Why We Should Fix Our Corporate Tax Code Before the Elections
Comprehensive tax reform has been an overarching goal of the Republican members of Congress for over a decade--especially for the new Speaker of the House, Paul Ryan--but it doesn't seem likely to happen anytime soon. A recalcitrant president, a Democratic party that's at best ambivalent about reform, internecine battles within the Republican party, and lobbyists keen to keep their favorite deductions, credits and exclusions all conspire against accomplishing it.
The GOP strategy at present seems to be to wait for a new president to try for comprehensive reform, but it's far from clear that the next president will be more amenable to comprehensive reform, and the other obstacles aren't going to magically fade away in a year.
The uncertain environment next year begs a question: Is there any facet of tax reform that can be accomplished this year, and is it worth getting half a loaf in 2016 than holding out to try for the whole kit and kaboodle next year?
The answer is an unqualified yes. The corporate tax code is in especially dire ned of reform, and there's reason to fix this sooner rather than later.
The United States has a high corporate tax rate--nearly 40% when we include state and local taxes. That is the highest in the OECD and amongst the highest in the entire world. What's more, we assess the corporate income tax on every dollar earned by a U.S. corporation, regardless of whether the money was generated in the U.S. or in a foreign company. The U.S. is one of only a few countries to treat foreign-sourced revenue this way, mainly because it makes for lousy policy.
This toxic combination puts U.S. companies at a competitive disadvantage, especially when operating abroad. A U.S. company operating in, say, Germany must compete against companies that pay the lower German corporate tax rate while they themselves operate under the higher U.S. rate.
U.S. companies do have ways to avoid the higher corporate tax rate on their foreign-sourced income. The first is to never repatriate that money back to the U.S. More than $2 trillion of corporate profits currently resides abroad for that very reason. That's a lousy deal for the U.S.; it would be much more beneficial for the U.S. economy if that money returned to the U.S. rather than be invested abroad.
The other way companies avoid the higher tax rate on foreign income is to simply cease being a U.S. company, usually by merging with a foreign entity and assuming the domicile of the foreign concern, a process called an inversion.
A corporate inversion doesn't affect the taxes owed on domestic income, and the reality is that few companies repatriate foreign-sourced income--since the punitive U.S. rate usually makes doing so impractical--so the United States loses little tax revenue overall from such a maneuver. In fact, the truth may be that corporate inversions don't affect domestic tax revenue at all: A recent study by two Northwestern University economists found no evidence that the tax bill of companies that inverted in the last decade was impacted in a material way.
In the last few years a number of major U.S. companies have availed themselves of this option, with each one inevitably triggering indignation from politicians and commentators.
Last year it was the proposed merger between Pfizer and Allergan, based in Ireland, that set off the last wave of heated rhetoric from the administration and liberal commentators.
Just this week Johnson Controls announced that it would merge with Tyco, based in Ireland, and relocate its headquarters there.
In response to the spate of inversions that past few years the Obama Administration issued new regulations to make it more difficult to invert, and--when that failed--it accused firms seeking to do such a thing of being "unpatriotic." Fixing the underlying tax problems that incentivize firms to do such a thing was never contemplated.
Several states have tried to deter corporate integration as well: For instance, The New Jersey State Assembly recently passed a bill that would prohibit companies domiciled abroad from receiving state government contracts of economic development grants.
The answer to the raft of inversions ought not be to declare such a thing illegal but to fix the corporate tax code in a way that makes it easier for U.S. companies to compete abroad. The way to do so would be to lower the corporate tax rate while at the same time getting rid of the tax on foreign-sourced income. Doing so would make inversions redundant, improve the competitiveness of U.S. firms across the globe and boost domestic investment.
Since the Obama Administration has all but ruled out any reform of the tax code that pertains to individuals and small businesses--or at least ruled out reducing their tax rates--some people conclude that there is no reason to attempt any tax reform until there's a new president.
But the reality is that few Republicans are keen to tackle the most egregious problems with the personal tax code either, such as the costly deductions for mortgage interest, state and local taxes, and employer-provided health insurance. Until that changes the sad reality is that all that can be done with the personal tax code is some tweaking around the edges, no matter who is president.
But the political barriers to reforming the corporate tax code are more surmountable and the benefits from accomplishing such a thing, in terms of the gains to economic competitiveness and growth, are potentially much higher. Each year we delay fixing the corporate tax code it costs our economy in the form of reduced investment, fewer jobs, and slower economic growth.
The solution isn't complicated: Congress should reform the corporate tax code this year by reducing the tax rate, paying for as much of it as possible by eliminating various corporate tax deductions, exclusions and credits, and adopting a territorial tax regime.
