When Congress concludes its histrionics on current and accumulated debt levels, corporate tax reform will be a topic for potential compromise and progress. Although some may be confused about the purpose, the main goal for tax reform remains the reallocation of profits and capital gains among three applications: government revenues, personal income and investment activities of the corporation.
Secondary reform goals are to fix distortions in the code that led to different effective tax rates among various business forms (sole proprietorship, partnership, S-corp. and C-corp.), and to address the “global tax policy” that causes stranding of corporate earnings abroad (about $1.5 trillion in 2011), where they are not used to spur US investment. The corporate federal income tax top rate of 35 percent is 7.6 percentage points higher than the average in other countries, encouraging US firms to invest in low tax countries.
Those obsessed with increased government revenues will call for higher tax rates or for moving tax bracket boundaries lower. A jingoist version of “closing tax loopholes” is inevitable. There are some special tax treatments that lack merit such as “carried interest,” however big corporate loophole closures can exclude and delay legitimate cost recoveries such as depreciation, or credit for taxes paid in other countries for profits earned there. Spin doctors for these populist thoughts describe exemptions and credits as “tax expenditures,” notionally money that our government charitably gives away instead of being other peoples’ money that the government did not yet seize.
Investment activities are the foundation for long term income and profit growth, enabling higher personal income and government revenues. That seems to be accepted across the political mainstream. Recent US growth is slow at 2.5% of GDP, foreshadowing poor income and tax production in years to come. Unfortunately, the US invests less of its GDP than almost any other country. Reversing that shortfall is a key challenge facing all senior economic policymakers. Any tax treatment that generates more investable corporate funds in the US can help in this regard.
Business format matters at lot. Businesses that operate as an unincorporated entity (i.e., as an individual) can face total federal income tax rates of 39.6% plus Social Security tax of 6.2% on the first $113,000 assessed to each of the employee and employer, plus 1.45% Medicare tax (and a 0.9% Medicare penalty if the employee earns more than $200,000). Since a small business operating as an individual can face these huge distortions in tax burden, most people acknowledge this injustice should be repaired.
When Congress gets around to corporate tax reform, it will likely tackle personal taxes at the same time. Some will wrongly demand a precondition of “revenue neutrality.” The complexity of the topic will require the members to exercise preternatural restraint to avoid populist name calling and the poisonous class warfare that spreads.
Alan Daley is a retired businessman who lives in Florida and who writes for The American Consumer Institute Center for Citizen Research