Why corporate taxes may go up under Romney or Obama by Cyrus Sanati @FortuneMagazine October 24, 2012, 3:08 PM EDT E-mail Tweet Facebook Google Plus Linkedin Share icons Corporate tax showdown FORTUNE — American companies should beware of Presidential candidates bearing tax cuts. Both President Obama and Mitt Romney have promised to slash the corporate tax rate and “simplify” the tax code in a bid to appear as “job builders” to voters. But while the proposed tax cuts seem large on the surface, the accompanying loss in deductions and tax credits could see U.S. companies paying more, not less, come tax time. Romney has won a lot of points from fiscal conservatives in the last few weeks by accusing the Obama administration of making the U.S. economy less competitive relative to its peers. Specifically, Romney points to how the President has failed to lower the corporate income tax rate or clean up the nation’s Byzantine tax code, both of which he claims are hurting U.S. companies from competing for business across the globe. He wants to lower the rate from its current 35% to a flat 25% and change the way income earned abroad is treated by the tax man. Strangely enough, President Obama actually agrees with Romney on this issue — in principle, at least. He agrees that the U.S. corporate tax code needs to be reformed and that the headline U.S. corporate tax rate should fall to a flat 28%, with limited deductions allowed. With Congress on board to also lower the rate, it is probably a good bet that whoever wins the presidency next year will push through some sort of corporate tax reform sometime in the next four years. MORE: China slowdown may be overstated So this is a good thing, right? Not necessarily. Both plans lack critical details necessary to gauge what, if any, impact the cuts would have on the nation’s economic growth rate or its precarious fiscal situation. But before we even attempt to look at the potential impact of such a change, let’s first focus on the problem. The premise behind the tax cut — that the U.S. has the highest corporate tax rate in the world — is simply false. Yes, the nominal tax rate is 35%, but the effective average tax rate for U.S. corporations is actually around 24%. Just like individuals, corporations can take advantage of generous deductions and tax credits (pejoratively known as loopholes) to lower their tax bills. The big accounting firms work with corporations to help them take advantage of every deduction that they have coming, and there are a lot of them – thousands, actually. Sometimes those deductions aren’t enough for corporations, so the government passes special tax holidays or deduction extensions under the auspices of stimulating the economy. For example, in 2011, corporations were allowed to accelerate the depreciation schedule on assets they bought during the year, instead of having to drag it out over several years. That lowered tax bills for corporations across the country by a staggering amount. This depreciation loophole helped bring the net effective corporate tax rate last year to a crazy low 12%, just one-third the nominal tax rate. Given those numbers, it is no surprise that you don’t hear corporations complaining too much about their tax bills – they essentially pay very little thanks to all the deductions granted to them under the tax code. In fact, corporate taxes contributed just 8% to federal revenues in 2011, a 50-year low. Now, the accelerated depreciation giveaway is going away next year, which should push the effective tax rate up into the mid-20s. Nevertheless, Congress could extend or even grant new giveaways for corporations to keep their taxes in check. MORE: Who needs a blind trust? The key reason why both Republicans and Democrats want to cut corporate taxes is because they believe (or have been told) that it would be a big boost to the nation’s sluggish economic growth rate, leading to a much needed decrease in the unemployment rate. There are some studies that back up this thinking and several others that negate it, but the general rule is that for every 10 percentage point decrease in the corporate tax rate, one can expect a 1% to 2% increase in economic growth. Nevertheless, while that may normally be true, it may not be the case today as U.S. corporations continue to hold a record amount of cash on their balance sheets (meaning they do not want to spend money). Unless that attitude changes, any additional money a corporation saves with a tax cut would probably be squirreled away instead of being spent, having little to no impact on the economy. But let’s say that corporations do start spending and the rule of thumb holds true, then Romney’s proposed 10 percentage point decrease in the corporate tax rate should yield a 1% to 2% increase in GDP, while the President’s plan should yield around a 1% increase in GDP. It seems like a no brainer move, right? Well, there’s a catch — actually a lot of them. The rule is only valid on a 10 percentage point decrease on the effective tax rate, not the 35% nominal tax rate. So to get that 1% to 2% increase in GDP