An Irrational Tax Bill? No Way!

Author: Jeffrey H. Birnbaum

Published: November 24, 2003

On at least one topic, Americans and Europeans agree: Current U.S. tax laws violate international trade treaties. With Europe threatening to impose $ 4 billion in tariffs on products ranging from cutlery to carpeting, Congress is rushing to fix the corporate tax code by late this year. There's only one problem: The cure may be worse than the disease.

To skirt rules prohibiting countries from explicitly subsidizing exporters (which the U.S. does now), Congress has devised a new, low income-tax rate for all manufacturers, which, of course, includes most exporters. The leading version would slowly cut the tax on manufacturing income to 32%, leaving the rate for other businesses at 35%.

But under the new law many companies are likely to start contorting their balance sheets, mostly by shifting expenses to the nonmanufacturing part of their business (to get higher write-offs) and then listing as much income as they can in their manufacturing divisions. Worse, to please constituents, tax writers are considering letting all sorts of groups (farmers, engineering and construction firms, oil refiners, natural gas producers, soft-lumber harvesters, and moviemakers) qualify for the new rate as well. Gamesmanship and tax sheltering of this kind led Canada to repeal its own low-rate system for manufacturers last year. "It's bad policy masquerading as a fix of international tax law," says Bill Gale of the Brookings Institution.

A better option would be to repeal the current subsidy and use the savings to lower either the budget deficit or taxes for all corporations. But with joblessness in the industrial Midwest threatening Bush's reelection, any goody for manufacturers is likely to live on.