Last fall the Manufacturers Alliance/MAPI and the National Associations of Manufacturers Manufacturing Institute released a report on their analysis of production costs in the United States relative to its top nine trading partners ? Canada, Mexico, Japan, China, Germany, United Kingdom, Korea, Taiwan, and France. The report revealed that on a trade-weighted basis, the U. S. tax rate is 8.6 percentage points higher than its trading partners in the 2011 cost study, considerably higher than the 5.6 percentage points of the first cost study in 2003.
While the U. S. federal and state combined tax rate has remained the same, every other country in the study has lowered corporate tax rates at least once since 1997, and most countries have done so several times. The result is that the U.S. rate is now second-highest to Japan in the Organization for Economic Co-operation and Development (OECD). The increase in the foreign advantage since the 2008 tax study is due to rate reductions in Canada (36 percent to 31 percent), Germany (38.4 percent to 29.4 percent) and Taiwan (25 percent to 17 percent).
If you think that a reduction in corporate tax rates would only benefit the large, multinational corporations doing business globally, think again. According to last MAPI/MI report, “Facts About Modern Manufacturing,” produced in 2009, 95 percent of the 286,039 manufacturers were companies of under 100 employees.
It isn’t just manufacturing corporations and their trade associations that recommend a reduction in corporate taxes. On July 26, 2007, the Treasury Department hosted a conference on Global Competitiveness and Business Tax Reform that brought together distinguished leaders and experts to discuss how the U.S. business tax system could be improved to make U.S. businesses more competitive. As a follow-up to this conference, on December 20, 2007, the U.S. Department of the Treasury released a 121-page report titled “Approaches to Improve the Competitiveness of the U.S. Business Tax System for the 21st Century.”
The report acknowledges that, “Globalization … has resulted in increased cross-border trade and the establishment of production facilities and distribution networks around the globe. Businesses now operate more freely across borders and business location and investment decisions are more sensitive to tax considerations than in the past.” Further, as globalization has increased, “nations’ tax systems have become a greater factor in the success of global companies.” The report notes, “Many of our major trading partners have lowered their corporate tax rates, some dramatically.”
In the 1980s, the United States had a low corporate tax rate compared to other countries, but now has the second highest. Japan has the highest corporate tax rate at 39.54 percent. According to the OECD, Ireland’s tax is lowest at 12.5 percent, while most of the other major industrial nations have corporate tax rates ranging from 19 to 30 percent.
The Treasury Department says, “As other nations modernize their business tax systems to recognize the realities of the global economy, U.S. companies increasingly suffer a competitive disadvantage. The U.S. business tax system imposes a burden on U.S. companies and U.S. workers by raising the cost of investment in the United States and burdening U.S. firms as they compete with other firms in foreign markets.”
The report states that the U. S., tax system “discourages investment in the United States” and “may also slow the pace of technological innovation. The pace of innovation is a key determinant of economic growth, and innovation tends to take place where the investment climate is best…Given this interplay between innovation and capital accumulation, allowing U. S. corporate taxes to become more burdensome relative to the rest of the world could result in a cumulative effect in which U. S. firms fall increasingly behind those in other nations.”
The study concludes that the current system of business taxation in the United States is making the country uncompetitive globally and needs to be overhauled. A new tax system aimed at improving the global competitiveness of U.S. companies could raise GDP by 2 to 2.5 percent. Rather than present particular recommendations, the report examines the strengths and weaknesses of the three major approaches presented:
Replacing the business income tax system with a Business Activity Tax (BAT)
- The BAT tax base would be gross receipts from sales of goods and services minus purchases of goods and services (including purchases of capital items) from other businesses.
- Wages and other forms of employee compensation (such as fringe benefits) would not be deductible.
- Interest would be removed from the tax base – it would neither be included as income nor deductible.
- Individual taxes on dividends and capital gains would be retained. Interest income received by individuals would be taxed at the current 15 percent dividends and capital gains rates.
Broadening the business tax base and lowering the statutory tax rate/providing expensing
- The top federal business tax rate would be lowered to 28 percent.
- If accelerated depreciation were retained, the rate would drop only to 31 percent.
