Commentary Robert Litan
With the fiscal cliff behind them, and notwithstanding the brief Inauguration flurry optimism, Hill-watchers are now obsessed with the extended but still looming debt ceiling, the renewed threat of sequestration, and an end-of-March potential government shutdown. The case for pessimism is strong.
A new study by Bloomberg Government senior tax analyst Patrick Driessen, though, offers a hint of optimism. While individual tax reform may be dead after the seeming finality of the fiscal cliff budget (aka tax) deal, there is at least a 50 percent chance that the country will get a corporate tax overhaul instead.
That’s because the policymakers charged with fixing the country’s revenue problems could find common ground in three critical areas:
- Both parties want to bring down the 35 percent corporate tax rate (one of the highest in the developed world) while “broadening the base” (reducing or eliminating various tax preferences, such as rapid depreciation deductions and various tax credits)
- The fiscal cliff deal reduced the amount of revenue needed for meaningful deficit reduction, making it politically easier to achieve at least a revenue-neutral corporate tax change
- Most importantly, the tax changes in the fiscal cliff package created a “rate inversion,” where the highest marginal individual tax rate exceeds the corporate rate of 35 percent (since although the top statutory personal rate is 39.6 percent, the effective rate exceeds 40 percent for taxpayers affected by the phase-out of exemptions and limits on deductions). This disparity between individual and business tax rates not only affects the choice of entity form by new businesses, but introduces a new degree of inequity in the tax code. Also, relative to current policy, the deficit deal made double taxation of corporate income even worse by raising tax rates on individual earnings, capital gains and dividends. These issues beckon legislative action.
While corporate rate reduction by itself would lessen double taxation, it would widen the rate inversion. This paradox could be solved by augmenting noncorporate tax subsidies, or using a new source, such as a carbon tax, to lower individual tax rates at the same time that the corporate tax is reduced.
Even so, getting to “yes” on some kind of business tax overhaul package still will be difficult. In earlier work with his Bloomberg Government colleagues, Driessen calculates that $125 billion over ten years in additional revenue from base broadening is required for every one percentage point reduction in the corporate rate. Moreover, most of the most expensive tax breaks are designed to assist manufacturing, from which elected officials will be reluctant to withdraw support.
We will have to wait and see whether the political momentum in support of corporate overhaul will overhaul these obstacles. At least in this arena, there is some bipartisan support for the broad framework for overhaul, which is more than can be said for the rest of the tax code or the budget. It is a measure of the political climate in Washington these days that this is what counts for optimism.
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