Obama Tax Plan Closes Loopholes, Opens New Ones

Cutting corporate tax rates and deleting loopholes is just what most economists prescribe for the tangled U.S. tax code.

So why isn't everyone cheering the plan President Barack Obama unveiled Tuesday to slash the top corporate tax rate and end breaks that let some companies pay little or nothing in taxes?

Economists note that Obama's plan would upturn the very playing field the administration says it wants to level. It would give manufacturers preferential treatment: Tax breaks would effectively cap their rate at 25 percent. Other companies would pay up to 28 percent.

The current top corporate tax rate is 35 percent.

Some say such varying rates can distort the economy by diverting investment into some industries and away from others that might pack a bigger economic punch.

"The administration is not making sense," says Martin Sullivan, contributing editor at publisher Tax Analysts. "The whole idea of corporate tax reform is to get rid of loopholes, and this plan is adding loopholes back in."

Other economists oppose a separate plank of the Obama plan: a minimum tax on foreign earnings of U.S. multinational companies. No other country imposes such a tax on its companies, they note. U.S. businesses would face a competitive disadvantage.

Facing resistance from Republicans and many businesses, Obama's plan is in any case a longshot proposal so close to Election Day.

"For anything that Obama recommends during an election year and with a divided Congress, the best one can say is, 'Good luck,'" says Henry Aaron, senior fellow in economic studies at the Brookings Institution. "Those who stand to lose are really upset and will work hard to defeat it."

Just about everybody agrees something has to change. When Japan enacts a corporate tax cut in April, the United States will be left with the highest tax rate in the developed world.

That puts the U.S. companies that actually pay the official corporate tax rate at a disadvantage against their foreign competitors. (Many U.S. companies effectively pay lower rates because of tax breaks.)

The loophole-riddled U.S. tax code now benefits numerous industries over others. One tax break, for example, lets oil companies write off drilling costs immediately instead of over time, as most businesses must.

In the end, different industries can pay far different effective rates. The Treasury Department says U.S. utility companies pay an average effective tax rate of 14 percent. By contrast, retailers pay an average 31 percent.

The administration says the point of its tax plan is to make the system fairer and more efficient — not to squeeze more overall tax revenue from corporations. Treasury Secretary Timothy Geithner calls the current tax code "fundamentally unfair." But the administration also needs to end some loopholes to help pay for a lower corporate tax rate.

The White House argues that tax breaks for manufacturers could ultimately pay off for the economy. When factories expand, for example, the benefits tend to spill into other businesses: Shipping companies and warehouses must add jobs, too, to transport and store the goods that manufacturers are producing.

Economists also note that manufacturers account for a disproportionate amount of the research and development that create innovative products and new ways of doing business. The National Science Foundation has found that manufacturing companies are nearly three times likelier to introduce a new or significantly improved product than other companies are.

"Does manufacturing deserve special treatment? This is a hot debate," says Elisabeth Reynolds, executive director of the Industrial Performance Center at the Massachusetts Institute of Technology. "A case can be made that there's a reason to encourage more manufacturing in the United States because of its links to innovation."

Other economists say that argument is overstated. Among the skeptics is Obama's own former economic adviser, Christina Romer, an economics professor at the University of California, Berkeley. In a column this month in The New York Times, Romer argued that there was no economic justification for the government to favor manufacturers over service-oriented companies.

"Our earnings from exporting architectural plans for a building in Shanghai are as real as those from exporting cars to Canada," Romer wrote.

Analysts are also divided over Obama's plans to impose a minimum tax on companies' foreign earnings.

Sullivan of Tax Analysts says the current system allows some companies — especially technology and pharmaceutical firms — to avoid U.S. taxes by shifting their earnings to tax havens such as Bermuda and the Cayman Islands. Other multinationals can indefinitely avoid paying U.S. taxes by keeping their earnings overseas.

Lacking such tax breaks, companies that do all their business in the United States suffer a competitive disadvantage.

The minimum tax proposal, Sullivan says, "would level the playing field."

But big U.S. companies complain that they already pay taxes to foreign governments on the income they earn in those countries. A U.S. tax on that income, they argue, would amount to double taxation.

That would raise costs for U.S. companies operating overseas, making them less competitive. Instead, the United States should move toward a "territorial" tax system, business groups argue. Tax would apply only to income earned within the United States.

"No other developed country imposes such a 'minimum tax' on the foreign earnings of their corporations," said the Business Roundtable, a trade group of chief executives of large U.S. companies.

Some economists agree.

The minimum tax proposal for international earnings "is totally misguided both from a competitive standpoint and a jobs standpoint," said Gary Hufbauer, a senior fellow at the Peterson Institute for International Economics. "Obama's plan, if enacted, will shrink the U.S. footprint in world markets and lose jobs."