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Obama's Tax Plan Gets Problems Right, Solution Wrong

by Brandon Greife / /

President Obama’s recently released “framework” for corporate tax reform is a hard document to pin down. On the one hand, it does an excellent job at describing the problems with the current system and laying out the case for broad-based reform. On the other, the solutions it offers would oftentimes only exacerbate the underlying problems. It’s as if President Obama and his team are excellent diagnosticians, but terrible surgeons. Their plan for tax reform is akin to properly diagnosing appendicitis and then deciding to remove your liver.

One of the primary problems, among the several we listed yesterday, is the creation of a minimum foreign tax on multinational companies. Rather than bring businesses, and therefore revenue, to our shores, this policy would only make us less competitive in the global economy.

Obama begins by saying the right things.

“The United States now essentially trades off greater tax expenditures, loopholes, and tax planning for a higher statutory corporate tax rate relative to other countries. This is a poor trade that produces a tax system that is uncompetitive relative to other countries, distorts business decision making, and slow economic growth.

In recent years, our major trading partners have overhauled their tax codes, lowered their statutory corporate tax rates, and in some cases broadened their tax bases. The United States has not enacted similar reforms, leaving the United States with the second highest statutory tax rate among advanced countries. In April 2012, after the scheduled reductions in Japanese tax rates go into effect, the United States will have the highest statutory corporate income tax rate in the Organization for Economic Cooperation and Economic Development (OECD).”

A nearly perfect diagnosis for the tax sickness that ails America. Moreover, it practically telegraphs what the administration should do to ameliorate those problems: close loopholes and follow the OECD trend towards lower rates and territoriality.

And then they begin the surgery…

On the issue of closing loopholes the framework does more harm than good. According to research conducted by the Tax Foundation the proposal would close six loopholes, out of around 250, while adding 11 – for a net loophole gain of 6. Not exactly progress on the road to simplifying the Tax Code.

The plan does succeed at lowering the corporate rate from 35 to 28 percent. Certainly progress, but not exactly a cure given the diagnosis of “a tax system that is uncompetitive relative to other countries,” especially since other nations continue to make progress in lowering their tax burdens. Even with the 7 percent rate cut that Obama envisions, the U.S. combined rate (federal and state taxation included) would still be 32.6 percent. That would move us from the having the highest corporate tax rate to the fourth highest among the OECD.

Perhaps worst of all, especially for international competitiveness, is the idea to create a “minimum foreign tax” that would raise the tax penalty on overseas profits.

Our current tax system is certainly broken. The high corporate rate coupled with a worldwide system penalizes American companies with burdensome rates. To ameliorate this problem our Tax Code allows firms to defer paying taxes on foreign profits until those profits are “repatriated” to our shores. Since our taxes are so high businesses are incentivized to park their cash elsewhere, leading to less investment and fewer jobs in the United States.

Rather than opt for the carrot of introducing truly competitive rates, Obama’s plan would use the stick of a new minimum foreign tax on business earnings abroad. But the result, especially when judged on the “fairness” rubric, isn’t the cure America needs. Essentially, this would mean that U.S.-based companies doing business abroad would face a tax hike, while foreign-based companies doing business in the U.S would see their tax rate cut. Rather than attract new companies and investment to our shore this would only incentivize them to set up shop in a more tax friendly locale.

So over all a good diagnosis of the problem. But let’s make sure to get a second opinion before anyone breaks out a scalpel.