Is Rangel’s Mother of All Tax Reforms Bullish?

Rep. Charles Rangel (D-NY) made some tantalizing comments yesterday in a CNBC interview, saying that Treasury Secretary Paulson had convinced him that lowering the U.S. corporate tax rate to 25% might be a good idea. On its face, this is very bullish news, although questions and qualifications apply. For example, is this enough to make the U.S. economy competitive for the long term? Or is it just enough to maintain the competitive status quo for the time being? Will it be hamstrung by so-called ‘paygo’ rules that simply shift the burden onto productive activity elsewhere? Or will it be based on analyses of the dynamic, behavioral effects of shifts in incentives, and their impact on future productivity?

On a minor note (one that’s of interest to our little firm), will it do away with or simply rearrange the current incentives and distortions regarding forms of corporate organization? For example, income of certain entities such as LLCs is typically deemed to ‘pass through’ to its owners, where it is taxed at their personal rates. If the LLC owners are successful, a maximum tax rate of 25% tax becomes much more attractive–especially if top marginal tax rates on personal incomes are pushed higher in order to ‘pay’ for a lower corporate rate (some estimates run as high as a 40% top marginal income tax rate). Among the many effects, this would be yet another ’make work’ gift to the legal and accounting professions from Congress. And if cost-effective options for business formation aren’t left on the books for small business owners, it could be quite harmful to labor markets, incomes, tax revenues, etc.

Of course, a serious problem remains in the corporate tax codes, which is the double taxation of profits on public companies (profits are taxed first the corporate income tax return, and again as shareholder dividends and capital gains). In fact, if Congress were to leave the capital gains and dividend rate of 15% untouched–something many Democrats are loathe to do–then a single 25% corporate tax rate can end up at 40% under many scenarios.

That mathematical exercise begs the question–is Rangel seeking a way to level a 40% tax on the most productive economic activity in the U.S. economy? If so, the Mother of All Reforms wouldn’t be so bullish after all. That probably would mean an easier Fed policy would be required to support the domestic economy, and in the context of a white hot global economy, that in turn means continued  stagflation here at home–although there’s still nothing in sight at the level of the 1970s stagflation, when the tax code and high inflation imposed a required return on capital in excess of 100%!!!