Fit to Be Tied

Corporate America and Uncle Sam may finally see eye to eye on tax reform.

Maybe conditions have finally gotten bad enough to inspire something good.

When President Obama came to Washington, D.C., two years ago, he vowed to overhaul the corporate tax code. Featuring the second-highest tax rate in the industrialized world after Japan, it was widely blamed for making U.S. corporations less competitive in the global economy and discouraging domestic investment.

The United States taxes corporate profits at a rate of 35%. State income taxes push the average total burden to 39.2%. By contrast, the average combined rate for the 30 industrialized countries in the Organization for Economic Co-operation and Development is about 25%, and most of those countries, unlike the United States, do not tax profits earned outside their borders.

Obama’s call for change didn’t bear fruit, as two wars and the push for health-care reform took precedence. But now, for a host of reasons, the President is again talking tax reform. Treasury Secretary Tim Geithner has floated the idea of ratcheting the rate down to the “high 20s” while eliminating many tax credits and deductions. The ostensible end-goal of this “revenue neutral” approach is a simpler and more equitable tax code that generates the same amount of income for the government as the current system, but from a broader tax base.

It’s no shoo-in, but some political observers think too much has changed over the past few years to let this chance for reform slip away. Not only has the federal debt ballooned to around $14 trillion, from $9 trillion at the end of fiscal 2007, but unemployment continues to hover stubbornly around the 9% mark despite seven consecutive quarters of GDP growth. On the political front, the wave of conservative Republicans who swept into Congress in the midterm elections is agitating for smaller government, and nothing says “smaller government” like a reduced tax rate.

Thank You, Japan?

But the single biggest impetus may not come from within the country’s borders, but from without. Japan is considering a 5% cut to its corporate tax rate, which would bring it below current U.S. levels. “I’ve got to believe that fact alone will increase the urgency of Washington to address this,” says Scott Hodge, president of the Tax Foundation, a Washington, D.C.-based think tank.

Corporate tax revenue as a share of GDP

Robin Beran, director of global tax and trade for $42.6 billion heavy-equipment maker Caterpillar Inc., is hopeful. “The U.S. is losing ground rapidly in terms of being a good place to invest or headquarter,” he says. “I think the political environment has moved enough to where we’re going to have a more serious discussion about tax reform. But it may take one of those highly motivating ‘crises’ that Rahm Emanuel used to talk about, such as further job losses or just no job growth, to actually get something to happen.”

Tax reform is never an easy sell. “No matter how you do it, you have people who win and people who lose,” notes Chuck Marr, director of federal tax policy for the Center on Budget and Policy Priorities, a Washington, D.C.-based think tank. “And human beings are loss-averse.”

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