President Obama’s Budget Proposal Violates the Principles of Sound Tax Policy

This week President Obama rolled out his budget proposal, which again demonstrates how incredibly out of step the president is with the rest of the country. Just a couple of weeks after outlining $320 billion in tax increases during his State of the Union address (and quickly backtracking on a plan to tax 529 college savings accounts), President Obama rolled out a budget proposal that would increase taxes by more than $1 trillion. Keep in mind that these proposals follow an election cycle that ousted tax hiking governors and swept governors promising to reduce taxes in Massachusetts, Illinois and Maryland.

In addition to the historic gains of fiscally responsible candidates in the last election cycle, 14 states acted to reduce taxes in 2014 and 17 states did so in 2013. Rather than taking cues from elections and economic leaders in the states, President Obama moved in the opposite direction with a proposal to dramatically increase taxes and spending. Overall the president’s budget proposal would increase current spending levels by 6.4 percent, resulting in a budget spending nearly $4 trillion.

Much of the president’s budget includes ideas outlined in the State of the Union address, including increasing the top capital gains rate from 23.8 percent to 28 percent and raising the death tax, which we have analyzed previously. However, the core of new taxes to pay for the massive increase in spending would come from a proposed “one-time” tax of 14 percent on corporate overseas earnings, of which there is about $2 trillion. But the proposal to tax foreign earnings doesn’t stop there, the budget also calls for a permanent 19 percent on future overseas corporate earnings. To understand the full gravity of this incredible revenue grab, it will help to review our current poorly designed corporate income tax.

In addition to having the highest corporate income tax rate in the developed world, at 35 percent, the United States in one of only a few countries that operate on a global corporate tax system. This means that when U.S. corporations earn income overseas, they pay taxes to the country in which the income was made. Then, if they want to bring that income back to the U.S., they receive a credit for the taxes paid to the foreign nation but must pay the difference between what was already paid to the foreign government and the U.S. tax rate of 35 percent. For example, company X makes $100 in profit and is taxed 20 percent by the government where that profit was earned. To bring the remaining $80 back to the U.S., they must pay an additional 15 percent in taxes (on the original $100).

Since the U.S. only collects this tax when the income is repatriated, many corporations keep that income out of the country, and, unless the president’s tax proposal is passed, that tax is deferred until the corporation brings that income back to the U.S. This creates a major incentive for corporations to keep profits earned abroad out of the U.S. and away from the IRS. By contrast, the vast majority of countries operate on a territorial tax system, meaning that when income is earned overseas, the corporation pays taxes where the income was earned only and is free to repatriate that income at any time with no tax penalty.

The best policy would be to switch the current global corporate income tax system to a territorial one and simultaneously lower our highly uncompetitive corporate income tax rate. But, instead the president’s budget would pull the rug out from many corporations by changing tax rules after business decisions have already been made based on current tax law. Not only would this negatively impact economic growth, but it would also make the U.S. corporate tax system even more hostile and uncompetitive.

A core component of sound tax policy is predictability. Changing tax rules for existing income, rather than future income, makes it difficult to plan and make decisions. While the states are busy reducing taxes and kick starting economic growth, the president’s proposal violates sound tax policy and hurts future prospects for higher rates of economic growth.

In Depth: Cronyism

Cronyism in tax policy stifles innovation, hinders competition and introduces a deep temptation for corruption. The 2014 ALEC Center for State Fiscal Reform study, The Unseen Costs of Tax Cronyism: Favoritism and Foregone Growth, found that in the most recent year in which states published their respective tax expenditure…

+ Cronyism In Depth