CONGRESSIONAL REPUBLICANS have a big new idea on corporate taxation that could nudge U.S. economic policy in a positive direction, if GOP lawmakers get certain details right, which is a big if.
First, the proposal, which Ways and Means Committee Chairman Kevin Brady (R-Tex.), labels “a key part of our built-for-growth” tax reform plan: Companies based in the United States would be taxed at a flat 20 percent, as opposed to brackets up to 35 percent (riddled with deductions) under current law. The tax would be levied only on net income earned within this country — revenue from exports would be effectively tax free. Also, companies would write off new investment immediately, but lose the deduction for interest expenses they currently enjoy. When you put these changes together, they create fresh incentives to locate economic activity — and register ownership of intellectual property — within the United States, to export rather than import, and to finance businesses with equity rather than debt. Other things being equal, that could improve tax efficiency and domestic job creation.
Like any major tax change, this one would create winners and losers. Perhaps hardest hit would be the real estate and financial industries, whose business models depend heavily on the current deduction for interest expenses. The best response to this concern is that recent experience suggests the U.S. economy might be just a bit over-dependent on real estate and finance. Major retailers, for their part, fret that the after-tax cost of importing the products they sell would go up; refiners of imported crude oil could also face higher costs, which may be why a spokesman for Koch Industries, of Charles and David Koch fame, threw cold water on the idea. Supporters of the plan respond, plausibly, that changes in currency exchange rates could offset any initial impact on import costs.
Now, alas, for those worrisome details. The GOP plan should add nothing to the deficit; it would be self-defeating, in economic terms, to have a debt-discouraging tax system for corporations that was debt-increasing for the government. Perhaps even more important, the Republicans are going to have to figure out how to make such a huge de facto shift in the U.S. tax treatment of imports compliant with international trade law. In its current iteration, the proposal would allow corporations to deduct the costs of wages paid within this country — a nice reward for hiring Americans and paying them well, which for complex reasons could be construed as a discriminatory subsidy under existing World Trade Organization doctrine.
No doubt President-elect Donald Trump’s instinct would be to dare other countries to sue us at the WTO and then resist a contrary ruling if and when it comes. A more intelligent strategy would be to devise an alternative that accomplishes the economic purpose of the wage-expense deduction without running the same legal risk. To be sure, history suggests that the biggest danger of all is that lobbyists will gut the GOP proposal of everything except the new, reduced flat rate. As a conversation-starter about the future of corporate taxation, though, the plan has already done some good.