Taxes: Retreat From Reform?

The U.S. tax code is too cumbersome and confusing, manufacturers say. George W. Bush agrees. A presidential advisory panel this summer will suggest ways to make the system simpler and fairer. But U.S.-based manufacturers shouldn't count on seeing much in

Barring an unforeseen economic crisis or the formation of an unexpected political coalition, you can just about write off the possibility of even relatively minor manufacturing-friendly tax reform being enacted in the U.S. this year or next. And Congress seems even further away from approving the kind of fundamental reform that promises to give a long-term competitive boost to U.S. manufacturing, especially to the producers and consumers of capital equipment.

"I don't rule out altogether that the dynamic may present itself late this year or next year that would result in something helpful to manufacturing. [But] I think the probability is not high," says Thomas J. Duesterberg, president and CEO of the Manufacturers Alliance/MAPI, an Arlington, Va.-based business and public policy research group of about 450 companies.

Allowing American manufacturers to adjust for taxes at U.S. borders would offset an international tax advantage that the Europeans and several other major competitors have in the global marketplace, contends Paul Freedenberg, vice president for government relations at AMT-The Association for Manufacturing Technology in McLean, Va. But "in this year and maybe in this Congress," which continues to the end of 2006, the probability of it being enacted "is very low," he judges. "It's too big a change, and it would be a complicated change."

Still, in Washington, D.C., and elsewhere, there's no shortage of proposed tax code changes that could work to the benefit of manufacturers, including the suggestion that the U.S. abandon the corporate income tax and adopt a value-added tax system that would allow U.S. manufacturers to recover taxes paid on the goods they export from the United States. Other suggested reforms include:

  • Faster depreciation or increased expensing, which would bring the tax lives of capital goods and other equipment closer to their actual productive lives and create an incentive for manufacturers to purchase equipment.
  • Making the R&D tax credit permanent, which would put manufacturers, especially chipmakers and other high-tech firms, on firmer ground from which to do their business planning.
  • Scrapping the alternative minimum tax for corporations, which would benefit companies with lots of fixed assets by restoring depreciation deductions to their tax calculations.
  • Further reducing the corporate income tax rate, which would reduce manufacturers' total tax burden and help improve international competitiveness.
  • Killing off the estate tax, which the National Federation of Independent Business dubs the "death tax," could help keep closely held firms in the family.

Even Britain's Economist magazine has weighed in on U.S. tax reform, urging serious consideration of a single-percentage, no-deductions flat tax based on what it claimed have been positive experiences in Europe and Russia.

The National Association of Manufacturers (NAM) is among a tide of trade associations and other business groups floating policy guidelines to federal tax reformers. A couple -- encouraging savings and investment while minimizing the double taxation of corporate earnings, and recognizing the important role of research and technology investment in the growth of U.S. jobs and innovation -- are the kind that both the Bush administration and the GOP-controlled Congress could easily grab on to. Another -- eliminating the corporate and individual alternative minimum income-tax rules -- is fiscally and politically problematic and would likely sink in rough seas.

It's not only the proposed reform facing significant fiscal and political objections. For example, says AMT's Freedenberg, in making the case for a value-added tax or any other tax that would allow for the rebating of taxes on exports, the revenue loss to the Treasury would be difficult to forecast. And that likely would be a deadly fiscal defect in the context of a federal budget deficit that remains well above $300 billion. What's more, "it seems to be a change that favors industry, and the Democrats would be very reluctant to allow that to occur," Freedenberg adds.

By the end of July, President Bush's Advisory Panel on Federal Tax Reform is slated to make recommendations to Treasury Secretary John W. Snow on ways to make the U.S. tax code "simpler, fairer and more pro-growth." Will the report of the panel, which is chaired by Republican Connie Mack III, a former senator from Florida, with Democrat John Breaux, a former senator from Louisiana, serving as vice chair, make a difference? The answer is probably not for manufacturers. "They could make a difference if they were to articulate one or two reasonably bold and reasonably simple scenarios," speculates Duesterberg of the Manufacturers Alliance. "[But] their charge from the President is more looking at the individual income tax side as opposed to the corporate tax side. So I don't see them changing the debate much on business taxes."

President Bush clearly is one of the key tax-reform figures that manufacturers need to keep their eyes on during the next several months and into next year. "The one thing I have learned from the last four years [is that] I do not underestimate this Administration," stresses Linda Carlisle, a tax partner in the Washington, D.C. office of the law firm of White & Case. Another person to keep close tabs on is Sen. Charles Grassley, R-Iowa, chairman of the Senate Finance Committee. "He was on the Finance Committee for the Tax Reform Act of 1986. He's been there a long time. He's a very smart, deliberate man," Carlisle says. But Rep. William M. "Bill" Thomas, R-Calif., may be the person most deserving of careful watching. Thomas is in his final two years as chairman of the House Ways & Means Committee, the congressional panel that originates tax legislation. "Chairman Thomas is not only head of what many consider to be the most powerful committee in the House, he is also a very savvy political player on tax issues. He is someone who has shown again and again the ability to get things passed that other people didn't think were possible," observes Mark Garay, director of tax policy services for Deloitte Tax LLP. Thomas has "this year and next year to really make a boom, if he wants to make a boom," quips White & Case's Carlisle.

Thomas' boom could be to combine Social Security reform and tax reform. Although the political emphasis is on Social Security reform, "you have Bill Thomas and really thoughtful people like that -- and even Grassley, too -- lurking in the background wondering if Social Security reform will morph into a wider set of reforms coordinated with tax reform to promote savings," relates Duesterberg.

"Bill Thomas . . . would like to leave as his legacy a much more robust individual savings account of some form or another which would shelter savings and push us toward a consumption tax." However, that would be tax reform for individuals, with manufacturers and other businesses benefiting only indirectly from the lower interest rates and larger amounts of available investment capital the changes might produce. "I am personally in favor of abolishing the corporate income tax," says Duesterberg. "But it's the very long run before that's even on the table, I think."

Nevertheless, tax reform is a public policy issue that is not going to go away. And White & Case's Carlisle believes that U.S.-based manufacturing has a vested interest in seeing that it does not go away. "I think to maintain our place in the worldwide economy we have to continue to encourage domestic manufacturing," she says. "Is there a drop-dead urgency? No. But we have a globalized economy, and our businesses have to be able to compete effectively abroad. And perhaps our income tax is not allowing us to do that -- and there is the urgency."

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