Although it can be a dangerous undertaking to predict what Congress will do, there is little debate that the United States is in serious need of comprehensive corporate tax reform. And it may be on the horizon.
1. The tax code is incredibly complex.This comes as no surprise, since complexity is not limited to the corporate side of things. Large companies, like Microsoft, reportedly avoid $2.4 billion in taxes annually through the uses of “ultra-complicated tax measures.”There are at least four good reasons for the need for tax reform for manufacturers.
Other companies, like the Bank of America, FedEx and General Electric, show profits in the millions of dollars but pay no tax. Small and medium companies pay a higher percentage of income in taxes, partially because they cannot employ in-house tax experts to help them navigate the uncharted tax waters. All the effort expended in avoiding taxes could be focused on more productive activities.
2. The United States operates under a worldwide tax system. Most of the world uses a territorial system. Under a worldwide system, United States companies are subject to tax on their worldwide income, regardless of source.
If the profits are earned outside the United States through a subsidiary, the company may avoid taxation if the funds remain outside the United States. Consequently, there are untold trillions of dollars that have not been repatriated.
3. The United States corporate tax rate is the highest statutory rate in the world as well as among the highest effective rates.
4. The compliance rate suffers with such high rates and complex laws, and there is a significant gap between taxes actually owed and taxes paid.
Significant reform should address these issues. What would reform look like?
Many feel that any tax reform should be revenue neutral, which really does not address the problem. Revenue neutrality simply means the federal government is collecting the same amount of taxes. In 2010, the National Commission on Fiscal Responsibility and Reform suggested reducing the corporate tax rate to a flat 28 percent.
However, the commission also would eliminate all deductions for business expenditures and most tax credits. The commission also recommended adoption of a territorial tax system.
In 2014, Sen. Ron Wyden proposed a tax reform bill that would reduce the corporate rate to a flat 24 percent. This plan would also lengthen depreciation schedules for fixed assets, repeal the domestic production deductions, and repeal the research and development credit, among other changes.
Most significantly, it would eliminate the “deferral” of taxes on income that is earned outside the United States and is not repatriated. It is estimated that this would cost U. S. multinational corporations $600 billion in additional taxes. Hardly significant tax relief.
These two proposals make it painfully clear that Washington is not looking at taking actions to reduce the corporate tax burden but merely making cosmetic changes that would allow them to reduce the statutory rates without a significant impact on the effective rate.
So what needs to happen in terms of corporate tax reform? Some suggest that it would be an economic boost if the corporate tax were eliminated altogether. This would, according to its supporters, have numerous beneficial effects in addition to the economic boost through increased profits. It is also seen as drawing international investment to the United States. Realistically, elimination probably will not occur.
It has been suggested that we should move to a simple business tax system that would apply to all businesses. This system would have a lower marginal rate and no special industry preferences, and investments such as fixed assets would be expensed.
In addition, it would be a territorial tax system, so profits earned in other countries would not be subject to U. S. taxation. This is seen as encouraging growth and investment along with more jobs and higher wages for U. S. workers.
Andrew Lundeen, director of federal projects for the Tax Foundation, suggests that a cut in the corporate tax rate would have significant effects on GDP and minimal effects on federal revenues in the long run. The lower rate would spur a lower cost of capital and increased investment.
Obviously, there is a huge gap in the views of what should happen in terms of corporate tax reform. Some “reform” proposals are not much more than a shell game, shifting things around, benefiting some and harming others. Other plans promise some measure of reform.
Two components are necessary to have significant reform. The worldwide system must be abandoned in favor of a territorial system, and the effective rates must be decreased. Unless the corporate tax is significantly reduced, any changes are merely a shell game. – John Stancil, CPA