Some Quick Thoughts on the Math of Obama’s Corporate Tax Reform Plan

Update, 10/4/12: Where bolded, I have updated some of these numbers to reflect more recent estimates and to “show my work”. Note that all estimates are 10-year estimates.

Yesterday, President Obama put forth his framework (pdf) for corporate tax reform. I’ve written at length about the international component of the reform—see my FT piece or my Huffington Post piece—so let me concentrate for now on the domestic side.

Here are the key components:

• Reducing the statutory rate from 35% to 28%.

• Eliminating “dozens” of corporate tax expenditures.

• Expanding two tax expenditures—one for manufacturing, and another for R&D.

• As a package, the proposal will not “add a dime to the deficit.”

Reducing the rate by seven percentage points would cost roughly $360 billion over five years$930 billion over ten years (7/35*projected corporate tax revenues), and the expansion of the manufacturing and R&D expenditures would add another $125 billion or so over five years$250 billion or so over ten years. So the total cost would be $1.3 trillion over ten years.

Obama would pay for this by broadening the corporate tax base. Although he specifically mentions eliminating five tax expenditures, it’s clear that these represent only a token amount of savings:

Note: These numbers have been updated; they come from the most recent “Green Book.”

  1. Favorable treatment of carried interest: $13.5 billion
  2. Accelerated depreciation of corporate jets: $2.2 billion
  3. Oil & gas subsidies: $29.5 billion
  4. Moving from last-in-first-out to first-in-first-out: $73.8 billion
  5. Reforms to the treatment of insurance companies: $16 billion

That’s $135 billion total if you assume a 35% tax rate—with a 28% tax rate, eliminating these tax expenditures would only raise $108 billion. At this point, Obama is still almost $1.2 trillion in the hole.

After mentioning these five particular tax expenditures, the proposal “lays out a menu of options that should be under consideration in reform.” Specifically, the proposal suggests:

• “Establishing greater parity between large corporations and large non-corporate counterparts” such as partnerships, LLCs, and S corporations. Without raising taxes on small businesses, this won’t be able to raise much revenue.

• “Addressing depreciation schedules.” This has a bigger budgetary impact—up to $109 billion over five years.

• And most importantly, “Reducing the bias toward debt financing.” I believe that this component could hold the key for the entire reform.

Reducing the tax preference for debt makes economic sense. Typically, economists want companies to make decisions based on underlying economic factors, not tax treatment. So harmonizing the treatment of debt with the treatment of equity could enhance economic efficiency.

Furthermore, reducing the tax deductibility of interest could raise significant revenue to pay for rate reductions. Nonfinancial corporations spend roughly $1 trillion each year (pdf–see Table 5 on Page 61) on interest expense. It would not be practical to completely end the tax deductibility of interest, but there are some proposals (pdf–see pages 72-74) floating around, such as limiting the deduction above a certain threshold. So, as this proposal develops and the details are filled in, expect the tax treatment of interest to be central in the discussion.

Bob Pozen is a Senior Lecturer at Harvard Business School and a Senior Fellow at the Brookings Institution. His latest book, Extreme Productivity, is now available at your favorite local or online bookstore.

One thought on “Some Quick Thoughts on the Math of Obama’s Corporate Tax Reform Plan

  1. I’d be interested in your opinion on the proposed minimum tax on overseas profits. There are already significant tax incentives for corporations to transfer or develop intangible assets off-shore; with a minimum international tax there would be even more reason to avoid the U.S. entirely if possible. Ideally we’d have a system that encouraged R&D without penalizing non-U.S. aspects of a corporate structure.