Tax Reform IV: Corporate Tax Reform

The United States has one of the highest corporate income tax rates in the world. While both the Obama administration and Trump administration have criticized American companies for moving operations off-shore, and considered a variety of policies for punishing them if they do, a better approach would be to design policies that make it attractive for all corporations to locate their operations in the United States.

One way to do that would be to lower the corporate tax rate. While the current 35% rate is high, many corporations pay minimal income taxes because the overly-complex tax code has so many loopholes. Eliminate them to simplify the tax code and make more revenue subject to tax, and lower the corporate rate to 22%. I’m suggesting 22% because in an earlier post I suggested a 22% personal income tax rate, and it’s good tax policy to set the personal and corporate rates at the same level so corporate income is neither favored nor disfavored by the tax system relative to personal income.

Despite there being a good case for eliminating all deductions and loopholes in the corporate tax structure, I’d argue for enlarging two.

First, corporate dividends should be deducted from taxable income. They are paid to individuals who pay individual income taxes on them, and this would eliminate a double tax. Interest payments are already deductible. Why shouldn’t dividends be treated the same way?

Second, allow corporations to expense all of their investment expenditures. Currently, they are depreciated, with complex rules that set up a host of different depreciation schedules. Their tax accounting is unnecessarily complicated, and depreciation for tax purposes is largely unrelated to the actual depreciation in the value of their assets. On the whole, expensing depreciation is revenue-neutral, although compared to the existing tax structure it would convey a tax advantage to expanding companies and a tax disadvantage to contracting companies. This is likely to be beneficial to the economy as a whole, however.

When thinking about corporate tax reform, the ultimate goal should be to design a system that attracts corporations to the United States rather than repelling them.

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