Position Paper on Baucus Tax Reform Discussion Drafts
By Senator Pat Toomey
February 2014
Introduction
Senator Max Baucus recently released tax reform discussion drafts detailing proposed changes to America's international tax regime, accounting methods, and cost recovery rules. These are important topics and I am grateful that Senator Baucus released these drafts before departing the Senate to serve as America's ambassador to China. Unfortunately, there are multiple provisions in these discussion drafts that I believe would impede economic growth and move tax policy backwards.
Lower Rates and International Taxation
America's corporate tax code is uncompetitive, overly complex, and costs our economy jobs by encouraging companies to locate their operations overseas. Two deficiencies are particularly egregious. First, our marginal rate of 35 percent, when added to state and local taxes, is about 14 percentage points higher than the average top combined rate of our major competitors. Marginal tax rates are a crucial metric because it is this rate that companies will pay on new investments and projects. Many commentators focus on overall effective or average rates paid. While these metrics demonstrate a company's total tax bill relative to its income, it is the marginal rate that determines the burden government places on a business's efforts to expand.
Second, the U.S. is one of the few countries that still relies on an outdated "worldwide" method of taxing income earned by American based companies in foreign jurisdictions. Under this system, companies owe taxes to the U.S. government on any earnings they generate in foreign countries, but they may defer paying those taxes if they keep that income overseas. This makes it harder for our companies to compete and discourages firms from reinvesting foreign profits here in the U.S.
Ultimately, the best way to make our business tax system more competitive and to create jobs here at home is to lower our tax rate and to move to a more rational and competitive method for taxing foreign income. Additionally, we must not forget about the millions of pass-through companies that pay taxes at individual rates. These companies, many of which are small businesses, are a vital part of our economy and must not be adversely impacted by any tax reform overhaul.
Unfortunately, the discussion draft released by the Chairman of the Finance Committee falls short on both accounts. While it mentions the need to lower corporate tax rates, this promise is vague and unspecified. A more competitive rate must be at the heart of any tax reform effort. As demonstrated by the non-partisan Tax Foundation in a recent report, lowering the federal corporate tax rate from 35 percent to 25 percent would boost GDP by 2.2 percent and raise wages for workers of all income groups by about 2 percent.
The proposed reforms to America's international tax regime are also flawed. Instead of moving to a more pro-growth "territorial" system that is now the international norm, the discussion draft exacerbates many of the problems of our current system.
The centerpiece of the Chairman's proposal for international tax reform is the establishment of a global minimum tax on all income earned by U.S. companies overseas. A global minimum tax will penalize American companies, drive customers into the arms of our foreign rivals, and create incentives for multi-national companies to establish headquarters overseas. Most developed countries have significantly lower rates than we do. Imposing a new minimum tax that is higher than the rates levied by many countries will make U.S. based companies less competitive in foreign markets and enhance the incentives for multi-national companies to relocate their headquarters outside the U.S.
Cost Recovery and Accounting Methods
I am also concerned about the Chairman's proposals to curtail companies' ability to deduct ordinary and necessary business expenses. In some instances, such as advertising and research costs, forcing companies to amortize part (or all) of these expenditures is not conducive to economic growth. In other cases, such as with affiliate reinsurance, the draft attempts to achieve the worthwhile goal of cracking down on base erosion, but does so in a clumsy fashion that arbitrarily punishes businesses engaged in legitimate activities while risking legal reprisal from our trading partners.
The discussion draft proposes an intriguing change to the system used by businesses to recover the cost of their investments. Currently, our tax code separates capital investments into a myriad of asset classes. These investments are then depreciated individually over a period of time depending on that particular asset's depreciation schedule and method. Attempting to simplify this process is an important objective, and the "pooling" system proposed by the Chairman is worth considering. However, the current structure of the proposal would significantly lengthen the recovery period for most capital investments, thereby discouraging investment and expansion here in the U.S. Even in the context of a significantly lower business tax rate, this proposal deserves extensive review and a high degree of skepticism, particularly regarding its impact on American manufacturing.
Conclusion
Finally, the Chairman's draft states that "tax reform on the whole should raise significant revenue." Since 2009, Congress has enacted about $1.8 trillion in tax increases when it passed Obamacare and failed to prevent all of the 2001 and 2003 tax cuts from becoming permanent. Further tax hikes are the last thing our economy needs.
Proposals that are committed to being revenue neutral are also likely to sacrifice good policy in order to satisfy an arbitrary accounting requirement. Additionally, revenue neutral tax reform is politically challenging, since it is by definition a zero sum game. In contrast, tax reform designed to modestly reduce statically scored revenue will create more winners than losers and allow Congress to focus on getting the policy right. If done properly, the revenue brought in through economic growth and improved job creation will dwarf any statically scored revenue loss.
While Senator Baucus will soon leave the Senate, Senator Ron Wyden, his successor, has long been a vocal advocate of tax reform. I am still hopeful that the Finance Committee will consider a full tax reform markup and look forward to working with my colleagues on both sides of the aisle to accomplish this important goal. Done properly, tax reform can simplify our convoluted system while growing the economy, spurring innovation, boosting wages, and creating jobs.
