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Annette Nellen, Esq., CPA
Annette Nellen

Clearing a path to a lower corporate tax rate

For years, lawmakers of both parties have supported a lower corporate tax rate. So, why don’t we have one yet?

October 31, 2013
by Annette Nellen, Esq., CPA

In 2011, both House Ways and Means Committee Chairman Rep. David Camp, R-Mich., and President Barack Obama called for a lower corporate tax rate. When Camp released his discussion draft for a territorial tax system, he said a proposal for a 25% rate would follow.

According to an October 2011 press release from the Ways and Means Committee, Camp’s proposal would reduce the corporate tax rate to 25%, bringing it in line with the average of countries in the Organisation for Economic Co-operation and Development. The release also said the committee was examining base-broadening measures that would replace the revenue forgone by reducing the corporate tax rate.

In his State-of-the-Union address in January 2011, Obama stated:

    I’m asking Democrats and Republicans to simplify the system. Get rid of the loopholes. Level the playing field. And use the savings to lower the corporate tax rate for the first time in 25 years—without adding to our deficit. It can be done.

A Treasury report released in 2007 on international competitiveness and the tax system noted that other countries were lowering their corporate tax rate, leaving the United States with one of the highest rates in the world. The conclusion:

    The presence of numerous special provisions that narrow the corporate tax base forgoes the opportunity for a more efficient and pro-growth tax system. If special provisions were eliminated, the top corporate tax rate could be lowered to 27 percent or more than 40 percent expensing could be provided to all businesses for the cost of tangible investments, and the tax system would produce the same level of revenue. [Treasury, Background Paper for Treasury Conference on Business Taxation and Global Competitiveness, p. 11 (7/23/07).]

Obstacles

The sustained calls for a lower corporate tax rate are stymied by some significant obstacles, including:

  • Revenue-neutral approach: Today, when Obama and Camp call for a lower corporate tax rate, they add that it must be done in a revenue-neutral manner. Thus, they must find other changes to offset the revenue loss from lowering the tax rate. The answer is typically to broaden the base by eliminating or reducing deductions, exclusions, and credits. Needless to say, this is not easy to do because many taxpayers want to keep special provisions that benefit them, such as currently deductible advertising, the lower-of-cost-or-market (LCM) inventory valuation method, last-in first-out (LIFO) inventory expensing, and tax credits.
  • How low should the rate be and at the expense of what tax preferences?: Eliminating or reducing tax preferences will increase revenues, but by how much? What current rules should be eliminated or modified? Some of these changes, such as repeal of LCM, will not generate a lot of revenue. A report from the Joint Committee on Taxation in October 2011 suggested that repeal or modification of most tax preferences, including changing from the modified accelerated cost recovery system (MACRS) to the alternative depreciation system (ADS) for depreciation might permit a 28% rate. But, if the rate reduction is intended to increase our international competitiveness, does switching to less favorable depreciation rules make sense? Also, if a rate reduction is paid for with changes to timing provisions to recover costs, revenue neutrality is unlikely to be achieved for the long term because the increased revenues will be short term (see JCT letter of 10/27/11, and Nellen, “The Rough Road to a 28 Percent Corporate Tax Rate,” AICPA Corporate Taxation Insider (Nov. 10, 2011)).
  • Language of agitation rather than consensus building: Usually in the corporate tax rate reduction debate, we hear about the need to get rid of “loopholes.” Generally, a loophole is a provision not being used as intended. The tax preferences that would need to be cut back or eliminated for a rate reduction, though, are not loopholes; corporations are using them as intended. The word “loophole” is pejorative, implying that corporations are doing something wrong. The word can be an obstacle to bringing all interested parties together to find solutions.
  • Individual rates should be lowered also, maybe: Lowering the corporate tax rate while keeping a top rate of 39.6% for individuals would create a disparity between corporations and passthrough entities (including sole proprietors). Camp and others have called for the top individual rate to be 25% as well. Obama, though, does not advocate a lower individual tax rate and has instead endorsed further tax increases for high-income individuals, such as capping the tax benefit of their deductions and exclusions at 28% (see Treasury, General Explanations of the Administration’s Fiscal Year 2014 Revenue Proposals, pp. 134–135 (April 2013)). Those wanting to also lower the individual tax rates need to find additional revenue to achieve revenue neutrality. Lawmakers also need to agree on a goal and plan for individual rates.
  • Revenue neutral vs. revenue generator: Senate Majority Leader Harry Reid, D-Nev., wants tax reform to be a revenue generator rather than revenue neutral. Republicans disagree (see Boles, “Reid Warns Fellow Democrat on Tax Talks—Senate Majority Leader Calls for ‘Significant Revenue’ Increase in Any Overhaul,” Wall Street Journal (Aug. 1, 2013)).

Clearing a path

The need to lower the corporate tax rate for global competitiveness and bipartisan agreement that the rate should be lowered should be strong drivers for success. The revenue estimates for outright repeal of special rules (such as the Sec. 199 deduction for domestic production activities, LCM, LIFO, and credits) should be published, along with the cost of each percentage point reduction in the tax rate. The same should be done for individual tax preferences.

Principles of good tax policy should guide which tax preferences should be repealed or modified. For example, would repeal make the system simpler? More efficient? Consideration should also be given to whether any provisions should stay (or be modified) if they further goals of improved international competitiveness.

Transitional rules should be enacted that allow provisions to phase out rather than be repealed outright. With that in mind, the rate reduction can be phased in.

In terms of the number of dollars and taxpayers involved, lowering the individual income tax rate while broadening the base is the more challenging task. These changes will need to be preceded with a major educational effort. If people better understand the inefficiencies, complexities, and inequities in our current system, they may be more likely to favor a system with a lower rate and fewer special rules that have a significant cost and often benefit only a minority of people.

Looking forward

A second term president and a tax committee chairman who will no longer be in that powerful seat after the 113rd Congress are well-positioned for completing a major tax reform effort by the end of 2014 (see Nellen, “What Are the Signs That Tax Reform Will Occur During This Congress?” Tax Insider (July 11, 2013), for details.) They must clear the path now and work together to reach their mutual goal of lowered corporate tax rates.

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Annette Nellen, Esq., CPA, is a tax professor and director of the MST Program at San José State University. She is an active member of the tax sections of the AICPA, ABA, and California State Bar. She is a member of the AICPA Tax Executive Committee and Tax Reform Task Force. She has several reports on tax policy and reform and a blog.