Max Baucus' self-defeating tax plan

Reuters

US Senate Finance Committee Chairman Max Baucus questions Health and Human Services Secretary Kathleen Sebelius during a Finance Committee hearing on "Health Insurance Exchanges: An Update from the Administration" on Capitol Hill in Washington November 6, 2013.

Article Highlights

  • Baucus’s misplaced priorities have resulted in an unnecessarily complicated and self-defeating plan.

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  • There’s bipartisan support for lowering the 35% fed corporate tax rate, which is extremely high.

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  • The details of Baucus’s plan involve adding complexity to the tax code.

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Senator Max Baucus, a Democrat from Montana and the chairman of the Senate Finance Committee, wants to cut corporate tax rates. But he’s finding that corporations are lining up to criticize his proposal.

As it happens, they’re right to: Baucus’s misplaced priorities have resulted in an unnecessarily complicated and self-defeating plan.

There’s bipartisan support for lowering the 35 percent federal corporate tax rate, which is among the highest in the developed world. Both parties see the rate as a burden for the economy because it pushes investors -- American and foreign -- to seek their returns in other countries. Economists argue that the tax therefore depresses wage growth in the U.S., a claim supported by numerous studies.

Yet business lobbyists are still complaining, for several reasons. The details of Baucus’s plan involve adding complexity to the tax code. It’s vague about where the rate would end up, aiming to get it somewhere below 30 percent. And it doesn’t make the clean shift that some activist groups (and economists) favor away from “worldwide” and toward “territorial” taxation.

The U.S., unlike most countries, taxes multinational companies based here on all their income as soon as it enters the country, regardless of where it was made. Most countries tax these companies on the income they make inside their territory. The Baucus plan generally moves away from territorial taxation, imposing significant levies on income before it even enters the country.

Main Defect

These features are not, however, the plan’s main defect. To pay for the reduction in the tax rate, the Baucus plan slows the rate at which companies can write off the cost of investment. This trade-off may have been made merely to get the numbers to work, but its effect is to favor past investments over future ones.

Consider a company that is still seeing payoffs from an investment it made and wrote off years ago. It enjoyed a relatively speedy depreciation schedule and will now face lower taxes on its returns: a clear-cut tax reduction. Companies that made investments pretty recently and are still in the process of deducting the expenses will be grandfathered in and the cost of those investments will be written off on the old schedule. So they, too, will get a clear-cut tax reduction.

A company that makes investments under the new rules, on the other hand, will have a lower rate on its future profits but will also get slower write-offs on its investments. Because the reform is designed to be revenue-neutral, the lower taxes on old capital will have to be balanced by higher taxes on new capital. That means the reform will favor older and established companies over startups. So the startups will have a higher total tax burden than they would have had without the reform.

This feature of the plan vitiates much of the purpose of the reduction in the corporate tax rate. Today’s high corporate rate harms the economy by inhibiting investment. To reduce the rate in a way that raises taxes on new investment is self-defeating.

That’s another way of saying that reducing the corporate tax rate shouldn’t be the most important objective of reform. Baucus isn’t the only one to overemphasize that goal. Republicans have tried to differentiate themselves from Democrats on tax reform chiefly by driving the corporate rate even lower. But if what you want is a corporate tax code that applies a lower rate than the current one but raises the same revenue, increasing taxes on new corporate investment becomes hard to avoid.

Better Approach

A better approach would be to scrap this whole way of thinking about corporate taxes and start over. The goal should be better treatment of business investment, which the current code treats much worse than consumption. Representative Devin Nunes, a California Republican, has a proposal that would treat business investment much better and sustain revenue by ending the tax break for corporate debt. Nunes also wants the corporate rate to decline, but his idea would be a step in the right direction even if it did not.

Businesses that rely heavily on debt would oppose anything resembling this idea, of course. That’s fine. The goal of reform shouldn’t be to make any group of businesses happy but to create a more rational tax code and a stronger economy. Like the Baucus plan, a pro-investment, anti-debt reform would produce winners and losers in the business world. At least in this case, though, they would be the right winners and losers.

(Ramesh Ponnuru is a Bloomberg View columnist, a visiting fellow at the American Enterprise Institute and a senior editor at National Review.)

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