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A wake-up on foolish tax policy

By John Spry

St. Paul Pioneer Press (MN) – Sunday April 1, 2012

The United States now has the highest  statutory corporate income tax rate in the industrialized world since Japan, as  of April 1, has cut its rate to 35 percent.

That’s not an April Fool’s Day joke, but it is a foolish tax policy.

Our 41.4 percent combined-federal-plus-Minnesota corporate income tax rate is 66 percent higher  than the average rate in other industrialized nations.

That large, uncompetitive tax gap hurts American workers through “reduced employment opportunities and lower wages”  according to President Obama’s Job Council.

Yet, U.S. corporate tax revenue is below average, compared to the size of the economy, because the high rate discourages  taxable investments and because of the many special tax credits, deductions and exclusions in the tax code.

Each dollar of corporate income tax revenue costs the private sector around $2 in economic damage, according to  economist Jane Gravelle of the Congressional Research Service.

Over $40 billion a year is wasted filing and auditing corporate tax forms. We are completely wasting resources that could  go toward productive, job-creating investments.

The United States has an indefensible corporate income tax code because Washington has paid too much attention to  special tax preferences for specific firms and industries and too little attention to the changing world economy.

“In a global economy in which capital can move easily across borders, differences in corporate tax rates have a growing influence on where multinational companies decide to invest,” says the President’s Job Council. “Yet while most of our competition has reduced their  rates significantly over the past three decades, corporate income taxes in the U.S. have changed very little. Broadening the tax base would simplify the tax code and enable the U.S. to lower the corporate income tax rate to internationally-competitive levels,” according to the President’s Job Council.

The current tax code foolishly favors debt financing over equity financing. It imposes a double tax on equity first at the  corporate level and again when dividends are paid. Yet, interest is tax-deductible.

The effective corporate tax rate on equity financed investments is slightly higher than the statutory rate, while the  effective tax rate on debt-financed investment is negative.

The history of Northwest Airlines provides a case study of the problems with subsidizing debt. Al Checchi saddled Northwest with massive debt in his 1989 leveraged buyout. Northwest got the tax benefit of deducting the increased interest payments, while using the threat of bankruptcy due to the new, staggering debt to win lower wages from its workers and a large bailout from the State of Minnesota.

Narayana Kocherlakota, president of the Minneapolis Federal Reserve Bank, suggests broadening the tax base by “replacing the corporate interest tax deduction with a lower corporate income tax rate. The lower corporate income tax rate would encourage business investment without simultaneously providing incentives for corporations to acquire leverage.”

The United States should lower its corporate income tax rate below the international average of 25 percent, while ending tax preferences for politically favored activities. The tax code should raise necessary revenue to run the government while imposing the smallest possible administration, compliance, and efficiency costs on people.

Corporate tax reform is about more than just equalizing tax rates for different types of business investment or making  life simpler for accountants and auditors. Ultimately, tax reform is about the fundamental relationship between citizens and the government.

When the government picks winners and losers through the tax code, the political establishment wins more power over the private sector economy. The Washington, D.C., area becomes more prosperous than the nation as whole. The free enterprise system is replaced by the soft  corruption of crony capitalism. People start to question whether financial success is due to successful competition to serve customers or the result of special favors from the government.

The politics of tax reform are challenging since every lobbying group with a sweetheart deal in the tax code, from heavily indebted industries to the green energy lobby, will fight hard to defend their group’s tax preference.

Only a focus on the real costs to people from our uncompetitive tax code has a shot of making tax reform possible. As we better understand the lower wages and lost job opportunities caused by our current tax code we increase the odds of reforming the tax code.

John A. Spry is an associate professor in the Department of Finance at the University of St. Thomas. Find him online at