Small Business, Killer of Corporate-Tax Reform: Ramesh Ponnuru

Feb. 28 (Bloomberg) -- Like the Republicans, President Barack Obama recognizes that our high corporate-tax rate puts U.S. companies at a disadvantage to their foreign competitors.

The result is less investment and lower wages in our country. You might think, then, that the administration’s announcement last week of a “framework for business tax reform” created a rare opportunity for a bipartisan improvement to our policies. You would be wrong.

There’s no congressional agreement in sight. It’s not just election-year politics blocking an agreement, and it’s not even Republican objections to some of the president’s proposals. What’s emerging as the biggest obstacle to a deal is the opposition of Republicans’ small-business supporters to a corporate-tax reform that ignores the rest of the tax code.

Republicans on Capitol Hill -- and business lobbies such as the Chamber of Commerce and the Business Roundtable -- raise three objections to Obama’s proposal. First, they think he should lower the corporate-tax rate more. Going to 28 percent from 35 percent is a good start, but would leave the U.S. rate above the average for the developed world. (We have too few details to know the proposal’s impact on the effective tax rates companies pay on investments after deductions.)

Second, many of them object to Obama’s proposals for special tax breaks for manufacturers as unfair and distortionary: a step backward from the proper goals of reform.

Third, they disagree with how the administration wants to treat multinational companies based in America. Obama wants to subject their foreign earnings to some unspecified minimum tax as a way of encouraging them to invest here. Republicans think the main effect of this tax will be to help multinationals based in other countries out-compete our companies in foreign markets. They want to follow the practice of almost every other country in the world and impose no tax on foreign earnings.

A Bigger Problem

Perhaps these differences could be resolved. The bigger problem concerns the majority of American businesses (the small businesses organized as S corporations, partnerships and sole proprietorships) that pay the individual income tax rather than the corporate tax. They wouldn’t benefit from the reduction of the corporate rate.

Some of these businesses pay the top individual-tax rate, which is scheduled to increase to 39.6 percent with the president’s blessing. Brian Reardon, the executive director of the S Corporation Association, points out that the president also favors raising taxes on dividends. Put these policies together, he says, “and it’s likely the overall impact of the Administration’s proposal will be to raise the cost of new business investment compared to the cost today.”

Many Republicans believe that it would be unfair to make some businesses pay 39.6 percent while others, filing under the corporate-income tax, paid 28 percent or less. The fairness argument is complicated, though, because filing under the individual-income tax generally reduces taxes on investment.

That’s a major reason why so many businesses do it, and why Congress has encouraged them to do it for decades. Take account of that, and the effective tax rate on corporate investment might end up being higher, even under Obama’s proposal, than the effective rate on other business investment.

But the effective rate may not matter as much politically as the statutory one. One well-connected lobbyist for a trade association that represents both small and big businesses says that a lower rate for the latter would look too bad for Republicans to support. She adds that her group’s small-business members would never stand for a reform that ignores all of their concerns with the tax code. If she tried to sell the idea to them, she says, they would probably fire her on the spot.

Little Optimism

Senator Rob Portman of Ohio, the Senate Republicans’ point man on jobs, wants to move ahead with corporate-tax reform. But he is one of the few Republicans on Capitol Hill who is optimistic about it. Most of them agree with Representative Dave Camp of Michigan, the chairman of the House Ways and Means Committee, who believes that corporate taxes should be addressed as part of a larger tax reform that brings rates for individuals down, too.

But agreement on a comprehensive tax reform seems even more elusive than an agreement on corporate tax. Democrats and Republicans at least agree that it is important to bring the corporate-tax rate down. They have no such common ground on individual-income taxes. Camp understands such concerns but still thinks comprehensive reform is what’s needed.

“Nothing’s easy to get done in Congress, so you may as well be bold,” he told me.

And it’s not as though congressional Democrats are enthusiastic about corporate-tax reform to begin with. Representative Sander Levin of Michigan, the ranking Democrat on the House Ways and Means Committee, greeted the president’s framework with a statement that was both terse and devoid of praise for the idea of a lower corporate rate.

So reforming taxes on corporations is likely to remain one of those topics that a lot of people talk about, but nobody does anything about.

(Ramesh Ponnuru is a Bloomberg View columnist and a senior editor at National Review. The opinions expressed are his own.)

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