Corporate Tax Reform

Corporate Tax Reform: An Illusion or a Reality?

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It has been a rallying cry that is as old as time and that rivals that of the standing ovation that the Rangers receive after scoring a power play goal: “Corporate tax in this country needs to be reformed.” Who is leading the charge? America’s chief executives. What is responsible for catapulting this into the public eye? None other than the nation’s aging tax code, which has been blamed for putting U.S. multinational corporations at a competitive disadvantage in the global marketplace.

As tax reform chatter grows louder, chief executives have become more outspoken. Timothy D. Cook, Apple’s chief executive, told lawmakers, “Apple has recommended to the Obama administration and several members of Congress — and suggests to the subcommittee today — to pass legislation that dramatically simplifies the U.S. corporate tax system.”

Last week, the business world got its wish from President Obama: a proposed overhaul of corporate tax policy in the United States. But it was not what they were hoping for.

President Obama’s budget calls for a lower overall tax rate — 28 percent, down from 35 percent. But the devil is in the details, and the details are too hard for U.S. chief executives to swallow. Specifically, it requires a 14 percent tax on assets stored overseas and a 19 percent tax on all foreign profits in the future, minus taxes paid abroad. The one-time 14 percent tax would hit businesses with the largest piles of cash stored overseas the hardest. This includes such companies as G.E. ($110 billion), Microsoft ($74 billion), Pfizer ($69 billion) and Apple ($54.4 billion).

Not only did Obama’s plan receive a chilly reception but it has been a rallying call for politicians on the right side of the aisle to band together with chief executives and pick up their swords. The ink on Obama’s plan wasn’t even dry before it incited scathing comments – from “confiscatory” and “dead on arrival” to everything in between. Representative Paul D. Ryan, Republican of Wisconsin, chairman of the House Ways and Means Committee, had a few choice words for the president’s budget: he said that it was based on “envy economics.” Of course, derogatory “names” may not break bones like “sticks and stones,” but one can’t help but think whether they caused hurt feelings among those who drafted the budget.

So what is it about Obama’s plan that has chief executives up in arms? After all, does it not seek to “fix” the very problem that keeps chief executives lying awake at night: the need for corporate tax reform?

Here’s the brush. While chief executives might be beating the drums for corporate tax reform, critics say that this is nothing more than “window dressing.” In other words, a ploy. At the end of the day, critics says that these companies aren’t actually interested in a simpler tax system. Instead, what they really want is one that lightens their tax burden.

If U.S. multinational companies think that such a plan is on the horizon, they are sadly mistaken. As the Obama administration has said – not-so-subtely – there is a better chance of hell freezing over before a proposal is made for reforming the tax code by reducing the tax burden of U.S. multinational corporations.

Why? For starters, in the same way that the “real feel” temperature is hardly the same as the level recorded by mercury in a thermometer, the true tax rate for cash stored offshore isn’t the statutory rate of 35 percent. Instead, it’s zero. Zero? How can that be so? This is because foreign profits aren’t taxed in the United States until they are repatriated back. This is known in some circles as “deferral.”

Deferral explains why true tax reform is so challenging: any rate higher than zero impacts a multinational company’s bottom line.

Against this backdrop, let’s discuss some of the recent proposals that have been floated by lawmakers.

Last month, senators Rand Paul, Republican of Kentucky, and Barbara Boxer, Democrat of California, proposed a one-time “tax holiday” that would allow companies to repatriate cash and use the money to finance the Highway Trust Fund. The proposed rate was 6.5 percent. Executives criticized this proposal on the grounds that it was “too high” because it was more than the 5.25 percent tax rate that Congress used when it granted a tax holiday in 2004.

How about the idea of a mandatory one-time tax on all foreign cash? That too was thrown out with the bathwater. Gregory Valliere, chief political strategist at the Potomac Research Group, explained why. In a note to his clients, Mr. Valliere said, “A 14 percent tax on corporate earnings held overseas is totally out of the question; the White House threw out that figure as a first offer. If that 14 percent figure was lowered to, say, 5 percent, then things might get very interesting.”

For those wondering where the idea of a one-time tax came from, you may be surprised to learn that this is not the first time that a one-time tax has been proposed. For example, back in 2014, Representative David Camp, Republican of Michigan (recently retired) proposed a one-time mandatory tax of 8.75 percent on foreign cash. Perhaps Rand Paul and Barbara Boxer should have examined Representative Camp’s proposal before going off half-cocked and introducing their own. Indeed, Representative Camp’s proposal never even get off the ground.

If a one-time tax can serve as “common ground” to unite politicians on both sides of the aisle – with the only obstacle being the amount of that tax – then the question that must be asked is whether a one-time tax of fourteen percent would be as devastating to a U.S. multinational company’s bottom line as chief executives suggest? Or is it just smoke in mirrors? According to Jeremy Scott, editor in chief of Tax Analysts commentary, “Obama’s deemed repatriation tax isn’t all that unreasonable of a plan. The idea of using a reduced rate to tax profits permanently reinvested overseas has been a part of almost every serious international tax reform plan for the last several years.”

Nor will it impact future behavior. “Taxing those earnings as part of the transition to an entirely new international tax system will have no effect on future behavior, since the earnings hoard relates entirely to the past,” Edward Kleinbard, a professor of law and business at the University of Southern California and former staff director of the Joint Tax Committee, told Congress last year.

Corporate tax reform cannot be debated without addressing an issue that cuts right to the heart of the debate: the very taxing of foreign profits in the first place. It is the 800-pound gorilla sitting in the room. And if it was a villain out of a Dr. Seuss book, it would be called the “Mean One Mr. Grinch.” And on this topic, there are as many opinions as there are experts.

Inherent in President Obama’s plan is the idea that foreign profits must be taxed. And this might be what has corporate executives crying foul.

Taking the side of businesses, James Pethokoukis of the American Enterprise Institute wrote: “This is the wrong direction for corporate reform. Under a better territorial system, the I.R.S. would only seek to tax those profits earned in the United States. American companies with foreign-earned profits would be free to leave that dough overseas or bring them home without any further tax consequences.”

Mr. Pethokoukis’ arguments cut right to the heart of the U.S. system of worldwide taxation – where the U.S. is one of the few countries left in the world that still taxes its citizens and corporations on their worldwide income, regardless of where it was earned. The overwhelming majority of developed countries only tax a company’s profits if they were earned inside the country’s borders.

“The fact is I’d take Germany’s or Japan’s or the U.K.’s corporate tax policy today, sight unseen, without any dispute,” Mr. Immelt said at Dartmouth College in 2011. “I would take any of those tax policies today.”

Just as important as the issue of U.S. worldwide taxation is on the corporate tax reform debate is the issue of whether any of the proposals on the table today will spur the economy and job growth.

Mr. Valliere provides sheds some light on this. “A repatriation deal could have a significant impact on stock buybacks, dividends, M.&A. activity, business fixed investment, etc.,” Mr. Valliere said. “Whether it would lead to a surge in hiring is debatable; it didn’t when earnings were repatriated a decade ago.”

How likely is it that Mr. Obama’s proposal will pass both houses? According to Mr. Valliere, “35 percent.”

While the political divide among lawmakers is stark, all hope is not lost. If there is anything positive to take from this, it’s that there is no lack of ideas when it comes to what corporate tax reform should look like. And that might just be the ace in the whole. With so many ideas, perhaps one will be able to bridge the gap between Republicans and Democrats.

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