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Corporate Tax Reform: Understanding The Debate Over A $2 Trillion Question

In the U.S., politicians continue to clash over corporate tax reform. But what exactly is all the fuss about?

“Corporate taxes are taxes against profits earned by businesses during a given taxable period.” – Investopedia

Corporations now house a monstrous $2.1 trillion in profits overseas in an effort to avoid U.S. taxes, making corporate tax reform an object of great debate amongst American lawmakers.

Now, both Democrats and Republicans, stand divided over a viable solution to encourage the repatriation of that chunk of corporate change–a solution, which if executed correctly could potentially reinvigorate the economy with hundreds of billions of dollars in tax revenue.

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At the center of the debate is one number: 35 percent. This is the United States’ nominal corporate tax rate, and the highest in the modern world.  (Note: the rate is actually about 27 percent after factoring in tax deductions, making it the second highest next to New Zealand in real terms)

As a result of President Obama’s announced budget, which includes proposals to knock the corporate tax rate down to 28 percent in addition to a one-time 14 percent rate for moving the profits back home, corporate taxes have once again come under scrutiny.

These talks, as usual, have centered around the repatriation of corporate profits, in hopes of  generating tax revenue.

Though both Republicans and Democrats alike agree (though for different reasons) that corporate taxes are in dire need of reform, neither side can decide on just how it should be done.

So, what exactly are the key issues fueling such a divide? Below are three points of contention at the center of corporate tax reform:

1.) Deciding the tax rate

Despite both sides acknowledging that the corporate tax rate could afford to undergo some serious change, the specific rate at which it should be set remains a topic of debate.

Discrepancy between either sides proposals, however, are not be quite as drastic as one might expect.

While Democrats have proposed a 7 percent slash of the current 35 percent corporate tax rate to 28 percent, Republicans have proposed a similar 25 percent rate.

The difference between the two, though small, is due mainly to concerns over what a rate lower than 28 percent might do to tax incentives for debt and therefore a corporation’s capital expenditures–capital expenditure being a major driver of the bond market and subsequently the economy.

In short: hesitation over lowering the corporate tax rate has centered around finding the exact number at which to set them.

2.) Tax on foreign income

This particular facet of corporate tax reform centers around creating a minimum tax for companies that choose to send their profits overseas–a tax which is currently nonexistent.

Some politicians have considered this lack of foreign tax to to be a loophole which has allowed companies to move taxes to havens, resulting in the current $2 trillion in untaxed corporate profit stored abroad.

Corporations, however, have claimed that current corporate tax rates are gratuitous and have thusly forced them to send profits abroad, so that they may remain competitive.

While proponents of a foreign tax (mostly Democrats) believe that a tax on foreign profits will help fuel the economy through increased tax revenue, opponents (mostly Republicans) are wary of any tax burden that may render multinational corporations less competitive.

The most recent plan for foreign tax issued by president Obama proposes a minimum 19 percent tax rate wherein companies can keep profits abroad, but are required to pay the difference between the two countries’ tax rates. (i.g. if a foreign country’s’ tax rate is 9 percent, the corporation will be required to pay 10 percent in the U.S.).

Republicans have mostly advocated for a territorial tax system wherein a corporation pays taxes only to the country where its money is held–not necessarily to the U.S.

This aspect of corporate tax reform has been a major point of contention, causing gridlock between the two parties.

3.) Revenue neutrality

Lastly, there is the issue of revenue neutrality–arguably the most divisive topic for debate in regard to corporate tax reform.

Naturally, this topic has formed two schools of thought. While most Democrats would prefer corporate tax reform increase overall tax revenue, Republicans would prefer that reforms generate just enough to pay for the lost revenue through lower taxes and not a cent more.

The most recent proposal by President Obama calls for revenue neutrality in the long-run with a lump sum of $238 billion in the short-term for infrastructure spending and efforts towards job creation.

Experts foresee this particular issue being a deal breaker for Republicans willing to consider President Obama’s proposal.

The takeaway

So, what are the chances of tax reform actually making its way into fruition? That depends on just what such a proposal might consist of.

Former director of President Obama’s National Economic Council has called corporate tax reform “doable” in 2015, even despite partisanship obstacles, while The New York Times’ Dealbook Editor, Andrew Ross Sorkin, paints a much bleaker picture of the potential for reform:

“While chief executives often give lip service to the need for corporate tax reform — and some believe in it — when it comes right down to it, companies aren’t necessarily interested in a simpler tax system, just one that significantly lightens their tax burden.”

Sorkin’s pessimism is centered primarily around the fact that the Government Accountability Office found that, though the nominal corporate tax rate is 35 percent, in reality corporations paid on average about 12.6 percent, due to a plethora of tax loopholes.

Regardless of ideology, those of interested in seeing corporate taxes reformed will have to wait and see how new proposals pan out.

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James Pero