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According to an article in the New York Times, the Obama Administration is seriously examining a proposal to reduce America’s anti-competitive 35 percent corporate tax rate.

The Obama administration is preparing to inject an unpredictable new variable into its economic policy clash with Republicans: a plan to overhaul corporate taxes. Economic advisers have nearly completed the process initiated in January by the Treasury secretary, Timothy F. Geithner, at President Obama’s behest. That process, intended to make the United States more competitive internationally, has explored the willingness of business leaders to sacrifice loopholes in return for lowering the top corporate tax rate, currently 35 percent. The approach officials are now discussing would drop the top rate as low as 26 percent, largely by curbing or eliminating tax breaks for depreciation and for domestic manufacturing.

This may be a worthwhile proposal, but this is an example where it would be wise to “look before you leap.” Or, for fans of Let’s Make a Deal, let’s see what’s behind Door Number 2.

To judge Obama’s plan, it is important to have the right benchmark. An ideal corporate tax system obviously should have a low tax rate. And it also should have no double taxation (tax corporate income at the business level or tax it at the individual level, but don’t tax it at both levels).

But it’s also important to have a simple and neutral system. The right definition of corporate income for any given year is (or should be) total revenue minus total costs. What’s left is income.

This may seem to be a statement of the obvious, but it’s not the way the corporate tax code works. The system has thousands of complicated provisions, some of which provide special loopholes (such as the corrupt ethanol credit) that allow firms to understate their income, and some of which impose discriminatory penalties by forcing companies to overstate their income.

Consider the case of depreciation. The vast majority of people understandably have no idea what this term means, but it sounds like a special tax break. After all, who wants big corporations to lower their tax bills by taking advantage of something that sounds so indecipherable.

In reality, though, depreciation simply refers to the tax treatment of investment costs. Let’s say a company buys a new machine (which would increase productivity and thus boost wages) for $10 million. Under a sensible and simple tax system, that company would include that $10 million when adding up all their costs, which then would be subtracted from total revenue to determine income.

But the corporate tax code doesn’t let companies properly recognize the cost of new investments. Instead, they are only allowed to deduct (depreciate) a fraction of the cost the first year, followed by more the next year, and so on and so on depending on the specific depreciation rules for different types of investments.

To keep the example simple, let’s say there is “10-year straight line depreciation” for the new machine. That means a company can only deduct $1 million each year and they have to wait an entire decade before getting to fully deduct the cost of the new machine.

Ultimately, the firm does deduct the full $10 million, but the delay (in some cases, about 40 years) means that a company, for all intents and purposes, is being taxed on a portion of its investment expenditures. This is because they lose the use of their money, and also because even low levels of inflation mean that deductions are worth significantly less in future years than they are today.

To put it in terms that are easy to understand, imagine if the government suddenly told you that you had to wait 10 years to deduct your personal exemption!

Let’s now circle back to President Obama’s proposal. With the information we now have, there is no way of determining whether this proposal is a net plus or a net minus. A lower rate is great, of course, but perhaps not if the government doesn’t let you accurately measure your expenses and therefore forces you to overstate your income.

I’ll hope for the best and prepare for the worst.

P.S. It’s also important to understand that a “deduction” in the business tax code does not imply loophole. If you remember the correct definition of business income (total revenue minus total costs), this means a business gets to “deduct” its expenses (such as wages paid to workers) from total revenue to determine taxable income. Some deductions are loopholes, of course, which is why a  simple, fair, and honest system should be based on cash flow. Which is how business are treated under the flat tax.

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Under current law, Social Security is supposed to be an “earned benefit,” where taxes are akin to insurance premiums that finance retirement benefits for workers. And because there is a cap on retirement benefits, this means there also is a “wage-base cap” on the amount of income that is hit by the payroll tax.

For 2011, the maximum annual retirement benefit is about $28,400 and the maximum amount of income subject to the payroll tax is about $107,000.

It appears that President Obama wants to radically change this system so that it is based on a class-warfare model. During the 2008 campaign, for instance, then-Senator Obama suggested that the programs giant long-run deficit could be addressed by busting the wage-base cap and imposing the payroll tax on a larger amount of income.

