February 25, 2012

PRESIDENT OBAMA’S plan to reform America’s corporate tax system begins with a succinct and accurate summary of its flaws. The top rate, 35 percent, is among the world’s highest, putting the United States at a competitive disadvantage abroad. Myriad loopholes and subsidies result in misallocation of capital and wasteful complexity.

Broadly speaking, the president’s prescription is right, too: Reduce the top rate to 28 percent and pay for the reduction by eliminating or reducing such items as oil and gas tax breaks or the deduction for interest, which favors debt financing over equity. One major tax expenditure, the credit for research and development, would be made permanent. This is justified: Private-sector underinvestment in R&D is a market failure requiring government correction.

Having announced the sound principle that tax laws should not favor or disfavor certain sectors of the economy, Mr. Obama unfortunately violates it. Under his plan, manufacturing would pay 25 percent instead of 28 percent. This would perpetuate a tax advantage manufacturing already enjoys, without guaranteeing a net benefit to the economy. The administration argues that manufacturing investments generate uniquely positive side effects such as supporting a cadre of engineers and other skilled workers. The question is whether steering capital into manufacturing would deny resources to some other sector that might generate even more positive returns to society.

No doubt businesses would keep a small army of lobbyists busy trying to qualify for the lower manufacturing rate or for the even lower rate for “advanced manufacturing” that Mr. Obama advocated — without specifying the rate or defining “advanced.”

Mr. Obama does not go as far in this unwise direction as a Republican opponent, former Pennsylvania senator Rick Santorum, who wants manufacturers to pay zero percent. And Mr. Obama offered more details than former Massachusetts governor Mitt Romney, who said on Friday that he wanted to lower the corporate rate to 25 percent, but did not identify offsetting reductions in loopholes.

Republicans in Congress predictably found fault with the president’s plan. A major disagreement is the treatment of U.S. corporate profits earned abroad, a dizzyingly complex issue that pits labor unions against corporations and different kinds of companies against one another. The administration favors subjecting those earnings to a minimum tax, as opposed to the de facto partial exemption they enjoy now. Mr. Romney and Dave Camp (R-Mich.), chairman of the House Ways and Means Committee, favor eliminating most or all taxation of foreign earnings. The economic merits of the overseas profits issue are hotly disputed, which suggests lawmakers can eventually compromise as part of a broader deal.

Indeed, there’s a lot on which Republicans and Democrats agree. Mr. Romney pointed to some of the same deficiencies in the current corporate code that Mr. Obama identified. Mr. Camp, who also has a plan to cut the top rate to 25 percent, at least said he “look[ed] forward to discussing” the Obama plan. Probably nothing will get settled before the election. But corporate tax reform is so necessary that it might have a chance even in Washington.