One of the most heated debates among Americans is whether to close the so-called corporate loopholes. However, there is wide misconception as to what exactly are “tax loopholes.” According to Eric Toder, co-director of the Left Leaning Tax Policy Center, people view tax loopholes as gaps in the law that corporations have taken advantage of for years. Toder explains, however, that “most of these proposals were not ‘loopholes,’ they were incentives.”
The Most Significant Corporate Tax Loopholes
Among the most attractive loopholes are inventory property sales, graduated corporate income, exclusion of interest on state and local bonds, research and experimentation tax credit, deferred taxes for financial firms on certain income earned overseas, alcohol fuel credit, credit for low-income house investments, accelerated depreciation of machinery and equipment, deduction for domestic manufacturing, and deferral of income from controlled foreign corporations.
The inventory property sales credit benefits multi-nationals with operations in high tax foreign countries. Since the foreign income of American companies is taxed in the country in which it is generated, the U.S. gives a tax credit for that amount in order to avoid double taxation. The cost to the government of this credit on a five-year projection is estimated at $16.7 billion.
Similarly, the accelerated depreciation of machinery and equipment credits benefit large manufacturing corporations in the airline and motor sports businesses that use large equipment that lasts many years. This credit allows companies to deduct all of the depreciation of a piece of equipment at once (as opposed to the amount of time it actually takes for the item to depreciate). The cost to the government of this credit on a five-year projection is estimated at $51.7 billion.
For example, auto racing track owners and the National Association for Stock Car Auto Racing (NASCAR) have greatly benefited from this credit. According to lobbying disclosure forms, NASCAR and track owners have spent hundreds of thousands of dollars lobbying for this credit. Their goal is to make the depreciation classification permanent so racetrack owners can deduct more in expenses, reducing the taxes that they must pay. Supporters in Congress argue that this break is necessary to maintain the current standard expected by their competitors and fans. The opposition groups counter that to keep this credit alive will cost taxpayers $46 million this year and an additional $95 million through 2017. As a result, a worker who earns $50,000 a year will pay at least $80 more per month in taxes.
Large corporations and multi-nationals are not the only ones benefiting from such corporate tax loopholes. The graduated corporate income loophole benefits individuals that own small corporations. This incentive places the first $50,000 of a corporation’s profit at a 15% tax rate, with higher profit levels subjected to higher tax rates until it tops out at 35% for taxable corporate income exceeding $335,000. By paying only 15% in taxes on the first $50,000 of profit, a small corporation is able to retain more money for reinvestment. The cost to the government of this credit on a five-year projection is estimated at $16.4 billion.
The deduction for domestic manufacturing benefits any U.S. company that produces a product within U.S. borders. This credit allows for a tax deduction for manufacturing activities by American companies within the country and covers from conventional manufacturers to industries such as software development and film production. The cost to the government of this credit on a five-year projection is estimated at $58 billion.
Is It A Good Idea To Close The Corporate Tax Loopholes?
During the recent presidential campaign, the issue of whether corporate tax loopholes should be closed was a hot topic. Neither party likes the current tax system for corporations. Both Democrats and Republicans agree it is riddled with too many loopholes. However, the process of closing corporate tax loopholes is not as easy as it seems. If done incorrectly, it could possibly hurt the poor and the working middle class, as well as remove incentives for businesses to invest. According to economists Hane Gravelle and Thomas Hungerford from the Congressional Research Service, “it may prove difficult to gain more than $100 billion to $150 billion in additional tax revenues through base broadening.”
Even if all loopholes were eliminated, the government would not be able to raise trillions of dollars because taxpayers likely would change their behavior to avoid higher levies. Furthermore, more than simply raising taxes on the “rich,” closing loopholes could negatively impact the middle class and poor. As Robert Rubin, President Clinton’s Treasury secretary explained, reducing tax expenditures “will not raise nearly the revenue needed for sufficient deficit reduction without increasing taxes on the middle class significantly.”
It is also important to consider that some loopholes serve vital public purposes such as the research and development tax credit. This credit encourages companies to conduct more research, which benefits their employees, other businesses, and ultimately customers—who pay taxes. In summary, Congress must carefully assess the impact on society of closing any of the current tax loopholes. Closing all loopholes may not raise the desired revenue, and worse, could motivate people to simply adjust their finances to avoid higher taxes and hurt the overall economy in the long run.