Blue Skies for Business Tax Reform? Part I: An Overview

April 19, 2016 10:30 AM

The year 2017 could be auspicious for badly needed reforms in US taxation of business income. Four forces underpin a blue skies forecast:

  • Foremost, House Speaker Paul Ryan is a fervent advocate of reform, he knows the tax code better than almost any other legislator, and Republicans will likely retain control of the House of Representatives in the November 2016 elections.
  • Democrats as well as Republicans widely recognize that the high US statutory corporate tax rate, at 35 percent, puts US companies at a disadvantage relative to peers located abroad.
  • Moreover, the US system of worldwide taxation imposes the same 35 percent rate on the repatriated earnings of foreign subsidiaries of US-based multinational corporations (MNCs). This encourages US MNCs both to retain earnings overseas and to "invert" (incorporate the parent abroad).  
  • Since the Great Recession, US investment in productive assets has limped along at 15 percent of GDP annually,1 one reason why labor productivity growth has averaged around a meager 1 percent for the past decade.

The political challenge is to enact a tax package that combines growth with fairness. The popularity of Donald Trump and Bernie Sanders owes much to widespread belief that the US economic system is "rigged." One element of the "rigging" allegation is a complaint that the top 1 percent gets too big a slice of the economic pie (a slice of about 20 percent). If business tax reform is seen as further enriching the top 1 percent, it will be stridently opposed by a large swath of the American public and many members of Congress.

Business Tax Plans of the Presidential Candidates

The leading Republican candidates (Trump and Ted Cruz) would lower the tax rate applied to corporate income. So would third place John Kasich. The Democratic candidates (Hillary Clinton and Sanders) have made no specific proposals but may prefer to leave the corporate rate at current levels.

More specifically, Clinton's tax proposals center on higher rates on capital gains and upper-bracket households. For example, personal income over $5 million would be taxed at 43.6 percent, up from the current 39.6 percent, and "medium term" capital gains (holdings less than 6 years) would be taxed at rates between 24 and 39.6 percent, up from the current top rate of 20 percent. Sanders' plan has a sharper edge: His top rate reaches 52 percent for income over $10 million and eliminates the capital gains preference for those reporting above $250,000.

By contrast, Trump has called for a 15 percent corporate tax rate, accompanied by unspecified tax penalties on firms that "offshore jobs," plus top marginal rates of 25 percent on ordinary personal income and 20 percent on capital gains. Cruz would replace the corporate income tax with a 16 percent business transfer tax applied to all business value added (profits, interest, and wages), accompanied by a 10 percent flat tax rate on both ordinary personal income and capital gains. Kasich offers the most practical plan: a 25 percent corporate rate, a 28 percent top marginal rate on ordinary personal income, and 15 percent rate on capital gains. In addition, Kasich would establish a separate "low tax rate" to bring foreign profits back to the United States.

Assuming Clinton is elected, but that Republicans keep control of the House if not the Senate, a tax reform bargain might couple somewhat higher rates on upper-bracket households with a reduced burden on corporate income. The election of Sanders would rule out any tax bargain unless the Democrats also captured the House and Senate by exceptionally large margins. On the other hand, the election of Trump or Cruz would seemingly pave the way for a sharp reduction in both business and personal taxes, while the election of Kasich would favor a corporate rate near 25 percent and somewhat lower personal rates on upper-bracket taxpayers.

These scenarios suggest that presidential and congressional odds favor modest business tax reform in 2017. Modest reform, assuming Clinton or Kasich is elected, could combine three features: a lower corporate tax rate; a tax repatriation holiday; and a larger role for "pass-through" taxation. In companion blogs, we discuss each of these elements.

Note

1. This figure includes intellectual property assets as well as nonresidential structures and equipment.