Introduction
Ahead of the next presidential primary debate this week, it is encouraging to observe that the entire field – both Republican and Democratic candidates – agrees that America’s tax structure is outdated, unfairly applied, and in need of reform. Unfortunately, consensus ends there, and all too many responses have been offered in campaign-rally settings that confuse punitive taxation with pro-growth reforms.
To give one of many examples, candidates and elected officials on both sides of the aisle often employ rhetoric calling for higher taxes on American energy companies. Parallels can be found in the areas of finance, transportation, manufacturing, and retail. Through it all, they often mischaracterize tax deductions or cost recovery measures as subsidies or handouts. Neither is accurate.
Recently, leading Senate Democrats released their comprehensive energy plan. Among its provisions is one that would strip from existing tax law key areas of relief, like deductions on outlays for drilling and extraction. Removing these legitimate write-offs would only penalize one of the most robust engines of growth for America’s economy. Such a scheme would also undermine the basic approach that is necessary for systemic tax reform: broaden the base and lower rates across the board.
At the upcoming debates, candidates should unite around one simple principle: treat all sectors of the economy equally and stop using tax policy to pick winners and losers. Guiding that principle should be three policy prescriptions:
1. The U.S. Tax Code Must be Simplified.
The U.S. Tax code is an unwieldy, burdensome mess that is desperate for reform. In the 102 years since the 16th Amendment to the U.S. Constitution – giving power to Congress to, “lay and collect tax on incomes” – was ratified, the annual process has come to evoke shockingly high expenses. In fact, we annually quantify the details:
Compliance with the federal income tax cost the U.S. economy $233.8 billion in productivity by our most recent annual calculation. That includes out-of-pocket expenses of $31.72 billion for software and tax-preparation assistance, as well as 6.1 billion hours of total labor time (an estimated $202.09 billion in labor).
The U.S. Tax Code comprises roughly 4 million words … more than seven times the length of Leo Tolstoy’s War and Peace, and more than two times the length of the King James Bible, plus the entire works of Shakespeare combined.
80 years ago, the Form 1040 instructions were just two pages long. Today, taxpayers must wade through 209 pages of instructions -- quadruple the number in 1985 -- the year before taxes were “simplified.”
2. U.S. Tax Reform Must be Industry-Neutral and Applied Uniformly.
The federal government should not be picking winners and losers in the marketplace. Unfortunately, Washington can choose (and sometimes has chosen) to wield the Tax Code as a business-crushing cudgel, ignoring economic history as well as the hopes of the electorate for a more prosperous future. All sectors of the economy should be treated as equally as possible, and not be subject to punitive taxation, or discriminatory accounting rules such as repeal of the “last in, first out” (LIFO) method, at the hands of their own government.
U.S. energy producers are a frequent target of tax reform rhetoric. Pledges to raise their taxes are always predicated on the assertion that they are failing to pay their “fair share” of the tax burden. In reality, traditional energy producers pay their share – and a great deal more.
Consider the facts:
In 2011, the reported tax burdens of the five major oil and gas companies added up to $95 billion for the year, or $261 million per day.
In 2012, the most recent year for which data are available, ExxonMobil, Chevron, and ConocoPhillips collectively paid $59 billion for an average effective tax rate of 44.7 percent for their taxes throughout the world.
Among the individual American companies paying the most in income taxes, “oil companies make up three of the top ten,” including the top two.
While the average overall effective tax rate for companies on the S&P was 29.1 percent, energy firms shouldered an even higher burden of 37 percent.
And yet, Senate Democrats, driven by political convenience, wish to penalize this sector with even higher taxes. Their plan would strip the Section 199 domestic manufacturing deduction solely from the oil and gas sector, while leaving it in place for other industries, even though virtually every company in the Dow Jones Industrial Average qualifies for this tax deduction.
3. U.S. Tax Policy Must Encourage American Competitiveness and Avoid Misusing Terms for Political Aims.
Against the backdrop of the pending Pfizer/Allergan merger to create the world’s largest pharmaceutical company, corporate inversions – where an American company lowers its U.S. tax burden by assuming an international corporate address – are a focus of recent news. But America would be better served if attention shifted instead to the cause – captured recently by House Speaker Paul Ryan when he said the U.S. is “nearly alone in the world in the way we punish foreign earnings” – and away from the symptoms.
Traditional American energy producers, in particular, operate on a global playing field, competing against foreign companies that are heavily supported or even directly owned by their governments. China, Russia, and Saudi Arabia are prime examples. Whereas these countries’ energy companies receive massive subsidies from their governments on account of being state-owned, American energy producers do not receive such giveaways. Rather, American energy companies take tax write-offs that are either the same or equivalent to provisions available to other types of U.S. firms.
The difference between subsidies and deductions is critical to fixing tax policy. A subsidy is a direct payment from the government to a corporation with the goal of boosting its prospects. A deduction enables a business to write off its legitimate expenses and calculate its tax liability based on net income. It is incorrect to lump in U.S. companies with countries like China when making the whole “subsidy” argument, and irresponsible to strip away Tax Code provisions selectively without reducing rates in a fair manner.
Equally important, other countries are lowering their tax burdens and attracting business and capital. As other nations move forward on corporate-tax reform by dropping their rates from an average of 45.4 percent to 29.6 percent, the U.S. stands still and thus falls behind.
Further handicapping American companies by inaccurately claiming they receive subsidies, repealing tax protections, and failing to lower corporate tax rates could drastically undermine America's ability to compete internationally.
Conclusion
It is time for America’s leaders to offer specifics about comprehensive tax reform. America’s political arena is characterized by fiery rhetoric, not all of which can be taken at face value. Still, ultimately both Democrats and Republicans should be held accountable for their words. Just as important, they should recognize that tax policies that punish one industry and artificially prop up others would only harm the entire country.
America’s elected officials – and those presidential candidates who aspire to lead us – must commit to a comprehensive tax reform whose guiding philosophy is to make tax burdens (and compliance) as minimal a consideration as possible in business decisions. Furthermore, this must apply to all industries, without picking winners and losers. A fair, simple, and universally applied tax code is essential to a healthy and growing economy.