Thursday, June 28, 2012
Examining corporate tax expenditures
Alex Engler, Executive Online Editor of Georgetown's Public Policy Review and a Master's of Public Policy student, recently shared with me his article in the Review - "We’re Doing It Wrong – Corporate Taxation in the United States" (6/13/12). He points out some of the weaknesses in the corporate income tax including its high statutory rate relative to other industrialized countries and the 50+ special rules ("tax expenditures") some of which appear misguided.
It is good to see more people looking in more depth at our tax rules. There is certainly a connection between our corporate tax rates and the special deductions, exclusions and tax credits. The special rules help support high rates. Republicans and President Obama are calling for cut back in these special rules - sometimes mislabeled as "loopholes."
For business taxation, it can be more difficult to discern what the special rules really are. That is, what rules are needed to determine business taxable income (similar to the concept of book net income). For example, businesses should be allowed a deduction for depreciation. The question is, at what rate and life? Alex points out that there are some oddities in our depreciation rules, such as special (shorter) lives for corporate aircraft and NASCAR track. I have written about the many weaknesses in our depreciation system. One obvious one is that the key rule on depreciation (Code Section 168) is 50 pages long! It should not take that many pages to describe how to calculate tax depreciation. And we also have Sections 280F and 179 that also have depreciation rules. Amortization rules (for intangible assets) are in different Code sections (167 and 197). Too many special rules. And, some lives are too long (computers at 5 years) and some are too short (the special ones for certain leasehold improvements and others). (For more, see my paper with Chad Jaben - Modernizing and Rationalizing Depreciation (2010).)
Alex questions the Section 199 manufacturing deduction, noting that it is available to more than manufacturers. There are other weaknesses as well such as it being a disguised rate reduction. It would just be better to change the rate rather than give an extra deduction.
He also suggests that LIFO is a problem. I don't agree with that. While LIFO allows costing sales at current prices, thereby lowering taxable income, it must also be used for financial reporting purposes resulting in lower book income as well. This is all just timing differences.
We need more of what Alex is doing - critique to find weaknesses in existing tax expenditures to help identify where improvements can be made. And, one important, first question should also be asked - why is this provision here? Is it crucial to determining taxable income (depreciation, for example) or not (such as the Section 199 manufacturing deduction). If crucial, then analyze the provision to be sure it is appropriately designed and meets principles of good tax policy such as equity, simplicity, neutrality and transparency. If not crucial, phase it out.
What do you think?