At a recent Center for American Progress event, Senator Elizabeth Warren (D-MA) announced that there were 50 Democratic senators and the President on board with an idea for tax reform. Unfortunately, that idea is one of Warren’s, and one of her worst at that.
Last year, in the thick of the congressional wrangling over Build Back Better, Senator Elizabeth Warren claimed to have the “solution” to large corporations paying little to no income tax in a given year. Her solution was a “minimum tax,” assessed on corporations’ book income rather than their taxable income.
Under Warren’s original proposal, affected corporations would be required to pay a 7 percent tax on book income over $100 million. In truth, it would function not as a “minimum tax” at all, but rather as a parallel corporate income tax.
Warren and her allies often point to differences between corporations’ book income and taxable income to decry the tax system as rigged, but the truth is that book income and taxable income often differ because they are different measures that serve different purposes. If they were always the same, there would hardly be a need to differentiate between them.
Book income represents a financial accounting of a business’s cash flow, as reported to shareholders. The purpose of the metric is to measure the financial performance of the business in question.
Taxable income, on the other hand, takes into account the tools worked into the tax code to shape economic activity. That means accounting for all the deductions and credits that Congress has added to the tax code over the years.
In this light, a parallel tax to ensure that large corporations do not reduce their tax liability more than Warren deems acceptable seems to represent an extremely roundabout and inefficient means of solving the problem she identifies. After all, if Democrats believe that the tax code’s credits and deductions are too generous, why not just propose to limit the elements of the tax code that allow corporations to limit their taxable income?
The answer is that they want to have their cake and eat it too. Most of the major deductions and credits used by corporations to limit tax liability are backed by most Democrats, including research and development credits, deductions for net operating losses, and accelerated depreciation of capital investments. So while most Democrats see these parts of the tax code as being good for economic growth and fair tax policy, they still want to retain the right to be upset when corporations end up with low tax bills by using them to reduce taxable income.
Unfortunately, it doesn’t work that way. Instituting a parallel tax that doesn’t account for elements of the traditional corporate tax code means that the effectiveness of those credits and deductions is muted, since they won’t help businesses with their book tax liability. After all, a credit that reduces tax liability for half of the corporate income tax code is hardly as beneficial as one that applies to the whole thing.
And this hamfisted workaround to the problem of being unable to point to the actual provisions in the tax code they want to get rid of would have severe economic consequences. The Tax Foundation estimates that the 7 percent parallel book tax would have a greater negative impact on GDP, employment, and wages than raising the corporate tax by 7 percentage points — largely by discouraging the kind of corporate investment that drives economic growth.
It might be politically popular to claim to be cracking down on corporations that “cheat the system,” but Congress is the one designing the system in the first place. Taxpayers should demand that instead of adding another layer to make the tax code even more complicated and unwieldy, Democrats should point out the parts of the tax code they actually want to “fix.”