Corporate tax reform: Talk grows louder

chart_corp_tax3.top.gif By Jeanne Sahadi, senior writer


NEW YORK (CNNMoney) -- There's the sweet deal for companies that make Puerto Rican rum. Or the tax break intended to promote U.S. manufacturing but that's so broad it can include the making of hamburgers.

The list goes on. Welcome to the American corporate tax code, which is front and center for a possible overhaul.

On Friday, Treasury Secretary Timothy Geithner will meet with business executives to discuss corporate tax reform. It is expected to be the first of several meetings as the Obama administration decides whether to push the issue this year.

Many business leaders and tax experts say the corporate tax code discourages foreign investment in the United States and hinders the ability of U.S. companies to compete internationally.

The main culprit: the 35% top corporate tax rate, which is among the highest in the world.

That's why one goal is to lower the top rate and in turn streamline the more than 130 business tax breaks currently on the books.

Sounds simple, but it's not. To push the top rate below 30% will require some serious slash-and-burn action. And since every tax break has its well financed defenders, there's likely to be strong pushback.

CNNMoney asked six tax policy experts which breaks they think should get the ax. Of their top picks, some are poorly targeted. Others are simply lobbyist-engineered loopholes with minimum value to the economy.

Boosting corn as high as an elephant's eye: Oil refineries can take a 45-cents-a-gallon tax credit for ethanol blended with gasoline.

"It predominantly benefits corn-based ethanol, driving up corn prices, distorting agricultural decisions, and having little if any benefit in terms of greenhouse gas emission reductions or fuel savings," said Gilbert Metcalf, an economics professor at Tufts University.

Eliminating the break could save $32 billion over five years, he noted.

A misguided 'manufacturing' break: The experts flagged the "Section 199" domestic production deduction -- one of the larger breaks in the business arena.

Under Section 199 of the tax code, income from "qualified production activities" conducted in the United States is taxed at a lower rate than other domestic (or foreign) activities by U.S. firms.

The tax break, created in 2004, was intended to encourage companies to manufacture their goods in the United States. But "manufacturing" can be very broadly interpreted to include things like the making of fast food hamburgers.

"[It] ... leads to absurd efforts to characterize activities like content production as 'manufacturing,'" said Edward Kleinbard, a law professor at the University of Southern California and a former chief of staff at the Joint Committee on Taxation.

Moreover, if the point of reform is to make the United States a more attractive place to invest, "any rationale for this rule would be greatly weakened by lowering the U.S. corporate rate," said Daniel Shaviro, author of "Decoding the U.S. Corporate Tax Code."

The estimated cost of this break to federal coffers over five years is $62 billion.

Too big a bang for a deductible buck: Oil and gas companies can take a tax credit for fees or payments they make to foreign governments for access to drill sites or to other infrastructure. But the experts said such fees are not officially a "tax" but are really just a business expense.

As a business expense the fee would qualify as a deduction, which is less valuable than the tax credit they've been getting.

Recharacterizing the fee as an expense rather than a tax could save $8.2 billion over 10 years, according to the Joint Committee on Taxation.

A break to understate income: So-called LIFO accounting rules ("Last-In, First-Out") let companies reduce how much taxable income they report.

And the rules are disproportionately used by just a few types of businesses -- most notably, oil companies, spirits manufacturers and car dealers.

Broadly, LIFO lets companies treat their most recently produced or purchased goods as if they were the first ones sold.

Take a tire company. At the start of the year it costs the company $10 to produce one tire. By the end of the year, because of rising rubber prices, it costs $11. Under LIFO, the company can assume that all of the tires it sold that year cost $11 to produce, instead of $10. (Please see correction below.)

That helps reduce the company's taxable income. Why? Because the cost of goods is subtracted from a company's income, and the higher the cost, the lower their net income will be.

"[LIFO] is a giveaway that benefits a handful of industries and [it] is not supported by standard income tax theory or the most modern financial accounting policies," Kleinbard said.

The estimated cost of this break to federal coffers over five years is $23 billion.

Rewarding racing and rum: TaxVox blogger Howard Gleckman says there are nearly 50 dumb special-interest loopholes -- "temporary" but frequently extended by Congress.

One of note is for Nascar racetrack owners, who are allowed to write off the costs of their racetracks -- plus related facilities, improvements and acquisitions -- over seven years. That's a much faster depreciation schedule than most other businesses are allowed.

The faster a business can write off its property costs, the lower its tax bill in the near term and the more money left in company coffers -- or owners' pockets.

"It is ... hard to see how continuing to allow generous tax depreciation for Nascar racetracks will create many jobs," Gleckman wrote in one post, calling it a "windfall."

Another is for Puerto Rican rum manufacturers. They get a hefty break on a $13.50 per gallon excise tax levied on distilled spirits produced in or imported into the United States. The net excise tax on Puerto Rican rum: 25 cents.

Cheers.

Correction:An earlier version of this article incorrectly stated that the company can assume that all of its unsold inventory can be priced at $11. To top of page

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