Baby Carrots and Big Sticks – The Failure of Obama's Tax Plan

When it comes to collecting taxes the government’s options can be broken down as carrots and sticks. Carrots are pursuing reforms that encourage more people to drop tax avoidance schemes and pay the tax. Sticks are trying to implement penalties to try and make people pay a tax.

In his latest tax plan, released yesterday, President Obama tries both. The problem is we’re talking baby carrots and big sticks, a recipe for disaster.

On the carrot side, the President’s plan proposes lowering the corporate tax rate from 35 to 28 percent. If seven percentage point sounds like a lot, that’s because it is. The problem are current tax rate is so high compared with the rest of the world that even that large of a cut would not be enough to make us competitive on the world stage.

“We need to remember that when the roughly 6.4 percent average state rate is added to the federal rate (and adjusted for federal deductibility) the new overall U.S. rate would be 32.6 percent, down from the current rate of 39.2 percent,” writes Tax Foundation president Scott Hodge.

That would mean U.S. businesses would go from suffering under the highest overall corporate tax rate in the world to the fourth highest. Not exactly a guaranteed boon for entrepreneurs looking for a country to set up shop. After all, Obama’s plan would still leave us with a higher overall rate than welfare states like Italy, Sweden, and Finland as well as close trading partners like Canada, the U.K., and Korea.

Obama would supposedly achieve these rate reductions by eliminating “dozens of business tax loopholes and tax expenditures.”

In this part of the plan the president is sure saying all the right things. The report points out that “preferences created by tax expenditures and loopholes add complexity to the tax system and contribute to the substantial business tax compliance burden.” It also rightly points out that such preferences can create significant economic distortions as businesses use the tax code rather than market cues to make investment decisions, leading to an inefficient allocation of capital.

But in terms of execution it leaves much to the imagination. Rather than the “dozens” of loopholes it promises to eliminate, it rarely gets specific.

“The administration proposes to close a mere 6 loopholes, out of about 250 (according to the Joint Committee on Taxation.) Worse, the administration proposes to add 11, for a net gain of 5 loopholes,” writes William McBride on the Tax Foundation’s blog.

Given recent history it should come as little surprise that those new loopholes are for green energy and manufacturing. Under Obama’s plan the top corporate rate on manufacturing would be 25 percent and even lower for “advanced manufacturing,” despite literally no one having any idea what that means.

One thing we do know is that rather than eliminate market distortions, as the paper suggests, the tax policies will encourage more Solyndras at the expense of other companies. Moreover, it is not at all clear why manufacturing, whether green or otherwise, is deserving of the specialized treatment the Obama Administration is giving it.

Even Christina Romer, the former chair of the Council of Economic Advisers who argued for a $1.8 trillion stimulus, is against the idea. “As an economic historian, I appreciate what manufacturing has contribute to the United States,” Romer wrote last week in the New York Times. “But public policy needs to go beyond sentiment and history. It should be based on hard evidence of market failures and reliable data on the proposals’ impact on jobs and income inequality. So far, a persuasive case for manufacturing policy remains to be made…”

Even though all the carrots don’t add up to much, Obama does include one giant stick to make sure that companies fall in line with his policies. The plan envisions a new “minimum tax on foreign earnings,” that would penalize multinations with an as yet unspecified rate increase.

This return to the failed policy of mercantilism will do nothing to make the United States a more attractive destination for capital, nor will it encourage businesses to flock to our shores. Rather, it will incentivize the exodus of businesses to lower tax countries, leaving America with a high-corporate rate, with few avoidance avenues, but sadly no one around to pay it.

Obama’s reliance on the stick of punishment rather than the carrot of incentives is what ultimately dooms his plan, and should it pass, our economy, to failure.