The state and local tax deduction for corporations should be repealed in exchange for pro-growth corporate tax reform.
In the Tax Cuts and Jobs Act (TCJA) of 2017, Republicans capped the state and local tax (SALT) deduction for individuals at $10,000. The deduction, which was previously uncapped, disproportionately benefited residents of high-tax states and shielded Democratic governors and legislatures from the full consequences of their high income and property taxes. By capping the deduction, Republicans were able to broaden the tax base, subjecting more income to taxation, which allowed them to reduce tax rates across the board, improving the tax code.
They have the opportunity to do a similar thing for the corporate tax code this year, and they should take full advantage. The corporate tax code also includes a SALT deduction, and it should be eliminated or capped for many of the same reasons that apply to the individual version.
As with individual income taxes, the corporate SALT deduction shields state-level Democrats from the full consequences of their high business taxes. There are probably some businesses that, in the absence of the corporate SALT deduction, would relocate to a lower-tax state.
From Congress’s point of view, repealing or capping the corporate SALT deduction would allow them to do the same things for the corporate tax code that they already did for the individual tax code. As Adam Michel of the Cato Institute wrote yesterday on Substack, capping and eliminating deductions covered about 60 percent of the budgetary cost of the individual tax cuts in 2017. The broadening of the corporate tax base would free up revenue to cut the corporate tax rate further.
The TCJA already did significant work by pulling the U.S. corporate tax rate from the highest in the developed world, at 35 percent, closer to the middle of the pack, at 21 percent. Trump has said he wants to cut the rate to 15 percent.
Ideally, the corporate tax would not exist, as it is a form of double taxation. Corporate profits should be taxed once, when they are distributed through dividends or share buybacks. That way, corporations don’t get punished for retaining profits to invest in workers, equipment, and innovation.
Estonia has a distributed-profits tax of 20 percent. Distributed profits in the U.S. are taxed at 47 percent because they are taxed twice. On a corporate profit of $100, the federal corporate tax plus the average state corporate tax takes $25.77, then federal and state taxes on dividends take another $21.70. The U.S. should strive to adopt the Estonian system, which is flat, transparent, and neutral with respect to how businesses choose to invest.
Eliminating or capping the corporate SALT deduction would get the U.S. one step closer to a flat corporate tax, and the extra revenue that repealing the deduction would raise would allow the rate to be cut further, getting it closer to zero.
Fully eliminating the corporate SALT deduction this time around “could raise between $432 billion and $793 billion over 10 years,” Michel wrote. Cutting the corporate tax rate to 15 percent would reduce revenue by between $460 billion and $675 billion over the same time span. That means it would be roughly revenue-neutral to swap the corporate SALT deduction for a cut to 15 percent.
Another option would be to use the extra revenue raised by eliminating the deduction to implement full expensing of business investments. Currently, businesses have to write off their investments in pieces over many years, never fully recovering the costs. They should be able to write off the full cost of the investment in the year that it is made. The TCJA allowed limited forms of this, which was good, but some of those provisions have phased down or are scheduled to expire.
A 2020 dynamic scoring of full expensing on all business investment from the Tax Foundation estimated it would reduce revenue by about $800 billion over ten years, just a hair more than the upper range of the estimate of revenue raised by eliminating the corporate SALT deduction. There are plenty of partial reforms that would comfortably fit in the revenue range and would still yield economic growth.
If Congress chooses to eliminate or cap the corporate SALT deduction, what it should not do is use the extra revenue to further cut individual taxes. What Republicans did in 2017 was smart because they broadened the individual income tax base to cut individual income taxes. Broadening the corporate tax base to cut individual income taxes would be raising taxes on businesses to pay for individuals.
All taxes are paid by people, whether they are called “corporate taxes” or “individual taxes.” Instead of showing up on individuals’ tax bills, the corporate tax shows up for them in the form of lower wages, lower investment, and lower productivity. Republicans should take this chance to build on their previous successes in reducing the burden of this especially destructive tax.