How Corporate Tax Reform Can Combat Crony Capitalism

by Reihan Salam

Congressional Republicans are astonishingly unpopular, and they deserve to be astonishingly unpopular. Remarkably, three-fifths of self-identified Republicans disapprove of the job congressional Republicans are doing, which tells you something. The good news is that a small number of elected conservatives, led by Utah Sen. Mike Lee and Florida Sen. Marco Rubio, have been pointing the way towards a GOP worth supporting. Both men have been making the case for a domestic policy agenda that explicitly, and creatively, advances middle-class economic interests. Most recently, in the Wall Street Journal, Lee and Rubio have outlined a new tax proposal that is a much bigger deal than it appears to be at first glance.

Drawing on Lee’s recent call for overhauling the personal income tax, Lee and Rubio create a two-rate structure (15 and 35 percent) that eliminates and revamps various tax expenditures while also adding an expanded child credit. Like Robert Stein, the father of family-friendly tax reform, Lee and Rubio justify this new child credit on the grounds that it represents a corrective to the tax bias against working parents. The political case for an expanded child credit has always struck me as strong, and so this aspect of their plan is very welcome.

Yet it is Lee and Rubio’s approach to overhauling corporate taxes that deserves particularly close attention. The recent controversy over high-profile corporate inversions has given the corporate tax reform conversation new life, and Lee and Rubio are right to weigh in. In the weeks to come, we will learn more about what exactly they have in mind. But for now, it looks as though they are committed to the following big steps: (a) allowing firms to deduct 100 percent of the expenses associated with capital investment in the year the these expenses are incurred; (b) consolidating the taxation of capital income by essentially having corporations pay taxes on behalf of their shareholders so that taxes on corporate income are paid only once at the firm-level rather than twice, at the level of the firm and at the level of the individual investor; (c) eliminating the deductibility of new debt, a measure that will, over time, greatly reduce the pro-debt bias of the tax code; and (d) moving to a territorial tax system.

If Lee and Rubio follow through on all of these steps, they will spark a revolution in the way business is done in America. As important as the fight over the Ex-Im Bank might be, the corporate tax code is where the battle over crony capitalism will be won or lost. The first two steps, 100-percent expensing and single-layer taxation, will make the U.S. a far more attractive destination for capital investment. But curbing the debt bias is potentially an even bigger deal. As Robert Pozen has argued, the debt bias in the tax code encourages firms to take on more leverage than they would under a truly neutral tax code, which in turn raises the risk of bankruptcy and the economic dislocation that follows from it. Curbing the debt bias will also weaken the relative position of incumbent firms, which can borrow cheaply, vis a vis upstarts. California Rep. Devin Nunes has long championed lowering taxes on business investment, and NR’s Ramesh Ponnuru has championed his cause. One challenge, however, is that lowering taxes on business investment creates a revenue hole that has proven hard for tax reformers to fill. Reducing the debt bias is an excellent way to raise revenue while reducing economic distortions, per Pozen. So these elements of Lee and Rubio’s proposal fit together perfectly.

Moving to a territorial tax system is another matter. A territorial tax system would make it far less likely that U.S. multinationals would change their tax domicile, as they’d no longer have to pay U.S. taxes on income generated abroad. In this sense, at least, the corporate inversion problem would be solved. But as the left-of-center Center on Budget and Policy Priorities has warned, a territorial system would make it more attractive for U.S. multinationals to shift economic activity to low-tax jurisdictions, as they wouldn’t have to go through the headache of a corporate inversion to take full advantage of tax havens overseas. Robert Pozen has offered a compromise — U.S. firms would pay one rate on their domestic profits and they would pay a separate “global competitiveness tax” rate on on their foreign profits, the latter of which would be pegged to the rates found in other market democracies. This would, according to Pozen, minimize the incentive for U.S. multinationals to shift economic activity abroad without unduly burdening them. (Moreover, the global competitiveness tax would raise revenue that could then be used to lower taxes on domestic profits, thus shrinking the wedge between these two rates.) It is easy to imagine other affluent countries moving in the same direction, which would be a good thing insofar as it would encourage firms to make location decisions on the basis of economic fundamentals rather than differing tax rates. Merits aside, Pozen’s approach might also prove more politically palatable, as it doesn’t appear to reward U.S. companies for shipping facilities and jobs out of the country.

In their Wall Street Journal op-ed, Lee and Rubio observe that “if we hope to realize a new American Century, many institutions and government programs will need to be updated, reformed, or replaced.” In a few short months, these two lawmakers have gotten off to an excellent start. If congressional Republicans are to ever deserve the support of rank-and-file conservatives across the country, they should follow Lee and Rubio’s lead. 

The Agenda

NRO’s domestic-policy blog, by Reihan Salam.