For the past two years, the White House (thankfully) has not followed through on this campaign rhetoric, but that’s now changing. His Fiscal Commission, as I noted last year, suggested a big hike in the payroll tax burden. And the President reiterated his support for a class-warfare approach earlier this week, leading the Wall Street Journal to opine.

Speaking Tuesday in Annandale, Virginia, Mr. Obama came out for lifting the cap on income on which the Social Security payroll tax is applied. Currently, the employer and employee each pay 6.2% up to $106,800, a level that rises with inflation each year. …Mr. Obama didn’t hint at specifics, though he did run in 2008 on a plan to raise the “tax max” by somewhere between two to eight percentage points for the top 3% of earners. …most of the increase could be paid by the middle class or modestly affluent—i.e., those who merely make somewhat more than $106,800. A 6.2% additional hit on every extra dollar they make above that level is a huge reduction from their take-home pay. If the cap is removed entirely, it will also mean a huge increase in the marginal tax rates that affect decisions to work, invest and save. In a recent paper for the American Enterprise Institute, Andrew Biggs calculates that this and other tax increases Mr. Obama favors would bring the top marginal rate to somewhere between 57% and 68% when factoring in state taxes. Tax levels like these haven’t been seen since the 1970s.

Obama is cleverly avoiding specifics, largely because the potential tax hike could be enormous. The excerpt above actually understates the potential damage since it mostly focuses on the “employee” side of the payroll tax. The “employer” share of the tax (which everyone agrees is paid for by workers in the form of reduced take-home wages) is also 6.2 percent, so the increase in marginal tax rates for affected workers could be as high as 12.4 percentage points.

This video from the Center for Freedom and Prosperity, narrated by yours truly, elaborates on why this is the wrong approach.

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Republicans are understandably nervous about polling data showing considerable opposition to the Ryan plan’s Medicare proposal – particularly since they just voted for a budget resolution in the House of Representatives that includes such a reform.

Their unease is warranted. GOPers almost surely will be subjected to a scorched-earth campaign in 2012, featuring lots of demagoguery about  Medicare “privatization,” mixed in with shrill rhetoric about big insurance companies and “tax cuts for the rich.”

I don’t particularly care about the GOP’s electoral prospects, but I do want to save my nation from fiscal collapse, so that means I don’t want entitlement reform to become radioactive.

So what can be done to counter the predictable onslaught against Ryan’s Medicare proposal?

First and foremost, reformers should borrow some advice about counter-attacks from President Obama. He said during the 2008 campaign that if opponents “bring a knife to the fight, we bring a gun,” and a high-ranking White House aide in 2009 urged supporters to “punch back twice as hard” when dealing with attacks against government-run healthcare.

While reformers obviously should avoid the unseemly rhetoric associated with the current Administration, they should copy the aggressive approach. Timidity is a recipe for defeat.

For instance, do not allow the left to compare the Ryan proposal to the status quo of unlimited handouts. That system is bankrupt and even the Obama Administration acknowledges that something dramatic needs to happen to control costs.

Indeed, the best strategy for reformers may be to compare the Ryan plan to Obama’s scheme for a beefed-up “Independent Payment Advisory Board.” Sounds wonky and technical, but IPAB is the bureaucratic entity that will be in charge of imposing price controls that lead to the rationing of health care for the elderly.

In other words, the real issue is who will be in charge of the pool of dollars that will be used to provide healthcare for the elderly. Ryan’s plan would let seniors choose a health plan that best suits their needs and provide a big subsidy to finance that policy. Obama’s plan, by contrast, will keep seniors in a government-run system and let a bunch of unelected bureaucrats decide what kind of care they should receive.

Moreover, reformers should fight fire with fire. If the left is allowed to use “privatization” to describe Ryan’s plan (notwithstanding massive government involvement and subsidies), then reformers should refer to IPAB as a “death panel.”

My colleague Michael Cannon is a one-man truth squad on these issues, and he already has explained that there was a lot of merit in Sarah Palin’s accusation that Obamacare would create something akin to a death panel, and he has documented the various ways that government-run healthcare will lead to rationing.

To conclude, here are excerpts from two excellent columns that recently have been published on Obama’s IPAB scheme.

Rich Lowry of National Review writes.

