The House GOP’s Idea for Business Taxes Could Win Bipartisan Support
The number of tweets that President-elect Donald Trump strings together on a topic seems to indicate its importance to him. His tirade on Dec. 4 against companies that move jobs overseas was an impressive six-tweeter. “There will be a tax on our soon to be strong border of 35% for these companies ...... wanting to sell their product, cars, A.C. units etc., back across the border,” he wrote in the weekend tweetstorm.
Trump is right that the U.S. is losing jobs overseas, and he’s right that the broken U.S. tax code is part of the problem. But even the people who should be his closest allies—top Republicans in Congress—couldn’t stomach his solution of punitive tariffs on imports from selected companies. “I think there’s other ways to achieve what the president-elect is talking about,” House Majority Leader Kevin McCarthy (R-Calif.) told reporters the next day. “I don’t want to get into some type of trade war.” Another House Republican, Justin Amash of Michigan, issued his own tweet: “This would be a 35% tax on all Americans—a tax that especially hurts low-income families. Maybe the slogan should be #MakeAmericaVenezuela.”
There’s a better way for a Republican president, and it happens to be called A Better Way. It’s the House Republicans’ agenda, encapsulated in red-white-and-blue handouts that Speaker Paul Ryan (Wis.) brandishes whenever he gets near a microphone. The provisions on business taxation in A Better Way would go a long way toward promoting investment and jobs in the U.S.—by getting the basic incentives right rather than through Trumpian threats and cajolements. And guess what? The core idea in the GOP plan—something called a destination-based cash-flow tax—is bipartisan. A version was promoted in 2010 by a Democratic think tank, the Center for American Progress.
The clean little secret about tax policy is that it’s not inherently political. Republicans and Democrats do disagree about how much revenue the tax code should raise, but that’s really a difference of opinion over how big government should be. They also have different ideas about soaking the rich. But there’s a surprising amount of agreement on the technical issue of how to raise any given sum of money while minimizing distortions of incentives to work and invest. Think of taxation as the engine of government; there’s not a Democratic or a Republican way to fix a car with cracked pistons.
“The current system has flaws that don’t make sense under any perspective,” says Alan Viard, a resident scholar at the conservative-leaning American Enterprise Institute. A basic rule of taxation is that a low tax rate on a broad base of income is less distorting—i.e., more efficient—than a high tax rate on a small base. The U.S. breaks that rule. It has one of the world’s highest corporate income tax rates, 35 percent, but it raises less money from it as a share of gross domestic product than the average of the 35 mostly rich countries in the Organization for Economic Cooperation and Development. U.S. businesses have found ways to avoid taxes by shifting operations or headquarters abroad or by organizing into entities that aren’t subject to the corporate levy.
The U.S. is also one of the few countries that attempt to tax domestic companies on their worldwide profits. It taxes profits made overseas only when they’re brought home, which induces companies to keep more than $2 trillion stashed abroad. The House GOP plan doesn’t just cut the rate on the corporate income tax—which would leave the flawed structure in place—it repeals it outright. Companies would be allowed to deduct the full cost of new equipment, software, or structures in the year they were purchased, rather than bit by bit as they depreciate. Because it taxes based on receipts and outlays as they occur, economists term it a cash-flow tax. The Better Way plan ends preferential tax treatment for interest payments, an old but unwise policy that induces companies to take on debt. And it brings the U.S. in line with the rest of the world by applying the tax territorially. Imports are taxed; exports aren’t. That’s fair to trading partners: Imports face about the same tax treatment as domestic products. And while exports aren’t taxed by the U.S., they can be—and probably are—taxed by the receiving country. (One snag: While economists judge the tax to be equitable, lawyers at the World Trade Organization may feel differently.)
A hidden beauty of the Better Way approach is that the U.S. would keep more jobs at home without racing to the bottom of corporate tax rates (chart). The tax would be immune to most strategies that minimize U.S. earnings, such as assigning patents to subsidiaries in low-tax jurisdictions.
In fact, the unavoidability of the new tax raises the question of why the House is setting its target rate for it at just 20 percent, thus losing revenue that could go toward shrinking budget deficits. “Because you eliminate all those disincentives you can afford a higher rate,” says the American Enterprise Institute’s Viard. “The 20 percent is really very low.”
Business groups are enthusiastic that corporate tax reform finally has a shot at happening now that a single party controls the White House and Congress. “It may have been viewed as a dead horse, but that horse is alive and well and ready to run,” Business Roundtable President John Engler told reporters on Dec. 6.
Trump hasn’t fully bought into the House plan. He once wrote in a Wall Street Journal op-ed that President Reagan’s 1986 tax reform act, a touchstone for today’s conservatives, was “one of the worst ideas in recent history.” That’s because it got rid of real estate tax shelters he benefited from. Trump hasn’t embraced the House idea of banning the deductibility of interest payments—no surprise for someone who has called himself the king of debt.
Then again, Trump may let Congress take the lead on tax reform. His own plan for business taxes has gone through changes and currently consists—publicly, at least—of just six brief paragraphs on the campaign website. In a sign of the looseness of Trump’s approach, Secretary of the Treasury designate Steven Mnuchin has told reporters that in the individual tax plan “there will be no absolute tax cut for the upper class”—even though the plan Trump announced definitely would cut taxes on the rich.
Goldman Sachs economists predicted in a Dec. 3 research note that the corporate tax rate will fall to 25 percent, rather than the House’s 20 percent or Trump’s 15 percent. Congress will allow full first-year expensing of capital spending, but it will only partially repeal deductibility of interest, they say. And it probably won’t shift to a destination-based system that taxes imports and exempts exports, they write, partly because it’s “a novel concept that … may make many lawmakers nervous about unintended consequences.” Sure enough, Representative Charles Boustany, a Louisiana Republican, told Bloomberg BNA that small businesses that depend on imports “are at risk, and we have to understand the implications.”
The U.S. business tax system is so broken that even partial reform would be welcome. But it won’t come easy. Each choice in the tax code involves trade-offs and changes the calculus of winners and losers. Responsible presidential involvement will be vital. This isn’t a topic that lends itself to tweetstorms.
—With Sahil Kapur and Kaustuv Basu