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Tax reform will help US companies compete globally
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There is widespread agreement the US corporate tax system is deeply flawed. The rate is too high; the base is too narrow; it is costly to administer; and it is riddled with credits, deductions, and special preferences that distort decisions.
Despite the high rate, corporate tax revenues comprise a relatively small share of government revenue, partly because a rising share of total business receipts — currently more than 30 percent — flows through so-called “pass-through” business organizations, which are not subject to corporate tax.
Indeed, most corporate tax revenues are paid by a small number of large multinational companies that earn more than half of their income from their foreign operations.
These companies compete in global markets with firms headquartered in countries that use business friendly tax policies to attract the investments, income, and associated externalities of multinational companies. The problem for the US is that developed and emerging economies have been slashing their rates, leaving the US — which had one of the developed world’s lowest corporate tax rates after the 1986 tax reform — at a disadvantage.
Reduced rate
Most recently, the United Kingdom reduced its rate to 20 percent, half of the combined US federal and average state rates. And, since 2013, the UK has applied a special tax rate on income from patents, which will fall gradually to 10 percent by 2017. Twelve European Union countries currently have or are implementing similar special tax regimes, or “patent boxes,” for income from intellectual property, which is taxed at rates of 5-15 percent.
The US statutory corporate tax rate, at 39 percent in total, is more than 14 percentage points above the OECD average — making it the highest in the developed world. These differences aff¡ect corporate decisions about how much to invest, how to finance investment, and where to do business.
The pro-growth rationale for a sizable reduction in the US rate has garnered bipartisan support — a rarity in today’s Congress. Obama has proposed a rate of 28 percent, with a preferential rate of 25 percent for manufacturing, and additional special provisions to promote investment in research and development and clean energy.
There is also bipartisan agreement that the foregone revenues from a rate reduction should be covered mainly by broadening the tax base — the same approach adopted in the 1986 tax reform. Broadening the base would also reduce the tax system’s complexity and enhance its efficiency.
But there remain deep fissures over which preferences should be eliminated and which activities currently outside the corporate tax base should be brought into it. Another area of controversy is how to reform the taxation of American multinationals’ foreign earnings.
Territorial tax
Every other G-7 country, and 28 of the other 33 OECD members, have “territorial” tax systems, which allow globally engaged companies to repatriate most of their active foreign earnings without paying a significant additional domestic tax.
By contrast, the US adheres to a “worldwide” model, which subjects American companies’ foreign earnings to US corporate tax, with a credit for taxes paid in foreign jurisdictions.
America’s high corporate rate and worldwide approach to taxing the foreign earnings of its multinationals undermine their competitiveness in global markets and in cross-border acquisitions.
In a world of mobile capital — especially profitable intangible capital with R&D externalities — the US should adopt a “hybrid” territorial system that includes base-protection measures consistent with those successfully used by other developed countries. And it should promote multilateral measures to combat profit-shifting to tax havens.
As the US embarks on corporate tax reform, policymakers should bear in mind that other countries are using carrots, not sticks, to compete for the activities and income of global companies. America should do likewise.
Laura Tyson, a former chair of the US President’s Council of Economic Advisers, is a professor at the Haas School of Business, University of California, Berkeley, and an economic adviser for the Alliance for Competitive Taxation. Copyright: Project Syndicate, 2015.www.project-syndicate.org
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