Why does Obama need specifics when he has the Independent Payment Advisory Board, or IPAB? If spending on health care is the biggest driver of government spending, then IPAB is Obama’s most important deficit-reduction initiative. …Obama…implicitly acknowledges that [Medicare] is broken and bankrupting us. Otherwise, he wouldn’t be proposing a cap on Medicare’s growth that is at least as stringent as anything New Gingrich proposed in the 1990s… Under Obamacare, IPAB is to hit a target for Medicare’s growth that significantly squeezes the program beginning in 2014 (in his budget speech, Obama said he wants to ratchet down the cap even further). …In the fact sheet released in conjunction with his budget speech, the White House says he wants to give IPAB “additional tools” and “additional enforcement mechanisms such as an automatic sequester.” …IPAB won’t make the notoriously inefficient Medicare program any more efficient. Through arbitrary reductions on payments to providers, it will simply reduce the supply of care. …Medicare’s chief actuary warned that Obamacare will drive providers out of the program. If you love Medicaid, you’ll adore the new IPAB version of Medicare. It will be the experts’ gift to America’s seniors.

The Wall Street Journal’s superb editorial page also has a good analysis.

The Independent Payment Advisory Board was created in the ObamaCare statute, and the President will appoint its experts in 2012 to six-year terms. …Starting in 2014, the board is charged with holding Medicare spending to certain limits, which at first is a measure of inflation. After 2018, the threshold is the nominal per capita growth of the economy plus one percentage point. Last week Mr. Obama said he wants to lower that to GDP plus half a percentage point.  Mr. Ryan has been lambasted for linking his “premium support” Medicare subsidies to inflation, not the rate of health cost growth. But if that’s as unrealistic as the liberal wise men claim, then Mr. Obama’s goals are even more so. …Since the board is not allowed by law to restrict treatments, ask seniors to pay more, or raise taxes or the retirement age, it can mean only one thing: arbitrarily paying less for the services seniors receive, via fiat pricing. …Now Mr. Obama wants to give the board the additional power of automatic sequester to enforce its dictates, meaning that it would have the legal authority to prevent Congress from appropriating tax dollars. In other words, Congress would be stripped of any real legislative role in favor of an unaccountable body of experts. …the board will decide “what works” and apply it through regulation to all of American medicine. …As a practical matter, the more likely outcome is the political rationing of care for the elderly, as now occurs in Britain… Messrs. Ryan and Obama agree that Medicare spending must decline, and significantly. The difference is that Mr. Ryan would let seniors decide which private Medicare-financed insurance policies to buy based on their own needs, while Mr. Obama wants Americans to accept the commands of 15 political appointees who will never stand for election.

Even though I play senior softball, I’m not a senior citizen by Medicare standards. But when I reach that age, I know what I’ll decide if my choice is “privatization” or a “death panel.”

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America is in fiscal peril in the short run because of a 10-year spending binge by Bush and Obama and in the long run because of a toxic combination of entitlement programs and demographics.

Congressman Paul Ryan has introduced a budget plan to address America’s fiscal crisis, but Senator Reid and President Obama have summarily rejected his proposal, so it appears the United States will continue to drift in the wrong direction.

Something is needed to compel action. One might think that such an impetus would have been provided by the recent decision by Standard & Poor to downgrade the fiscal outlook for the United States. But this development hasn’t affected the spending culture in Washington.

But there is hope. Senator Corker has legislation that would force Congress to act – and automatically impose fiscal discipline if they don’t. His bill caps – and then slowly reduces – government spending as a share of national economic output (gross domestic product).

I’ve already written about the merits of this proposal, including an explanation of the all-important enforcement mechanism of sequestration (automatic spending cuts). Here’s Senator Corker’s description of his plan, as delivered at a Cato Institute conference on the Economic Impact of Government Spending.

To build on the Senator’s comments, there are two things that deserve special emphasis.

1. He correctly understands that the problem is the size of government. As explained in this video, spending is the problem and deficits are a symptom of that problem.

Unfortunately, many policy makers focus on the budget deficit, which often makes them susceptible to misguided policies such as higher taxes. At best, such an approach merely substitutes one bad way of financing federal spending with another bad way of financing federal spending. And it’s much more likely that higher taxes will simply lead to more spending, thus exacerbating the real problem.

2. Senator Corker’s legislation has a real enforcement mechanism. If Congress fails to produce a budget that meets the annual spending cap, there is a “sequester” provision that automatically takes a slice out of almost every federal program.

