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The Coming Corporate Tax Reform

from the magazine

The Coming Corporate Tax Reform

With Donald Trump’s leadership, a long-awaited deal to lower rates and end loopholes is within reach. Winter 2017
Politics and law
Economy, finance, and budgets

During the presidential campaign, Donald Trump promised to enact sensible corporate tax reforms that would do much to promote equity, economic efficiency, and growth. Amazingly, the political climate is such that these proposals have a fair chance of becoming law.

Many of the corporate tax code’s present flaws show in the huge sums that U.S. firms hold abroad. Some $2.6 trillion sits overseas because the current U.S. corporate tax rate of 35 percent is a third higher—or more—than in other countries. To bring these monies home, Trump has proposed a one-time tax holiday offering corporations a low, 10 percent rate on repatriated earnings. The homeward flow of funds would undoubtedly promote growth. More, it would help directly with public finances. If only half the money returned, the Treasury would receive a $130 billion revenue windfall.

Statutory tax reductions would also end the trend of American firms incorporating abroad, usually by buying a foreign firm. Such “inversions” let firms skirt laws forcing them to pay high U.S. rates on global earnings, wherever they are accrued. Reform the code, and corporate activity would remain at home.

More fundamentally, the Trump proposals would promote growth by fostering efficient use of corporate resources. Now, a labyrinth of exemptions and tax breaks prompts firms to make decisions based on tax rules rather than on what serves clients or enhances productivity. Because exemptions have less to do with economic logic than with political influence, the economy suffers. A glimpse at the code’s distortions can be had by comparing the tax rates that different industries pay. There is no economic reason that the trucking industry should pay an average tax rate verging on 31 percent, while the better-connected software-and-services industry pays at only a 10 percent rate. The metals and mining industry pays at a 7.4 percent rate, while the petroleum and natural-gas industry pays at a negative 2.2 percent rate. Reducing the statutory tax rate would reduce the value of these breaks. Eliminating the exceptions as proposed would erase the distortions altogether.

Ridding the code of special breaks would aid the economy still further by strengthening corporate finances. Because the code gives generous allowances for financing costs, it encourages business to use debt instead of equity financing. The bias toward debt is far higher in the U.S. code than in the tax codes of other economically advanced nations. American firms carry heavier relative debt burdens than do their foreign counterparts. These differences mean little during normal times, but they can become dangerous during hard times, as was apparent during the 2008 financial crisis. When earnings wane, firms that finance with direct-equity investments simply pay out less. Firms that have a lot of debt, however, lack this option. Their obligations remain fixed, allowing an earnings shortfall more readily to threaten bankruptcy. Tax reforms of this kind can’t answer for a clear cultural bias toward debt in corporate America, but they can ease the extremes that currently exist.

For all the Trump proposals’ benefits, they still fall short of what is needed. Simple reductions in statutory rates would require safeguards to prevent individuals from sheltering in corporations what they might otherwise claim as personal income. Inside shelters, these monies could accumulate at lower tax rates until distributed through dividends or capital gains, both of which are also tax-advantaged. The Trump team has so far offered nothing to protect against such maneuvering. More generally, any reduction in the corporate rates would need to address the gap that would open between what corporate structures pay and what individual proprietorships and other organizational structures pay. The current code’s high corporate rates have twisted business away from straight corporate structures. Suddenly putting this process into reverse could inadvertently create considerable hardship and inefficiency.

It’s doubtful that we’ll get all the corporate tax reform that we need. Still, some progress looks likely. President Obama’s 2010 National Commission on Fiscal Responsibility and Reform recommended lowering statutory rates and reducing or eliminating loopholes. Disputes over details have scuttled reform legislation time and again. Washington could have overcome past failures with powerful sponsorship, but Obama remained either unwilling or unable to take the risk. Now it’s up to Trump. Republican congressional leaders have described this as a “rare and golden moment for tax reform.” Senate majority leader Mitch McConnell has called Trump’s election a “historic opportunity to fundamentally overhaul the U.S. tax code.” Senator Chuck Schumer, incoming Senate minority leader, is enthusiastic about a deal. If Trump is the dealmaker he claims to be, then corporate tax reform in 2017 should be a slam-dunk.

Photo by Zach Gibson/Getty Images

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