last year, the effective tax rate on corporations would have needed to be 2%, not 25%. With the effective tax rate expected to hover around 24% next year, then the effective corporate tax rate would need to be in the low teens just to move the needle on the economy. This brings us to the most troubling piece of the Romney and Obama corporate tax cut plans – they actually could end up being stealth tax hikes. Let’s first look at President Obama’s plan. He believes his 7% nominal tax cut to 28% will be revenue-positive, which means that the Treasury will end up seeing more money coming in from corporations, not less. The President says he can pull off this magic piece of financial engineering by eliminating and reducing all the temporary deductions and tax credits given to corporations, as well as ditching some of the permanent ones, like those that subsidize drilling risk for energy companies. The details of the President’s plan are vague, but he claims it would raise $250 billion in revenue by changing the treatment of some manufacturing subsidies, allowing the research and development tax credits to expire, repatriating profits from U.S. companies abroad and raising – yes raising – taxes on the foreign operations of U.S. corporations. MORE: Obama has a jobs plan. Why isn’t he talking about it? Now, raising taxes on those foreign operations implies that he would keep in place the current “worldwide” U.S. tax regime, which allows the federal government to tax the foreign subsidiaries of companies domiciled in the U.S. Under the worldwide system, the government taxes foreign earnings when they are repatriated back to the U.S. That is why there is billions of dollars of cash belonging to U.S. companies sitting in foreign bank accounts. If those companies brought the money home, Uncle Sam would instantly want his cut. The President says he will get that money to come back, but he offers no solutions as to how that would be possible. It is therefore difficult to see how U.S. corporations will end up paying less in taxes under the President’s plan. If the effective tax rate with deductions in 2013 is slated to be 24%, then the President would need to leave enough deductions and loopholes in place to get to that number while at the same time raising $250 billion — an unlikely scenario. Romney’s plan is more aggressive with a 10% cut in the nominal tax rate to 25%. The plan aims to be revenue-neutral, which means that there would be no change in the amount of money flowing into the Treasury. The Romney plan is even lighter in specifics that the President’s plan, with no clear understanding as to what deductions are on the table. But he has said he would want to move the U.S. from a “worldwide” tax regime to a “territorial” tax regime. This means that the earnings of U.S. corporations would be taxed in whatever country they made the profit, not in the U.S. That may seem like Romney is leaving a lot of money on the table, but he assumes that once those foreign earnings are taxed (at a low rate) then corporations will have no reason to keep their cash pile overseas and would finally bring it home. It is then assumed that all that cash will flow through the U.S. economy, pumping up GDP, increasing tax revenue and creating jobs. But as with his personal income tax plan, Romney’s corporate tax plan requires some very generous assumptions to function properly. For example, why is it assumed that all those foreign corporate earnings would flow back to the U.S.? Indeed, switching to a territorial system might actually encourage U.S. corporations to invest more inside countries that have a lower tax rate, far lower than even Romney’s proposed 25% nominal tax rate. MORE: 10 craziest places to vote The plan also assumes that the tax cut would spur a strong enough boost in economic growth to make up for any shortfall in revenue, which, given the information available, seems highly unlikely. So without all that extra cash coming in the door, it is difficult to see how the plan can fund the necessary loopholes that would bridge the gap between the new 25% nominal tax rate with the lower 24% effective tax rate. Without bridging that gap, Romney’s plan would end up being a de facto tax hike. Of course it is hard to know what exactly would happen to corporate America under the two tax plans, but it looks extremely unlikely that many companies would see some, if any, tax relief. There are scores of companies that Romney might say are part of the corporate 47%, as in they pay little to no income taxes (not sure if they think they are victims, though). Think oil companies like Chesapeake Energy CHK , big banks like Citigroup C and government contractors like Boeing BA . These companies not only usually pay zero income taxes, due to all the corporate tax loopholes; they actually get fat refund checks from the federal government each year. That means whoever is elected next month will have to tell a pretty powerful bunch of folks that it is time to pay their fair share of taxes, which is a conversation that neither candidate would probably find enjoyable.