Tax Reform Plan Draws Skeptics

President Barack Obama’s plan to overhaul business taxes by lowering rates while repealing dozens of deductions and subsidies is drawing sharp criticism from the chemical industry and other businesses that fear the proposal would hurt their ability to compete in the global market.

At the same time, activist groups are attacking the Administration’s framework for being too timid and not raising more money from corporations to help address the U.S.’s long-term budget deficit and protect government programs.

“In order to make us more competitive and create jobs here at home, we must reform our corporate tax code,” Treasury Secretary Timothy F. Geithner remarked on Feb. 22 as he outlined the plan. “We want to restore a system in which American businesses succeed or fail based on the products they make and the services they provide, not on the creativity of their tax engineers or the lobbyists they hire.”

Business groups aren’t buying it. “The President has said he wants America to lead the world in manufacturing, and we strongly support that goal,” says Calvin M. Dooley, president and chief executive officer of the American Chemistry Council, a trade group representing more than 140 U.S.-based chemical manufacturers. “Getting there will require a fair, simple tax system that allows U.S. companies to compete evenly abroad. Unfortunately, this proposal falls short.”

On the other side, several organizations criticize the plan for failing to generate more tax revenue. “It’s very disappointing that the President has proposed what is at best ‘revenue neutral’ corporate tax reform,” says Robert S. McIntyre, director of the liberal tax advocacy group Citizens for Tax Justice. “We can and should collect more tax revenue from corporations. Right now, America’s biggest and most profitable corporations are paying, on average, a ridiculously low amount in federal income taxes, and many of them are paying nothing at all.”

The long-awaited reform plan would reduce the top corporate tax rate to 28.0%, down from 35.0%, which is currently the second highest in the industrialized world after Japan. Left unchanged, the U.S. corporate tax rate will soon become the highest in the world when Japan implements a planned rate cut in April. Under the Administration’s proposal, the top U.S. tax rate for businesses would drop to fourth highest among developed countries, after Japan, France, and Belgium.

The average global corporate tax rate is 25.0%, with rates as low as 8.5% in Switzerland and 12.5% in Ireland.

Geithner acknowledged that tax reform, which analysts say has little chance of passing Congress in this election year, will be “politically contentious.”

The President’s proposal would eliminate numerous loopholes in the current tax code that Geithner said benefit a favored few and are “fundamentally unfair.” And it would impose a new minimum tax on the foreign earnings of U.S. companies, a move that is opposed by multinational corporations and perhaps is the most contentious provision in Obama’s plan.

Most countries have territorial tax systems, taxing only income earned within their borders. The U.S. is one of the last countries that taxes corporations on their worldwide income. Multinationals can defer paying U.S. taxes on income earned overseas until they bring the money home, either by paying dividends or investing in the U.S. In many cases, however, foreign profits are simply reinvested overseas, so they are never subjected to U.S. taxes.

“Our tax system should not give companies an incentive to locate production overseas or engage in accounting games to shift profits abroad, eroding the U.S. tax base,” Geithner said.

But business groups maintain that many elements of Obama’s plan would put the nation at a competitive disadvantage around the world. The new minimum tax on foreign income, for example, “would doubly tax U.S. companies that have become global leaders—a very anticompetitive proposal,” Dooley says. “We hope the Administration will consider moving to a territorial system, as has virtually every other modernized country.”

Dooley also says that the plan’s higher taxes on oil and natural gas companies “could inhibit domestic energy production just as new supplies are helping U.S. manufacturers grow and create jobs.”

The Administration, he adds, should set aside its “piecemeal” proposal, warning it could further erode U.S. manufacturing and kill more American jobs. “Any future proposal must be comprehensive, with ample time for transition, in order to preserve American competitiveness,” Dooley says.

Under the President’s plan, some businesses would pay more taxes and others less. The oil and gas industry would pay substantially more because many tax breaks for fossil fuels would end. But a tax credit that encourages the production of wind, solar, and other renewable energy technologies would be made permanent.

The framework would also give preference to manufacturers by lowering their maximum effective tax rate “to no more than 25%, while encouraging greater research and development,” a Treasury Department document states.

The Administration’s proposal would permanently authorize a long-standing but temporary R&D tax credit. Since its enactment in 1981, the credit has been repeatedly renewed by Congress for a year or two, and at times it has been allowed to lapse temporarily. Many businesses say that the uncertainty has blunted their R&D efforts.

In addition to making the tax credit permanent, the President’s plan would increase the value of the R&D incentive from 14.0% to 17.0%.

“The President suggests some changes that will help, but many of the proposals completely miss the mark and would make U.S. businesses less competitive,” says Jay Timmons, president and CEO of the National Association of Manufacturers, the nation’s largest industrial trade group.

Thanks to the bevy of tax breaks available to them, U.S.-based companies now pay vastly different effective tax rates, with many far below the 35.0% statutory rate. A company’s effective tax rate is the actual amount it pays in federal taxes as a percentage of its income.

The most recent studies show that the average effective corporate tax rate for corporations with headquarters in the U.S. is roughly 27.0%, whereas the average in other developed nations is about 20.0%, according to the Tax Foundation, a nonpartisan research group based in Washington, D.C.

By contrast, a report published by Citizens for Tax Justice in November 2011 found that dozens of large U.S. corporations paid no federal taxes in recent years, and many received government subsidies despite earning healthy profits. The average effective tax rate for the 280 companies examined from 2008 to 2010 was 18.5%.

And 78 of those companies—including Eli Lilly & Co., Eastman Chemical, and DuPont—enjoyed at least one year in which their federal income tax was zero or less. “Our study provides proof that too many corporations are already being coddled by our tax system,” McIntyre says.

In Congress, Republican reaction to the Administration’s plan has been largely negative. Sen. Orrin G. Hatch of Utah, the ranking Republican on the tax-writing Senate Finance Committee, calls the framework “ill-defined” and chides Obama for ignoring recommendations from Republicans to lower the corporate rate to 25.0%. The President’s plan amounts to a “set of bullet points designed more for the campaign trail than an actual blueprint for fixing our tax code,” he charges.

But Senate Finance Committee Chairman Max Baucus (D-Mont.) says the proposal will “advance the discussion on tax reform” and help set the stage for a battle that likely will not be resolved until after the November elections.

“Businesses are looking for certainty, simplicity, and fairness, and replacing the patchwork we have right now with a modern tax system will be a major shot in the arm for our economy,” Baucus says.