Obama’s New Tax Reform Proposal

President Obama has put out a “framework” for a tax reform proposal, that is very short on details but would essentially trade lower marginal tax rates for corporations for the elimination of “loopholes” — good luck getting a coherent definition of what that is — that will supposedly raise more revenue. And the experts are pointing out some of the problems with it. Scott Hodge writes:

Also, it is ironic that Obama is proposing a 20 percent tax cut for corporations just weeks after proposing a “Buffett rule” for high-income individual taxpayers, many of whom are pass-through businesses such as S-corporations and LLCs. Interestingly, the top corporate tax rate and the top individual tax rate are at the same level – 35 percent – for the first time in the history of the U.S. tax system. I thank that parity should be maintained, but under Obama policies we would have a 28 percent corporate tax rate and a top individual of at least 39.6 percent. Thus you would see an exodus of S-corporations flipping to C-corp status…

The plan creates a new 25 percent tax rate for manufacturing – perhaps, even a lower rate for “advanced” manufacturing. We can only imagine the feeding frenzy this would generate from lobbyists to get their industry declared manufacturing. As it is, the current “199” manufacturing deduction that was enacted in 2004, is available to architects, companies that grind hamburger, software firms, and companies that produce rap albums.

He’s right about those things, of course. And Obama’s plan doesn’t really eliminate “loopholes,” it only moves them around a bit. And here’s what The Economist has to say about it:

But deciding whose tax breaks get closed is what makes tax reform hard. Mr Obama has called for, and proposed budgets that include, eradication of a dog’s dinner of loopholes covering inventory accounting, oil and gas production, corporate life-insurance policies, hedge-fund profits, and corporate jets. He would impose a minimum tax rate on foreign-source income. But this still leaves a lot of money that must be raised through other means. On the remainder Mr Obama sadly but predictably grows vague: curbing depreciation, the deductibility of interest, and the use of non-corporate business forms, such as “S corporations”, partnerships, and LLCs, should all be “considered”.

The single biggest corporate tax breaks are for depreciation and expensing of capital equipment, and a tax deduction for American-based production. But, awkwardly, among the greatest beneficiaries of these benefits are manufacturers whose cause Mr Obama now loudly champions. Rather than eliminate those tax breaks altogether, Mr Obama would preserve them for manufacturers so that their effective tax rate would drop a bit, to 25% from 26% currently. (The effective tax rate equals taxes, after all deductions, as a share of income. It’s a better measure of the tax burden than the top corporate rate.)

Mr Obama’s proposal is better than what America already has, but not by much. His well-intentioned goal of broadening the tax base is betrayed by the preferences he insists on maintaining for manufacturing and “green” energy whose economic merits have been questioned, even by former members of his own administration. By maintaining many of the current tax breaks but apportioning them more variably, the tax code would become more complex rather than less so…

Then there are the devilish politics. Marty Sullivan, an independent tax analyst, says high-technology and pharmaceutical multinationals such as Apple and Merck that have benefited from low taxes on foreign-source intellectual-property income would be losers, as would utilities and telecommunications companies with significant interest and depreciation charges. They are unlikely to accept a tax hike quietly.

Both of those sources point to the real reason why such proposals should not be taken seriously. No matter how well-intentioned the president might be, there isn’t a snowball’s chance in hell that what he proposes will actually happen. The moment such a bill gets submitted, the corporations who benefit from all those tax breaks he wants to eliminate will flood Congress with money to preserve their favored loopholes, tax breaks and subsidies. And most of them will succeed in doing so.

And remember, they have far more leverage now than they used to have — not because of Citizens United, which really didn’t change much, but because of the ruling in the Speech Now case, which is what allowed the Super PACs to flourish. A corporation, alone or in a group or through a trade organization like the Chamber of Commerce, can now walk in to a legislator’s office and say, “You’re going to make sure this provision is removed from the bill or we’ll be spending $10 million in your district in the next election to make sure you don’t get reelected.” And they can do it; hell, they do it all the time. And the pro-reform forces don’t have even a fraction of the money that the corporate beneficiaries of government largesse have.

That is what prevents genuine tax reform. It’s also what prevents all legislation from being considered on a rational basis. If we do not fix the problem of corporate influence in politics, we can fix almost no other serious problem facing the country.

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  • Michael Heath

    I’ve never heard of Scott Hodge before but I think he’s at best a moron. He writes:

    it is ironic that Obama is proposing a 20 percent tax cut for corporations just weeks after proposing a “Buffett rule” for high-income individual taxpayers, many of whom are pass-through businesses such as S-corporations and LLCs.

