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Posted at 5:35 PM ET, 02/ 7/2011

One man's loophole is another man's R&D tax credit

By Ezra Klein

"So tonight, I’m asking Democrats and Republicans to simplify the system. Get rid of the loopholes. Level the playing field. And use the savings to lower the corporate tax rate for the first time in 25 years -- without adding to our deficit. It can be done."

That, of course, was Barack Obama at the State of the Union, calling for corporate tax reform. But if you want to see why corporate tax reform will be so hard -- and why it remains such a longshot -- read Eric Toder's breakdown of the corporate tax code. The first number to keep in mind is $640 billion. That's how much the various breaks and deductions and off-ramps are projected to cost between 2011 and 2015. Wipe them all out and you could bring the rate down from 35 percent to 23 percent without losing a dime in revenue. Sounds great, right? Well, it won't sound as good once you hear what's hiding behind the word "loophole."

The largest estimated loss ($169 billion) over five years comes from deferral of foreign source income of U.S. multinationals. In the past, the revenue gain from eliminating deferral has been estimated as much smaller than the ongoing revenue cost under current law. And the corporate leaders now advising the President are likely pushing him to move in the opposite direction, following our major trading partners, who exempt foreign-source income. The second largest, accelerated depreciation of machinery and equipment, costs an estimated $147 billion. But this tax expenditure, which broadly subsidizes domestic investment for a wide range of business firms, has just been increased, with the support of the Administration, by allowing full expensing for investments made in 2011. The President has endorsed making the research credit permanent (scored at $13 billion over 5 years last year, but since increased because Congress extended it) and no one would even consider eliminating expensing of research and experimentation activities ($32 billion over 5 years).

Other items among the ten costliest provisions that seem unlikely to get chopped include the credit for low-income housing ($36 billion), accelerated depreciation on rental housing ($41 billion), and exclusion of interest on hospital construction bonds ($21 billion). Adding up all these items reduces the potential saving from $640 billion over 5 years to just $180 billion, or less than 10 percent of 5-year corporate revenues. And even getting this far would require eliminating alcohol fuel credits -- think, Iowa primary -- ($32 billion), the deduction for domestic production activities ($77 billion), preferential tax rates for small corporations ($16 billion), and all tax incentives for renewable energy ($26 billion, excluding alcohol fuels). The only tax breaks the President proposed removing in his speech were tax breaks for fossil fuels -- a mere $14 billion over 5 years.

Those won't be easy to get rid of. Some of them wouldn't even be wise to get rid of. And every time one "loophole" gets preserved, another group of corporations can make a stronger argument that their favored tax breaks should also be preserved. After all, do you really want less domestic production? Less research and development? Less clean energy investment? More corporations moving overseas?

By Ezra Klein  | February 7, 2011; 5:35 PM ET
Categories:  Taxes  
Save & Share:  Send E-mail   Facebook   Twitter   Digg   Yahoo Buzz   StumbleUpon   Technorati   Google Buzz   Previous: The death of the DLC?
Next: Reconciliation


Corporate tax loopholes are just the next iteration of earmarks and waste, fraud, and abuse and welfare queens. Everyone agrees they're bad and we should get rid of them, but it turns out they don't really exist the way politicians talk about them.

Posted by: RobertBeard | February 7, 2011 6:56 PM | Report abuse

Ezra, could your own posts dealing with how hard it is to reduce the deficit maybe cause you to start waking up to the sectoral balances:
and the simple fact that Government deficit is largely non-discretionary. They are the accounting offset of: Current Accounts Deficit (M-X) and Private sector surpluses (S-I). Substantially reducing govt deficits without either/or (a) turning around our trade deficit into a trade surplus ; (b) driving domestic private sector into deficit is impossible, by the inescapable logic of the accounting identity above.
Do not try to square a circle, learn to love the deficits:

Posted by: pdrub | February 7, 2011 7:32 PM | Report abuse

If you want to see why corporate tax reform fails in one graph (effective tax rate by industry):

The source is listed on the site -data was collected from hundreds of listed companies over years.


Posted by: chrisgaun | February 7, 2011 10:22 PM | Report abuse

"no one would even consider eliminating expensing of research and experimentation activities "

That's because they are EXPENSES. You don't tax expenses... On the other hand, the credits are out of line.

Posted by: staticvars | February 7, 2011 10:56 PM | Report abuse

Thank you so much for pointing this out. I felt like the blogosphere was completely ignoring this point and shouting "get rid of tax loopholes!" the way some shout "cut the deficit!" without pointing out the hard choices behind the words.

Posted by: madjoy | February 8, 2011 4:25 PM | Report abuse

Here'a an idea. Cut all of the loop holes and just give grants to those specific areas you want to boost. You could lower the rate and make collection much easier. There would be added expense in administrating the grants, but it could be done. You also could more narrowly target those areas of "research" that get incentives. It would probably reduce graft.

Posted by: hotbbq | February 9, 2011 11:39 AM | Report abuse

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