CQ TODAY ONLINE NEWS
Nov. 2, 2011 – 11:07 p.m.
Corporate-Only Tax Rewrite Has Its Defenders
By Sam Goldfarb, CQ Staff
It may be heresy for many lawmakers, but some tax experts say that Congress could easily overhaul the corporate tax system on its own, without rewriting the entire code.
Although this conclusion may seem uncontroversial, it is at odds with a widespread view among lawmakers that reducing the corporate tax rate and eliminating tax breaks for companies is feasible only if Congress undertakes a similar exercise for individual taxpayers.
The big problem, Republicans and Democrats say, is that a majority of American companies do not pay the corporate tax at all but instead have their profits assigned to their individual owners for tax purposes. Such “pass through” companies — including sole proprietorships, partnerships and what are known as S corporations — would not benefit from a reduction in the corporate tax rate and might actually face a higher tax levy if Congress closed tax breaks that apply to all companies.
At a time when the Joint Select Committee on Deficit Reduction is considering whether to call for a rewrite of the tax code to raise revenue and increase economic growth, this potential conflict is an important, if often overlooked, issue.
Wary of making changes only for corporations, lawmakers also know that a more ambitious tax overhaul — one that reduces rates for high-income households and restructures popular tax breaks, such as the deduction for mortgage interest payments — might prove even more challenging and controversial.
Rep.
Though eager to be fair to all businesses, Hensarling may be among those willing to listen to people who dispute the assertion that a corporate-only overhaul would wreak havoc on small, closely held companies.
Contrary to common assumptions, the challenge of rewriting the corporate tax system on its own is “political more than technical,” said John Buckley, a visiting professor at Georgetown University’s law school and a former Democratic aide on the Ways and Means Committee. Buckley and others argue that a corporate tax overhaul would be the most direct response to tax changes that other developed economies have embraced during the past decade.
Much to the chagrin of Republicans and Democrats alike, only Japan now taxes corporations at a higher rate than the United States, where the top rate is 35 percent, or an average of 39.2 percent if state taxes are counted.
Companies are able to use special credits and deductions to push their effective tax rates below 35 percent. Still, a high statutory rate can lead companies to invest more of their profits overseas, according to several studies, including a 2005 report by the Congressional Budget Office.
Offset Options
Advocates of a corporate tax overhaul offer a wide-ranging defense of their proposals.
Buckley, for one, says a reduction in the corporate tax rate could be paid for by eliminating business tax breaks that are seldom claimed by the individual owners of small companies. Of the money that the government loses by offering tax breaks for company research and development expenditures, for example, about 98 percent goes to corporations. The remaining 2 percent is claimed by individuals with business income, according to statistics kept by the Joint Committee on Taxation (JCT).
Corporate-Only Tax Rewrite Has Its Defenders
Another option to pay for a lower corporate tax rate would be to raise taxes on capital gains and dividends. And although that would prompt immediate objections from congressional Republicans, it would align with international trends.
In recent years, the United States has gone in the opposite direction from other countries, maintaining a high corporate tax rate while reducing the tax on dividends from a maximum of 39.6 percent to 15 percent.
Many economists view taxes on dividends — and to a lesser extent, taxes on capital gains — as essentially a second tax on business income.
And while taxing individual investors is generally frowned upon on Capitol Hill, foreign governments have started to tax a greater percentage of business income on the individual level “under the theory that corporations are more mobile than individuals,” said Reuven Avi-Yonah, a specialist in international tax law at the University of Michigan.
Apart from the United States, the 34 member nations of the Organization for Economic Development and Cooperation (OECD) collect an average of 36.7 percent of their corporate tax receipts by taxing dividends. The ratio for the United States is 24.8 percent, according to OECD figures.
Eliminating a few sizable corporate tax breaks might allow Congress to reduce the corporate tax rate to about 30 percent without adding to the deficit, but “if you want to go below that, I think you need to increase the dividends and capital gains rate,” Avi-Yonah said.
In line with Avi-Yonah’s thesis, a JCT report issued Wednesday suggests that eliminating all corporate tax breaks would pay for reducing the top corporate rate to 28 percent — but no lower. House Republicans, including Ways and Means Chairman
One final defense of a corporate-only tax overhaul, sometimes made by corporations themselves, is that partnerships and S corporations can always give up their pass-through tax status and pay the corporate tax instead, if they have an incentive to do so.
“Simplifying the rates, simplifying the code — it may mean that some of the smaller companies choose to form themselves as a corporation, a small corporation, but a corporation nonetheless,” said Judy Brown, the chief financial officer of Perrigo Co., a publicly traded pharmaceutical manufacturer, at a Ways and Means hearing on June 2.
Evening Playing Field
Should such a switch occur, that would be yet another development bringing the United States more in line with other countries, where “the definition of what is a taxable corporation is much broader,” Avi-Yonah said.
Signs are mixed that Congress might embrace a limited but still ambitious tax overhaul. Echoing Hensarling’s sentiments, House Budget Chairman
But other lawmakers, including Camp, remain wedded, at least publicly, to a more comprehensive effort. And the forces that have been pushing them in that direction have not given up the fight.
Corporate-Only Tax Rewrite Has Its Defenders
Most closely held companies “would not see any benefits from corporate-only reform,” said Brian Reardon, executive director of the S Corp Association, a lobbying group. “In fact, they’d likely get punished.”