Obama's Tax Plan Gets Problems Right, Solution Wrong

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

One of the primary problems, among the several we listedyesterday, is the creation of a minimum foreign tax on multinationalcompanies. 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 essentiallytrades off greater tax expenditures, loopholes, and tax planning for a higherstatutory corporate tax rate relative to other countries. This is a poor tradethat produces a tax system that is uncompetitive relative to other countries,distorts business decision making, and slow economic growth.

In recent years, our major tradingpartners have overhauled their tax codes, lowered their statutory corporate taxrates, and in some cases broadened their tax bases. The United States has notenacted similar reforms, leaving the United States with the second higheststatutory tax rate among advanced countries. In April 2012, after the scheduledreductions in Japanese tax rates go into effect, the United States will havethe highest statutory corporate income tax rate in the Organization forEconomic Cooperation and Economic Development (OECD).”

A nearly perfect diagnosis for the tax sickness that ailsAmerica. Moreover, it practically telegraphs what the administration should doto ameliorate those problems: close loopholes and follow the OECD trend towardslower rates and territoriality.

And then they begin the surgery…

On the issue of closing loopholes the framework does moreharm than good. According to research conducted by the Tax Foundation theproposal would close six loopholes, out of around 250, while adding 11 – for anet loophole gain of 6. Not exactly progress on the road to simplifying the TaxCode.

The plan does succeed at lowering the corporate rate from 35to 28 percent. Certainly progress, but not exactly a cure given the diagnosisof “a tax system that is uncompetitive relative to other countries,” especiallysince 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 wouldmove us from the having the highest corporate tax rate to the fourth highest among theOECD.

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

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

Rather than opt for the carrot of introducing trulycompetitive rates, Obama’s plan would use the stick of a new minimum foreigntax on business earnings abroad. But the result, especially when judged on the “fairness”rubric, isn’t the cure America needs. Essentially, this would mean thatU.S.-based companies doing business abroad would face a tax hike, whileforeign-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 onlyincentivize them to set up shop in a more tax friendly locale.

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