    I don’t find that ironic at all. Especially when you break down how various businesses structure themselves. There’s no contradiction in arguing for a lower corporate tax rate and higher individual income rates. Of course there are arguments on whether we should change rates, but there’s no inconsistency in Obama’s position, only the ignorant would claim that. Mr. Hodges goes on to claim this would influence the mix of structures businesses deployed where I’m sure he’s correct some changes would occur, but without also considering the degree, impact, and mitigation opportunities by government to maintain or enhance fairness his argument is vacuous.

    And here’s some real ignorance by The Economist:

    The single biggest corporate tax breaks are for depreciation and expensing of capital equipment . . .

    Depreciation is no more a tax break than deducting the cash cost of sales, administration, and operating expenses to the determine taxable profit and then taxing the profit. They’re conflating depreciations with subsidies in a way that guarantees confusion. Now depreciation schedules are frequently abused, in fact reading the IRS form on those schedules is a vivid presentation of how lobbyists secure benefits for their clients [IIRC it’s form 362]. But my criticism is not the exceptions, but instead The Economist misconstruing the purpose of depreciation schedules when it comes to tax reform.

    Suppose I buy a piece of manufacturing equipment, “MA-1”, that costs me $1 million dollars. On my balance sheet I’ve reduced my cash position on the asset side of the balance sheet with a piece of equipment valued at $10 million, though the balance remains the same since I’ve also added a $10 million asset on that ledger in the form of a piece of capital equipment. Capital equipment is an investment which one uses to generate a profit/loss in operating their equipment. A pump which pumps oil to the surface in order to sell that oil is a perfect example of a piece of capital equipment.

    Prior to using my new machine (simplifying all other factors), no real change has occurred in my performance for a period of time (which is tracked in a Profit & Loss Statement). This equipment’s useful life is 10 years. Managerial accountants and finance experts would prefer expensing this equipment against profit across 10 years. So rather than getting a $10 million deduction from the first year’s profit, which would be misleading since consumption of the machine will occur over 10 years, they spread the cost over those ten years, reducing profit by $100,000/year. They do this by writing in “Depreciation Expense – MA-1 – $100,000 in their Profit & Loss Statement. It’s a type of non-cash expense which is a very real expense. They then write down the balance sheet value of the machine by $100,000 each year until it balances out to zero after year 10. That’s when their perspective is booking transactions in order to gauge the performance of the company, not necessarily when booking transactions in order to minimize tax liabilities. For example, in 2004 I was able to depreciate 100% of a truck I purchased that year in spite of planning to use it for several years. I didn’t do it, but if I’d booked it that way it would appear I under-performed in 2004 and over-performed in subsequent years where I used that truck, all to accelerate tax savings for one year.

    Subsidies on the other hand provide incentives for suppliers and consumers to favor the supply chain benefiting from such subsidies. It’s not about how to spread the cost of doing business across a period of time, but instead artificially reducing the price of a product at the expense of taxpayers and competing unsubsidized industries. Often at the expense of other industries, e.g., coal subsidies which result in artificially low electric prices vs. electricity generated by dams, wind, nuclear, solar, or natural gas. Depreciation schedules which do match the useful life of a product but are instead accelerated also serve as a type of subsidy, but that is still the exception and not relevant to how The Economist misinforms its readers.

    I think the more interesting question regarding the president’s proposal is whether it increases the effective tax rate on businesses or not. Given the enormous amount of tax breaks some businesses enjoy, getting a stated rated cut coupled to less deductions might very well increase their effective tax rate.

  • Chiroptera

    Does he propose increasing taxes on poor people who fail drug tests? ‘Cause if not, then that’s socialism!

  • LiveFreeOrDie

    Hodge is wrong about S-corps flipping to C-corps for one simple reason: double taxation. An S corp is taxed only once on the owners’ individual income taxes. C corps are taxed once at the corporate level and again as dividend income to the owners. Plus there are a whole host of other hurdles that C corps have to deal with that S corps don’t.

  • D. C. Sessions

    Meh. It’s a tax cut, pure and simple. The reason is simple, and we’ve seen it before: cut rates, eliminate tax expenditures, and next year the tax expenditures are back — if they ever left.

    I’ll be a lot more impressed when Congress does two things:

    1) Cut the tax expenditures first.

    2) Tie the rates such that any new tax expenditures have to be paid for in increased rates.

    (2) is the key. It makes the tax giveaway game a zero-sum, and as a result any attempt by one group to get special treatment will be countered by a host of others who will lose as a result. Right now they just come with hands out for their own cookies, and are the more likely to get them when someone else already has gotten theirs.