Modeled after a similar provision in the successful Gramm-Rudman-Hollings law of the 1980s, this sequester puts real teeth in the CAP Act and ensures that the burden of government spending actually would be reduced.

Some people complain that Senator Corker’s plan is too timid and that it doesn’t balance the budget by 2021. While it would be desirable to impose additional fiscal restraint, the Tennessee Senator has deliberately chosen a more modest goal in order to attract support from colleagues on the other side of the aisle. And he does have Democratic co-sponsors, something that is critical given the composition of the Senate.

Since I’m just a policy wonk, I’ll leave it to the other people to argue about what’s feasible in the current political environment. My final comment, though, is that we’re on an unsustainable path that will lead to the end of American exceptionalism and turn the United States into a decrepit, European-style welfare state. So I’m not going to complain if someone has a plan that finally moves policy in the right direction, albeit not quite as fast as I prefer.

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President Obama didn’t offer a budget plan yesterday. The White House hasn’t released anything beyond a set of talking points.

But that’s not terribly surprising since his speech was really the opening salvo of his 2012 reelection fight. And it’s clear that a central theme of his campaign will be class warfare.

But if we translate his campaign-style demagoguery into the overall budget framework, we get something like this fiscal continuum. Obama, for all intents and purposes, has taken the moderately left-wing proposal crafted by his Fiscal Commission and moved it significantly in the wrong direction by adding class-warfare tax policy. As such, he is close to the left end of the line, which represents “Statism.”

The Ryan plan, by contrast, is the moderately right-wing mirror image of the Fiscal Commission. But rather than cementing in place bigger government, as proposed by Simpson and Bowles,  Ryan’s budget slowly shrinks the fiscal burden of government. As such, it is on the “Liberty” side of the continuum.

America’s Founding Fathers had the right idea, of course, They envisioned a very limited central government, and for much of our nation’s history, the federal budget consumed about 3 percent of GDP. Unfortunately, the Hoover-Roosevelt policies began the process of moving America in the wrong direction, and federal spending now consumes nearly one-fourth of America’s economic output.

But enough history. Let’s revisit Obama’s speech and the accompanying talking points. In addition to the class warfare (more on that below), we also see an explicit call to reduce the growth of Medicare spending by “strengthening the Independent Payment Advisory Board.”

In other words, Obama wants to use his control of the purse strings to give bureaucrats more ability to decide what kind of care seniors can receive. It’s politically incorrect to call this type of entity a “death panel,” so I’ll simply contrast Obama’s top-down bureaucratic approach with the Ryan plan, which is based on giving vouchers to future seniors so they can pick the health plans that best fit their needs (people over 55 would be stuck with the current system). And since this is very similar to the system used to provide health care for Members of Congress and their staff, you know it must work reasonably well.

Let’s briefly return to the tax side of the fiscal equation. I’ll have more to say about this in a separate post giving a behind-the-scenes look at what Democrats really hope to achieve in the area of tax policy, but I want to offer a basic explanation of why the soak-the-rich approach is doomed to fail. There are five reasons in this video to reject class warfare, including a very important warning that high tax rates on the rich almost always are a tactical move to facilitate higher taxes for the rest of us.

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Responding to widespread criticism of his AWOL status on the budget fight, President Obama today unveiled a fiscal plan. It already is being criticized for its class warfare approach to tax policy, but the most disturbing feature may be a provision that punishes the American people with higher taxes if politicians overspend.

Called a “debt failsafe trigger,” Obama’s scheme would automatically raise taxes if politicians spend too much. According to the talking points distributed by the White House, the automatic tax increase would take effect “if, by 2014, the projected ratio of debt-to-GDP is not stabilized and declining toward the end of the decade.”

Let’s ponder what this means. If politicians in Washington spend too much and cause more red ink, which happens on a routine basis, Obama wants a provision that automatically would raise taxes on the American people.

In other words, they play and we pay. The last thing we need is a perverse incentive for even more reckless spending from Washington.

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Maybe Obama’s not so bad on Second Amendment issues.

His Administration has contracted with the folks at Ruger to produce a special pistol in honor of the government workforce.

This new gun will be called “The Bureaucracy Special.” The only downside is that it doesn’t work and you can’t fire it.

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