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Corporate tax reform is an arcane subject that rarely reaches the public consciousness. But sometimes even the dullest topic gets its moment in the spotlight: The Democratic candidate, Senator John Kerry, has proposed changing the tax system to make it less appealing for companies to move jobs overseas. Liberals point out that companies are paying an historically low share of their income in taxes, even while CEOs complain about being hit by the corporate alternative minimum tax.
That's why it's time to start thinking about changing both the way corporate income is taxed and the way corporate taxes are reported to investors. Start with the system itself. Right now, the U.S. has the worst of both worlds: a high corporate tax rate of 35% combined with an excessively complicated set of loopholes, special provisions, and tax shelters that allow most corporations to pay far less in reality.
The main goal should be to lower the corporate tax rate substantially, while simplifying the corporate tax system and broadening the types of income subject to tax -- with the aim of collecting the same amount of revenues. The lower rate would make it less worthwhile for corporations to go to the trouble of constructing elaborate tax shelters. It would boost aftertax return on investment, encouraging companies to buy new equipment and fostering long-term growth. Moreover, companies now have an incentive to reinvest their profits abroad, since they can defer paying taxes on overseas earnings until they are brought back to the U.S. A sharp cut in the corporate tax rate -- to far below the 33.25% suggested by Kerry -- would reduce that incentive.
Corporations must also provide more and better data about their tax liability in their financial statements. Today, it's difficult for even experienced investors to understand how much of its taxes a company is paying, and how much it may be able to defer indefinitely. After the Financial Accounting Standards Board finishes dealing with stock options, it should turn its attention to improving accounting for corporate taxes. That would be good news all around.