Commentary

Corporate Tax Tangle

This article was published in the Washington Times, July 11, 2004.

The wrangling over the corporate tax bill in Congress continues, but prospects for passage before the election are becoming increasingly dim.

That may not be a bad thing because the bill is the worst show of special interest tax lobbying in years. Hundreds of narrow provisions litter the bill, illustrating congressional sausage-making at its most complex. The list of provisions in the Senate version of the bill is 7 times longer that the list of provisions in last year’s income tax cut bill.

This sausage started out as a lean reform bill, which responded to a World Trade Organization ruling a special tax break for U.S. exporters was illegal. The House and Senate both agreed the break should be repealed to comply with WTO rules. Then each chamber added some meaty reforms to simplify the tax code and help U.S. corporations compete abroad.

Currently, the United States applies uniquely complex rules to the foreign activities of its corporations. These rules are so complex that, for example, four-fifths of Dow Chemical’s 7,800-page federal tax return relate to its foreign investments.

Proposed reforms to such items as the “interest expense allocation rules” and “foreign tax credit baskets” would help U.S. firms compete with firms based in countries with less burdensome systems.

But that’s where the lean ends and the pork begins. The House bill includes tax breaks for alcohol fuels, electric vehicles and $10 billion for tobacco farmers. The Senate bill includes dozens of tax incentives for coal, oil and gas, fuel cells, biodiesel and other energy activities.

While most such special interest provisions distort the economy, some may be justified if they make the tax code simpler and more neutral. For example, the House bill repeals the 10 percent excise tax on fishing tackle boxes. Tackle box manufacturers apparently suffer because fishermen buy similar utility and sewing boxes that don’t face the tax. In this case, repeal makes sense to neutralize an existing distortion.

However, the biggest item in the House and Senate bills is a tax cut for manufacturers, which would add a large distortion to the tax code. The House bill would reduce the tax rate for manufacturers from 35 percent to 32 percent while the Senate bill would create a special deduction. That would increase tax code complexity and put manufacturers into a separate lobbying camp less interested in overall tax reforms.

Many other industries add great value to the U.S. economy such as financial services. Shouldn’t tax policy encourage growth in those industries as well?

There is a better way. If the House and Senate can’t reconcile their different bills, Congress should start fresh with a simple across-the-board corporate tax rate cut. That would provide a direct competitive response to the recent decline in tax rates around the world.

The average corporate tax rate for the 30 major industrial countries has fallen from 38 percent in 1996 to just 30 percent today. By contrast, U.S. corporations face a rate of about 40 percent, including the 35 percent federal rate plus an average state rate of 5 percent.

The downward trend in global corporate tax rates is expected to continue, further increasing competitive pressures on U.S. companies. This will cause investment to gravitate toward countries with more attractive tax climates, reducing U.S. productivity and wages. Another problem with a high tax rate is it creates a big incentive for firms to adopt Enron-style tax shelters to move paper profits abroad.

Most analysts would agree a corporate rate cut makes economic sense, but point to the huge budget deficit as a barrier to reform. The solution is to combine a corporate tax cut with an equal cut of federal spending on corporate subsidies, which total about $90 billion yearly. Such a reform package would reduce special handouts that distort the economy while spurring growth across all industries.

Because such a clean reform package would have to overcome special interest lobbying, presidential leadership would be needed. The current corporate tax bill is a mess partly because the Bush White House has hinted from the sidelines it would sign any pork barrel bill that passes Congress. White House invisibility on the issue has been irresponsible, but perhaps understandable, given election year politics.

The good news is Democratic presidential hopeful Sen. John Kerry has introduced his own corporate tax plan, which gives the White House cover to begin engaging the issue. Mr. Kerry’s plan includes wrongheaded rule changes for foreign investment, but he does propose a small corporate tax rate cut. Mr. Kerry also says he favors cutting corporate subsidies.

President Bush should one-up Mr. Kerry and draft a reform bill that cuts the tax rate enough to put U.S. companies on an equal footing with foreign competitors.

While the public may think both Republicans and Democrats shower corporations with big tax breaks, the truth is corporations have not received a substantial tax cut in decades. The landmark 1986 tax act cut the corporate tax rate, but raised corporate taxes overall. The depreciation tax cut enacted in 2002 expires at the end of this year. Thus there is a pent-up demand for corporate tax reforms, especially since other countries have cut tax rates so much.

That pent-up demand is why the corporate tax bill has generated such a lobbying frenzy this year. The Bush administration can play a constructive role by channeling that frenzy into tax changes that are good for the whole economy, not just businesses on the inside track in the halls of Congress.

Chris Edwards is director of tax policy studies at the Cato Institute.