The main goal for any tax reform that merits being called a reform is to boost economic growth. The way to do that, most economists whose last name isn’t Krugman aver, is to reduce marginal tax rates on businesses both large and small and make up the lost revenue by eliminating various tax deductions, exclusions, and credits. Spending cuts, too, if possible.
But is any part of it possible?
Congress late last year made permanent a number of “temporary” tax measures such as the Research and Experimentation Tax Credit and the expensing of capital investment for small businesses. It also extended some provisions set to expire, including tax breaks for alternative energy production. The basic idea was to set the stage for reform: By making these elements permanent Congress lowered the tax-revenue “baseline.” Thus, under the Capitol’s arcane budget rules, future tax reforms don’t have to produce as much compensatory revenues to count as being “paid for.”
Still, the near-term prospects for tax reform aren’t exactly robust. One big roadblock to action in 2016 is the fact that, in 2013, President Obama raised the top individual tax rates — the rates that also apply to most small businesses. He’s not likely to give up those increases anytime soon. Jason Furman, head of the president’s Council of Economic Advisers, told a Brookings Institution conference in November that, while the administration remains open to some sort of corporate tax reform, they see no compelling reason to reform the personal side of the tax code.
It leaves tax reform advocates in a quandary: Does it make sense to wait another year before attempting some sort of tax reform, or does it make more sense to get whatever corporate tax reform is possible now — especially given that 2017 could bring not only another Democratic president, but a Democratic Senate as well?
Last year, then-chairman of the House Ways and Means Committee Paul Ryan and Senate Finance Committee chair Orrin Hatch signaled their intent to try for half a loaf. They sent a letter to various small business constituencies asking them to propose ways to make their lives easier without lowering their top tax rates. Small business responded immediately and en masse that the rate is what matters first, second, and third to them, and that they would oppose any tax reform that did not mean lower rates. Small businesses worry that action on corporate taxes now would scotch the chances of further tax reform in the next administration.
Given the hostility of small business to a corporate-only tax reform, tax writers had to ask themselves: Is it worth pursuing a limited tax reform, focusing on the corporate tax code, in 2016? The answer, I think, should be yes.
For starters, it’s important to recognize that there is no compelling economic reason for doing corporate and personal tax reform together, just a political one. It’s argued that the top rates for pass-throughs — companies that pass both profits and tax obligations through to their shareholders — and corporations should be nearly the same so that a company’s incorporation decision isn’t skewed by tax disparities. But a good chunk of corporate profits are already being taxed twice, first at the corporate level and then again as dividends or capital gains, making C corporation status something to avoid. Indeed, the steady decline of corporate income tax revenue as a proportion of federal revenue (grist for many anguished editorials at the New York Times) is largely thanks to a shift away from C corporation status. Taxes paid by all businesses — C corporations, S corporations, and partnerships together— account for roughly the same proportion of total tax revenue as three decades ago.
And it’s worth repeating that the corporate income tax isn’t all that progressive. While liberals have it in their heads that corporate taxes come from the hide of rich plutocrats, the reality is that it’s paid by workers (in the form of lower wages), consumers (in the form of higher prices), and shareholders. Often — thanks to 401(k) plans — the shareholders and the workers are one and the same.
Individual and corporate tax reform would have to be done separately, even if Congress tackled them concurrently. Corporate reform cannot use a reduction in credits or deductions from the personal side to make up for revenues lost from lower corporate tax rates, though the most consequential tax breaks — the mortgage interest deduction among them — are contained in the personal tax code. And even if changes to individual taxes could be used to offset changes to the corporate code, mixing the two would make it too easy by half to undermine reform. All it would take is one member of Congress (paging Bernie Sanders) to link corporate tax items that reduced revenue with personal tax items boosting revenue: Each and every piece of corporate reform would be denounced as a break for rich businesses paid for by taxpayers.
The advocates of corporate tax reform are already up against a major barrier to getting anything done in the near term: The president won’t sign any reform that doesn’t bring in more money to Washington. It’s hard enough making tax reform palatable under the constraint of revenue neutrality: A 2008 study by the Treasury Department proposing revenue-neutral corporate tax reform had trouble identifying enough revenue-raisers to get the corporate tax rate below 30 percent, which isn’t much of a reduction from the current 35 percent. If the White House insists on depositing a few hundred billion dollars of “savings” accrued from any reform into federal coffers, prospects for reform go from slim to none.
Yes the personal tax code is in desperate need of reform, but there’s no reason to think Congress has the stomach to get rid of any of the big-ticket personal deductions that would have to go in any real reform. Who’s going to take on the mortgage interest deduction?
Given that chances for significant reform of personal taxes are remote, it makes little sense to tether corporate tax changes to that dead weight. A partial victory, focused on corporate tax reform, is possible. It would be both an economic success, making U.S. corporations better able to compete around the world, and a political success, showing that Republicans and Democrats can reach compromise on issues of major importance.
And, who knows, it might even set the stage for reform of personal taxes that would benefit small businesses and individuals.
Ike Brannon is president of Capital Policy Analytics, a consulting firm in Washington.