- Acquisitions of new investment could be partially expensed (35% could be written off immediately)
Specific areas of our current business tax system that could be addressed
- Multiple taxation of corporations (corporate capital gains and dividends receive deduction)
- Tax bias favoring debt finance
- Taxation of international income
- Treatment of losses
- Book-tax conformity
If the business tax rate were lowered to 31 percent, it would mean that the United States would have the third highest tax rate, while a 28 percent corporate tax rate, would mean the United States would have the fifth-highest tax rate. The report acknowledges that these lower rates might not be enough as other countries are continually changing their tax systems to gain competitive advantage. The Treasury Department study says, “Thus, it remains unclear whether a revenue neutral reform would provide a reduction in business taxes sufficient to enhance the competitiveness of U.S. businesses.”
The Executive Summary also comments on the importance of individual income tax rates. Roughly 30 percent of all business taxes are paid through the individual income tax on business income earned by owners of flow-through entities (sole proprietorships, partnerships, and S corporations). These businesses and their owners benefited from the 2001 and 2003 income tax rate reductions. This sector has more than doubled its share of all business receipts since the early 1980s and plays a more important role in the U.S. economy, accounting for one-third of salaries and wages. Moreover, flow-through income is concentrated in the top two tax brackets, with this group receiving more than 70 percent of flow-through income and paying more than 80 percent of the taxes on this income.
The Executive Summary concludes that “now is the time for the United States to re-evaluate its business tax system to ensure that U.S. businesses and U.S. workers are as competitive as possible and Americans continue to enjoy rising living standards.”
Unfortunately, the recommendations of the Treasury Department haven’t been addressed by Congress in legislation in the more than four years since the report was released.
At the same time that we address the corporate tax rate, we need to close a huge tax loophole that multinational corporations are enjoying at the expense of American workers and which is a big incentive for U. S. firms to invest abroad in countries with low tax rates.
In June 2006, James Kvaal, who had been a policy adviser in the Clinton White House and was then a third-year student at Harvard Law School, published a paper “Shipping Jobs Overseas: How the Tax Code Subsidized Foreign Investment and How to Fix It.” In this well-researched paper, Kvaal points out that “American multinationals can defer U.S. taxes indefinitely as long as profits are held in a foreign subsidiary. Taxes are only due when the money is returned to the U.S. parent corporation. The result is like an IRA for multinationals’ foreign investments: foreign profits accumulate tax-free. U.S. taxes are effectively voluntary on foreign investments.”
There’s no rule saying American companies ever have to bring that money home. As long as they reinvest earnings overseas, they pay only the host country’s (usually lower) tax rate. Many companies just put the money they make overseas back into their foreign operations, which means more economic growth for other countries, and less here at home. Kvaal wrote that “when multinationals choose to return profits to the U.S. they can offset any foreign taxes against their U.S. tax. … As a result, the effective tax rate on foreign non-financial income is below 5 percent, well below the statutory rate of 35 percent.”
He recommends changing the tax code to a “partial exemption system” that “would tax foreign income only if a foreign government failed to tax it under a comparable tax system. As a result, all corporate income would be taxed at a reasonable rate once and only once.” He opines that this system would reduce incentives to invest in low-tax countries, simplify the taxation of corporate profits, and reduce tax competition by removing the benefit of tax havens. He urged immediate action “to ensure that our tax code no longer exacerbates incentives to move offshore.”
The importance of low tax rates to the success of start-up companies is emphasized by Henry Northhaft, CEO of Tessera Corporation, in his book Great Again, co-authored by David Kline. They wrote, “… lower tax rates on the last dollar earned encourage individuals and businesses to work harder, take more entrepreneurial risks, and expand their operations because they can keep more of the fruits of that added labor or activity … a reduction in the marginal tax rate of 1 percentage point increases the rate of start-up formation by 1.5 percent and reduces the change of start-up failure by more than 8 percent. … Tax rates don’t just influence how much investment and growth a firm will choose to undertake. In an increasingly globalized economy, they also profoundly affect where a business will chose to invest or expand … the relative tax and regulatory burdens on U.S. start-ups have grown exponentially, whereas those on European and other foreign ventures have declined sharply.”
Nothhaft “As a result, America now has the highest corporate rate in the world (with the lone exception of Japan). At 39.2 percent, it’s more than 50 percent higher than the OECD average of 25.5 percent. … A number of empirical studies by OECD economists and others have discovered that the best “revenue-maximizing” tax rate – the rate that brings in more total revenues than either a lower or a higher tax rate – is around 25 percent.”
Comprehensive tax reform is needed because under the current system multinational corporations are favored over domestic companies. Taxes can foster economic growth or hinder it. Our domestic economic growth is being hindered by the current tax system and must be addressed by Congress in the near future if we want to help American compete successfully in the global economy and create more jobs.