Obama's business tax reform: A good start

The president's Framework for Business Reform does a great job in identifying what's wrong with the way businesses are taxed. But the cure for those problems leaves a lot to be desired.

Here’s what I love about President Obama’s Framework for Business Tax Reform: His diagnosis of the problem is spot on. In just a few pages, the Treasury Department does a marvelous job describing what’s wrong with the way the U.S. taxes business. Anybody interested in understanding why the tax code is such a mess should read this.

Here’s what I don’t like: After doing a great job explaining the problem, Obama often flops when it comes to a cure. Sure, he proposes cutting the corporate rate. These days, who doesn’t?  But when it comes to which tax preferences he’d dump, Obama often ducks the tough choices. More troubling, some of his proposed cures may make the disease worse.

Here are a couple of examples. The joint White House and Treasury Department paper explains what’s wrong with business subsidies and high tax rates. One big flaw: this toxic brew distorts business decisions. It encourages firms to finance with debt instead of equity, it drives firms to organize as pass-throughs such as partnerships to avoid paying taxes twice on corporate profits, and it drives investment to low-tax industries and away from high-tax industries.

So far so good. But now, Obama’s cure: He proposes to cut rates for all non-manufacturing corporations from today’s top rate of 35 percent to a flat 28 percent. Manufacturers would enjoy a more generous 25 percent rate, and “advanced manufacturing”, whatever that is, would receive an even lower rate. But wait a minute, didn’t the president just tell us that it is bad thing to use the tax code to distort investment decisions?

Similarly, he decries income shifting by U.S. based multinationals. But his solution, an alternative minimum tax on overseas profits, seems entirely wrongheaded. He says this would prevent companies from moving profits overseas. Maybe it would. But more likely it would encourage companies to move themselves overseas. Companies domiciled on sunny Caribbean islands would not be subject to this new AMT, only U.S. firms would.

On the other side of the ledger, Obama does what all of his GOP rivals have done. He parades his lower rate, but never quite says which tax breaks he’d eliminate.

Obama does pluck a few low hanging fruit, at least for his base. As he’s promised in the past, he’d tax carried interest at ordinary income rates, eliminate oil and gas preferences, raise taxes on buyers of corporate jets, and boost taxes on insurance companies. But this is the equivalent of promising to balance the budget by eliminating waste, fraud, and abuse and foreign aid. It won’t come close to paying for a 7 percentage point and more cut in rates.

When it comes to the really tough stuff such as broad changes in depreciation rules or interest deductions, Obama is silent. In fairness, given the challenges of making these reforms, his 28 percent rate is probably more realistic than the GOP alternatives.

Newt Gingrich, for instance, says he’d cut the corporate rate to an impossibly low 12.5 percent without ever saying how he’d pay for it. Rick Santorum says he’d cut the rate on manufacturing to zero with saying how he’d pay for that.

In all, Obama’s plan is a modest but useful step in the direction of reform. We now have all the major presidential candidates on record supporting lower rates and a broader base. House Ways & Means Committee Dave Camp (R-MI) will have his own proposal very soon. By recent Washington standards, that is progress.

Of course, there are big disagreements on how low to take rates and mostly black boxes when it comes to which tax preferences to eliminate. And there is a yawning chasm between Obama, who would collect at least as much in business taxes after reform as government does today, and most Republicans, who would deeply cut business taxes. But at least they all are, in their way, talking.