What President Obama Got Right (and Wrong) in the State of the Union

flickr / Barack Obama

I heard a lot of things I liked during President Obama’s State of the Union address this evening. I also heard a couple of things I didn’t like. I’ll get to those.

I want to talk specifically about his statements on corporate taxation. I’ll have to leave his statements on individual taxes to someone else. From the transcript of tonight’s State of the Union:

Right now, companies get tax breaks for moving jobs and profits overseas. Meanwhile, companies that choose to stay in America get hit with one of the highest tax rates in the world. It makes no sense, and everyone knows it…So let’s change it. [N]o American company should be able to avoid paying its fair share of taxes by moving jobs and profits overseas. From now on, every multinational company should have to pay a basic minimum tax.

Obama is referring to a number of things here, but most notably he’s talking about tax code overhaul and simplification. This approach involves two components. First, legislators would close loopholes that allow companies to drive down their effective tax rates far below the official rate. Second, Obama and members of Congress would lower the corporate tax rate.

This approach has its merits. There are far too many corporate tax loopholes—which are deductions, credits, and other tax expenditures that benefit certain activities—and they often result in very different marginal tax rates for different companies who conduct very similar business activities. Obama is right that we should close these loopholes to align the effective corporate tax rate with the official rate. Proponents hope this approach would level the playing field so that corporations all pay the same rate or as Obama calls it a “minimum tax.”

I also agree that legislators should couple a (thorough) closing of tax loopholes with a reduction in the corporate tax rate. If U.S.companies paid the current official corporate tax rate—not their effective rate that includes loopholes—they would pay the highest rate among developed nations. Maybe we can argue about whether or not this is economically viable, but I don’t believe it would make sense for U.S. companies to pay a full 14% more than their UK counterparts and 9% more than those in Germany.

But that’s not to say corporate taxes should be reduced drastically. As Citizens for Tax Justice has pointed out the cumulative effect of these changes should be “revenue-positive,” which means that revenue gains which result from closing tax loopholes should more than offset the revenue losses from the reduction in the corporate tax rate.

Are these reforms politically achievable? Maybe. Pat Heck, a partner at the Washingtonlaw firm KL Gates, already called Obama’s statements a potential “game changer.” “While it would be naïve to think tax reform legislation will be drafted overnight,” he noted “a long journey always begins with a first step.” True.

But even if these reforms are enacted there is no guarantee they would work. The truth is that Obama’s minimum tax rate can only be achieved if domestic tax reforms are enacted in conjunction with international tax reforms. Multinational corporations reduce their effective tax rates not just through loopholes, but also by using transfer pricing to shift profits to low tax jurisdictions and retain losses in the high ones. We can close all the loopholes we want, but if we don’t change these practices we’re not going to effectively align the effective corporate tax rate with the official rate.

Obama did obliquely refer to this reality when he said: “[N]o American company should be able to avoid paying its fair share of taxes by moving…profits overseas.” But it’s one thing to talk about the problem and another to endorse the solutions. Only time will tell if the President will embrace those solutions.