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Forget the Promise of Revenue-Neutral Corporate Tax Reform

David Callahan

President Obama came out strongly for tax reform in his State of the Union address, casting this challenge as crucial for raising for new revenue and avoiding harsh cuts. Obama argued that the U.S. could:

save hundreds of billions of dollars by getting rid of tax loopholes and deductions for the well-off and well-connected. After all, why would we choose to make deeper cuts to education and Medicare just to protect special interest tax breaks? How is that fair? How does that promote growth?

It's no surprise that the administration is looking to tax reform to raise big revenues. While the President originally wanted $1.6 trillion in new revenues as part of a "fiscal cliff" deal, it only got about $600 billion. So now it hopes to make up some of the difference through tax reform.

That's not going to be easy for the obvious reason that the House is inclined to block any legislation that raises new revenue and the administration doesn't have the leverage it did during the fiscal cliff deal. 

Moreover, one clear path for raising big money from tax reform would mean going after some very popular tax breaks and curtailing them not just for the wealthy, but for upper-middle class households. Unless Congress achieves reductions in the three biggest tax expenditures -- for mortgage interest, employee healthcare, and 401(k)s -- it would be hard to bring in the big bucks. But going after those would spark a holy war with some of the strongest interest groups in Washington and potentially rile an upper middle class that benefits disproportionately from these breaks and makes up a very big chunk of today's electorate. (Voters from households earning over $100,000 constituted 28 percent of all voters in 2012.)

Thankfully, there is another way. 

Tax reform doesn't have to end in failure -- or only raise puny sums -- amid a backlash by interest groups and the upper middle class. Obama has a real chance here if he keeps the focus on cutting perks that benefit the rich and corporations -- sticking with the populist frame that served him so well in the fiscal cliff standoff. Done right, this strategy can both raise serious money and back Republicans into a corner way at odds with public opinion.

A crucial prerequisite here is for Obama to abandon his pledge that corporate tax reform be revenue-neutral. That promise was made a year ago, when Obama released his corporate tax reform plan and was intent on showing that he wasn't "anti-business." As I noted at the time, the pledge was misguided, given that revenue from corporate taxes is now near a historic low as a percent of GDP.

While it's true that the U.S. has one of the highest corporate tax rates in the developed world on paper, most companies never pay that rate and many pay nothing in some years. Moreover, the United States raises less revenue from business as a percent of GDP than many OECD nations. In other words, it's a canard that corporations are more taxed here than elsewhere and that this puts U.S. business at a disadvantage. 

If the Obama administration can quietly forget its promise of revenue neutral corporate tax reform, it can raise serious money by going after some of the last popular tax breaks -- such as those for oil companies -- without offering a reduction in corporate tax rates as it had originally promised. Perhaps most crucially, Congress needs to succeed in ending deferred taxation of foreign profits -- a topic I've written about a lot here. Corporations shouldn't be able to endlessly pile up more and more of their earnings in offshore tax havens tax free. They should pay taxes on foreign profits the year they make them. Business may fume, but the public will eat this stuff up.

How much revenue are we talking about raising?

Through most of the 1950s and 1960s -- a golden age of growth for business -- revenue from the corporate income tax averaged between 3 and 4 percent of GDP. But through much of the past decade, that figure has been under 2 percent. (Except for a few years in Bush's second term when it rose to 2.7 percent.)

OMB is currently projecting that revenue from corporate taxes will rise to about 2.4 percent of GDP in the next few years as growth revives. But let's say that, as result of tax reform, that figure became more like 3.5 percent -- consistent with the early postwar era. This would mean at least another $160 billion or so of revenue every year -- or $1.6 trillion in revenue over the next decade. 

Now that is serious tax reform.