“It’s just far-fetched to believe that Congress would lower corporate rates at the expense of small business,” says Rep. Devin Nunes, R-Calif.
That, in a nutshell, is why corporate tax rates are unlikely to fall, even though there is a bipartisan consensus that they’re too high. Nunes may, however, have the beginning of a solution.
The U.S. corporate tax rate is higher than that of any other developed country. We have kept it at 35 percent even as other countries have reduced theirs. Republicans, unsurprisingly, want to cut the rate; most of them think 25 percent is the right target. President Barack Obama has suggested that eliminating loopholes would enable a reduction to 28 percent.
A lower rate would lead to more investment, and thus higher wages. But most businesses, especially small ones, don’t pay corporate taxes. They file under the individual income-tax code, partly because it treats investment better than the corporate code does. These businesses have no stake in seeing the corporate-tax rate fall – since their own taxes just rose at the start of the year, when the Bush tax cuts on high earners expired.
Both the White House and Republican Sen. Rob Portman of Ohio are willing to tackle corporate tax reform in isolation from the rest of the tax code. Many members of Congress will balk, however, at enacting a 25 percent corporate rate just after letting rates on a lot of small businesses rise to 39.6 percent. Portman is isolated in his party on this issue.
Reforming the entire code, individual and corporate alike, doesn’t hold much promise, either. There is no bipartisan agreement that the top individual rate should fall. Nor is there any agreement on which tax breaks to eliminate or reduce to pay for lower individual rates. So the two most obvious paths for a corporate rate reduction – a reform of the corporate code, or of the whole tax code – appear to be blocked.
That’s where Nunes comes in. He suggests a new approach: a “business consumption tax” that treats all businesses the same, whatever their organizational form. Instead of taxing their income, it taxes their cash flow – income minus expenses, except for interest payments. That way, businesses would no longer write off their investments according to a complicated depreciation schedule. Investments would be tax-free.
Both U.S. and foreign companies would have more reason to invest here. “This would make the U.S. the largest tax haven in human history,” Nunes says.
I’ve run across two objections to Nunes’ idea. The first is that it is simply too ambitious to be politically viable. If Congress is having trouble reforming the corporate tax, goes the argument, it won’t be able to digest a new approach to taxing business income. What this objection ignores is that the moderately ambitious proposals all face obstacles that are probably insuperable – obstacles this proposal avoids.
The second objection is that Nunes’ proposal would cost the federal government a lot of revenue. A Joint Committee on Taxation estimate of the proposal’s budget impact would make it possible to evaluate this claim, but it sounds plausible. If it turns out to be expensive, the concept can still work. The tax rate would have to be higher than the 25 percent that Nunes has tentatively put forward.
Even if the rate was left at the 35 percent that currently applies to corporations, the shift to the new tax still would be a boon for the economy. The statutory rate would be higher than that of other countries, but the number that matters – the effective tax rate on investments – would be a very competitive zero, thanks to companies’ ability to write off their costs immediately. Eliminating the deduction for interest would end a destabilizing distortion in the economy: the federal tax code’s preference for corporate financing via debt rather than equity. That preference also gives an advantage to established firms that have greater borrowing capacity.
If Congress still finds the Nunes proposal too ambitious to contemplate, it could undertake reform on a smaller scale. Leave tax rates alone, keep the separate schedules for different types of companies and just make a trade. Companies would get write-offs on investments and in return, lose the interest deduction. That trade would probably leave the government’s revenue at the same level. It would certainly be simpler than most other proposals to reform business taxation..
Two things have to happen for these ideas to have a chance. More people in Washington must realize that the conventional approaches to these issues aren’t going to work. And they will have to start listening to Nunes.
• Ramesh Ponnuru is a Bloomberg View columnist, a visiting fellow at the American Enterprise Institute and a senior editor at National Review.