The following editorial was written by Bloomberg View editors:
“One of the most insidious tax loopholes out there” just got a little smaller. But President Barack Obama, who announced the change on Tuesday with much fanfare, didn’t go nearly far enough: The tax code itself, not just its loopholes, is what needs fixing.
It’s hard to overstate just how bad the U.S. corporate tax code is. Imagine it was designed by foreign saboteurs – and prepare to be impressed by their ingenuity.
It taxes profits at 35 percent, one of the highest rates in the world. This excessive rate applies to a base riddled with exemptions and exceptions. U.S. companies pay taxes on their non-U.S. earnings, but only when the money is brought home, thus creating an incentive to park profits abroad. In these and other ways, the system manages to combine maximum economic damage with relatively meager revenue collection.
To avoid this tax, some U.S. companies have bought smaller foreign firms and switched their residence for tax purposes overseas. These are the so-called inversions that new treasury rules are intended to block. They may have already had an effect, with Pfizer’s termination of its $160 billion takeover of Allergan.
A sensible tax system would eliminate the incentives both for inversions and for parking income abroad. Actions like the administration’s shouldn’t be confused with reform.
In fact, they make the code even more complicated when it desperately needs to be simpler. By relying on executive discretion rather than legislation, they make the system less predictable. Worst of all, they leave in place the excessive basic rate, from which so many other problems flow.
There are two basic approaches to fixing the system. The less radical option would be to set a lower, internationally competitive tax rate and then apply it to a broader, simpler base. Merely doing that would help a lot. However, where international companies are concerned, efficient taxation also requires much closer cooperation among governments. This would be easier if the U.S., like almost all other governments, were to adopt a territorial system, which taxes profits according to where they’re earned, not according to where the company resides.
The more radical option would be to abolish corporate taxes altogether, and treat business income as just another form of personal income – taxing it not at the company level, but as ordinary income when passed on to investors. This approach may seem far-fetched, but it’s worth considering.
One of its biggest advantages is that it would bring progressivity to corporate taxes. Taxing corporate income as personal income would lower the rate paid by ordinary taxpayers and (assuming revenue neutrality) raise the rate paid by the rich. A fair tax system is one that’s moderately progressive: Abolishing the corporate tax would serve that purpose.
Obama needs to settle on one of these approaches. The first is closer to what his administration has already proposed, and even has some appeal in the Republican-controlled Congress. Now all the administration needs to do is pursue the cause with the same zeal it brings to criticizing businesses for lawfully trying to reduce their tax liabilities.