President Obama’s Tax Deform Agenda

For a while there, I thought President Obama was going to embrace tax reform in his State of the Union address.  Instead, following the lead of his predecessors, he offered a laundry list of new tax subsidies, bragged about some old ones, and said almost nothing about a top-to-bottom rewrite of the Tax Code.

Here’s just a partial list of the targeted tax breaks Obama promoted: Tax credits for clean energy and college tuition, as well as tax cuts for small business that create jobs, domestic manufacturers, high-tech manufacturers, and companies that close overseas plants and move production back to the U.S.

At the same time, he’d require individuals making more than $1 million to pay an effective income tax rate of at least 30 percent, in part by eliminating their ability to take many deductions. And, he’d use the tax code to punish companies that do business overseas, creating a new minimum levy that is supposed to assure that all multinationals pay some U.S. tax.

Obama’s embrace of the tax code as a vehicle to pick winners and losers sounded more than a little discordant in a speech whose theme was “everyone gets a fair shot and plays by the same set of rules.”  Not so much in a tax code where you get special rules for the government’s favored activities.

As Obama was tossing out his tax baubles, I kept wondering about those firms that somehow didn’t get on his gift list. I can just imagine lobbyists’ cell phones abuzz from furious clients wondering why they weren’t getting a tax break of their very own.

For instance, think about a start-up software company that has to compete with an established firm. Because new businesses rarely make money in their first years, extra tax deductions do them no good. By contrast, a more established competitor, especially if it can qualify for Obama’s high-tech tax break, would benefit—perhaps substantially.

The multinationals’ minimum tax would be entirely unworkable. Even if Congress passed the levy, which it won’t, those firms will find ways around it. Minimum taxes are Band-Aides for a flawed tax system. The solution is not to create a new penalty for firms that learn to manipulate the law, it is to fix the basic law in the first place.

If Obama wants to prevent companies from gaming the system, he could lower the corporate rate and eliminate tax preferences. He raised this in last year’s state of the union address but did nothing about it. That’s too bad. With a low enough domestic tax rate, companies would have less incentive to shuffle income overseas.

Or he could go in the opposite direction and eliminate deferral, the practice that allows multinationals to avoid U.S. tax until they bring earnings back to the U.S. But this minimum tax seems to be a half-measure that may play to his populist base but will achieve little.

I suppose it is inevitable that a president beginning his fourth year in office and facing a deeply divided Congress would go small-bore. After all, there will be no fundamental tax reform in the current environment and even proposing such a step would only open him to criticism from the usual suspects in housing, non-profits, finance and other industries that are very happy with the system as it is.

Still, it is a shame that, instead, Obama would make things worse.