his druthers: "We would be very interested," he said in October, "in finding ways to lower the corporate-tax rate so that companies that are operating overseas can so do effectively and aren't put at a competitive disadvantage." In a recent NPR interview, Mr. Obama talked about "a conversation over the next year" aimed at "simplifying the system, hopefully lowering rates, broadening the base."

Any Obama pitch, perhaps in the State of the Union, will be that corporate-tax reform will make America "more competitive," induce more companies to invest here, reduce costly complexity and improve long-term growth prospects. Truth be told, this won't do a whole lot to boost growth, but this is one of the options that is free and doesn't widen the budget deficit. Congressional Republicans say they're at least interested in talking.

Unlike income and payroll taxes, the corporate tax has been shrinking. From 3.8% of gross domestic product, the value of goods and services produced in a year, in the 1960s, it was down to 2% of GDP before the recent recession. "The corporate tax is a shadow of its former self," Congressional Research Service economist Jane Gravelle has said. It's largely a big-company tax: Half of all business profits go to entities organized to be taxed as individuals, a way to pay less in taxes; 85% of corporate income taxes are paid by 0.5% of companies, fewer than 10,000 in all.

In the past 25 years, the corporate tax has grown barnacles, some crafted to encourage investment, others narrow provisions with little economic merit. With the capitulation of Japan and the U.K., the U.S. is the only major economy that tries to tax multinationals on world-wide income instead of profits made at home, an unsustainable perch. Although various deductions mean most companies pay far less than the 35% statutory rate, most estimates suggest that the actual U.S. federal-state corporate-tax rate in ordinary times (when the government isn't offering the temporary investment tax breaks it is now) is higher than in many, not all, other big countries. Several others, most recently Japan and Canada, are moving to cut corporate rates, which could put the U.S. at a disadvantage at a time when capital moves across borders with increasing ease.

Before the financial crisis, the Bush Treasury was eyeing the corporate tax, arguing that it distorted decisions, fostered inefficiency and cost business $40 billion a year in compliance. Mr. Obama's Presidential Economic Recovery Advisory Board (Perab) picked up the baton, saying in August that the current corporate tax has "deleterious economic consequences," encourages borrowing and induces investment "for tax reasons rather than for reasons of economic efficiency."

In short, the corporate income tax has few defenders. But changing it without losing revenue is challenging. Each percentage-point cut in the existing corporate tax reduces revenues by about $120 billion over 10 years. Closing a few loopholes won't do enough to reduce the rate significantly: Taxing credit unions as corporations yields $19 billion over 10 years, for instance; taxing Blue Cross/Blue Shield yields $8 billion.

To make this worth doing, the rate probably needs to fall toward 25%. That means big changes. Take the 2004 tax break for "domestic production," described as a way to boost manufacturing but so broadly defined that it covers hamburger making. If it were eliminated, the corporate tax rate for all companies-from Wall Street to the Rust Belt-could be reduced by 1.4 percentage points. But to the one third of companies that get the tax break, it shaves the rate by 3.5 percentage points. So their taxes would go up unless some other popular deductions are eliminated, such as accelerated depreciation (which allows companies to write off investments for tax purposes more quickly than for accounting purposes).

Basically, there's a trade-off: Fewer tax breaks for companies to do what Congress has been convinced (either by economists or lobbyists) they should do, versus a lower tax rate. Deeper rate cuts may mean bigger changes, perhaps limits on the interest on debt that companies can deduct or forcing big businesses now outside the corporate tax to pay it.

Deficit hawks will say any savings should reduce debt, not tax rates. Some executives will say just cut the rate, forget the base-broadening. Some liberals will object to shielding business from paying more. And every loser will lobby hard. Ultimately, Mr. Obama likely will try to make this a problem for big business: You want lower rates, he'll say, find us a way to pay for it.