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The tax proposals in President Obama’s 2016 budget combine two interesting ideas for international reform with his often-stated--but still vague-- goal of a broad-based corporate tax overhaul.
First, the framework: Obama has once again proposed cutting the corporate tax rate to 28 percent from the current 35 percent, with a special 25 percent rate for manufacturing. And once again, he’s promised to finance these rate cuts with mostly unspecified cuts in tax preferences.
His budget reserves about $141 billion over 10 years for corporate reform. But that falls far short of what it would cost to lower rates to the levels Obama promises without adding to the deficit. My Tax Policy Center colleague Eric Toder calculates that $141 billion represents less than 3 percent of total projected corporate tax revenues over the next decade.
This is the game that politicians of both parties (Dave Camp excepted) have been playing for years. They couple promises of rate reductions with ambiguous assurances that they’ll be financed with mostly unspecified “loophole closers.” It is a political con game and a policy dead end.
But at the same time, Obama is proposing a major international tax reform. First, he’d create a one-time 14 percent tax on the $2 trillion in unrepatriated foreign earnings of U.S.-based multinationals and their subsidiaries. Next, he’d set a 19 percent minimum tax on those firms’ future overseas earnings as they accrue.
The Treasury estimates the one-time tax would raise $268 billion over 10 years (all of it in the first six). Obama would use the money to pay for a big chunk of a $478 billion infrastructure spending initiative over the same six years.
Whatever the merits of the transition tax, using it to fund road construction is a terrible idea. Building and upgrading public infrastructure is a long-term policy challenge. Funding it with a one-time tax-- even a big one—makes little sense.
A much stronger case can be made for the levy as a bridge to broader international tax reform. Supporters say that, at the current 35 percent rate, businesses will never return those earnings to the U.S. which, in turn, constrains their ability to invest here. Because Obama’s new tax would be imposed no matter how (or where) firms use their overseas earnings, it would no longer penalize repatriation.
Obama and many members of Congress agree that eliminating the repatriation tax should be accompanied by some levy on existing foreign assets. But they broadly disagree on how to accomplish this goal. Business lobbyists are already gearing up to oppose Obama’s 14 percent rate, which they insist is too high. And many lawmakers back a different approach entirely—a temporary tax holiday on repatriated earnings. Senators Barbara Boxer (D-CA) and Rand Paul (R-KY) are the latest to join that crowd, with a proposed 6.5 percent levy.
The president sees his 14 percent tax as a transition to his most interesting proposal: A new 19 percent minimum tax on future foreign earnings in excess of normal returns on tangible assets. In effect, the tax would target profits from intangible assets such as patents (those assets that are most easily shifted to low-tax countries). My former TPC colleague Rosanne Altshuler and career Treasury economist Harry Grubert have proposed a similar levy.
Under Obama’s plan, firms would lose their ability to defer U.S. tax on overseas earnings but receive a credit for 85 percent of the tax they pay in countries where they do business. Credits received in high-tax countries could not be used to offset their minimum tax liability in tax havens.
The idea is creative and worth exploring. But I fear Obama will agree to a much lower transitional rate, or even a temporary repatriation holiday, to fund his infrastructure ambitions. And will he and Congress ever tie this quick revenue fix to a permanent international tax solution—one which would be complicated and time-consuming to design?
Even if it does, there is the matter of how it would all hang together. In effect, Obama would set a statutory rate for U.S. based multinationals of 19 percent on future foreign earnings but 28 percent on domestic income. Manufacturing firms (however they are eventually defined) would pay 25 percent. And the vast majority of U.S. businesses that are organized as partnerships, sole proprietorships, and other “pass-through” entities would still be subject to top rates as high as 39.6 percent, though they'd still avoid the corporate-level tax.
One of Obama’s primary goals is to simplify the tax code. But multiple business rates create all sorts of tax arbitrage opportunities. In addition, there is a real question about whether his plan would help create U.S. jobs—another of Obama’s stated aims.
The answer will depend, in large part, on what happens to effective U.S. business tax rates. And that will turn on which tax preferences are eventually eliminated in a broad-based reform. So far, neither Obama nor congressional Republicans have been willing to show their cards.
Obama’s international tax initiative is a serious attempt to improve the way we tax multinationals. But when it comes to broader business tax reform, he’s left a lot of unanswered questions.
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