Corporate tax Reform - some ideas

In addition to targeting “the (evil) rich”, loud noises are being made about businesses not paying “their fair share” of taxes. Without jumping into an argument over what could/would be considered “fair”, I’ll admit there *ARE* some problems with business taxation.

I will accept as fact that Corporate tax revenues are now at historical lows as a share of the economy. This is happening at a time when we face deficits and debt that are expected to grow to unsustainable levels. HOWEVER, the top statutory corporate tax rate is high, the average tax rate (the share of profits that companies actually pay in taxes) is substantially *lower* because of the tax code. This is due to a multitude of write-offs and ‘loophole’ advantages, implemented over the years, so corporations can reduce their taxes. And while I think U.S. corporate tax rates are WAY too high to be competitive on a global scale, when measured as a share of the economy, U.S. corporate tax receipts are somewhat low compared to other developed countries.

But, this is all about dealing with that nagging debt problem…

In ‘fairness’, some (not all) of the burden of helping us get out of this deficit mess will have to fall upon business. I’ll make the flat statement that *ALL* parts of the budget and the tax code, including corporate taxes, should contribute to deficit reduction. This will require across-the-board reform of the tax code itself.

Now, I’m on record as supporting the Fair Tax for a variety of reasons. (The application of true ‘Fairness’ into the tax code itself is the biggest.) But since doing the Right Thing - moving from income tax to consumption tax via the Fair Tax – is unlikely in our current political environment, here’s a few suggestions for what to do under the current set of rules.

1. Reduce the tax code’s bias towards debt financing. The current corporate tax code encourages corporations to finance their investments with debt (by issuing bonds) rather than equity (by selling stock). This encourages corporations to rely excessively on debt, which, as the recent financial crisis demonstrated, poses risks for both the firms and the broader economy. It’s not good for individuals *or* business to rely on debt. The tax code should be more even-handed in treating these two types of financing. And it goes without saying that reversing the recent trend in ignoring bond holders and shareholders (e.g. the GM debacle) must *never* happen again.

2. Reduce the tax code’s bias in favor of overseas investments. U.S. multinationals pay much lower taxes on profits from their overseas investments than on profits from their domestic investments. That gives corporations a strong incentive to shift economic activity and income from the United States to other countries. Policymakers should address aspects of the corporate tax code that allow so much business activity to escape taxation and that favor foreign investments over domestic ones.

3. Improve economic efficiency by reducing special preferences. This is the absolute height of ‘fairness’… The existing corporate tax code taxes different kinds of corporate investments at very different rates. This “un-level playing field” encourages businesses to choose among investments in a large part based on their tax benefits, instead of making those decisions based entirely on investments’ real economic value. Policymakers should level the playing field.

4. Provide neutral treatment of corporate and non-corporate businesses. Over time, various policy changes have made it easier for companies to enjoy the benefits of corporate status without being subject to the corporate income tax. Reform should reflect the principle that firms engaging in similar activities and enjoying similar legal benefits should be taxed at similar rates… just add more ‘Fairness’ again.

5. Take specific steps to discourage tax sheltering. If policymakers lower the statutory corporate tax rate to *well* below the top individual tax rate, they should also establish safeguards to prevent high-income individuals from sheltering their income in corporations in order to pay taxes at a lower rate. Again, level the playing field: more fairness.

That’s a few points. I think they make sense. A lot of folks won’t like them, but that’s because they’ve been given advantages over others. Favoring one group over another is WRONG – it just isn’t fair.

Of course, if we can develop the courage to dump the existing tax code entirely and shift to the Fair Tax, none of this would be necessary.

- Steve