Tax reform would fuel U.S. economy

By Douglas Holtz-Eakin

The following opinion piece was printed in POLITICO on July 31, 2013

Momentum is building for tax reform — and with good reason. America's broken tax system was last reformed in 1986, and the global marketplace is moving much faster than a once-a-generation pace. The current rules were fine when U.S. exports dominated a global economy crushed by two world wars, but they are ill-suited for a digital age of intense competition.

While other countries have modernized their international tax systems, the United States remains mired in the past. The U.S. tax system isn't working for American businesses, workers or the economy as a whole. All of the G-8 member nations except the United States, and 28 of the other 33 countries in the Organization for Economic Cooperation and Development, have moved to an international tax system with modern territorial features — meaning income is taxed only where it is earned. And the trend is clear: Fifteen of those 28 countries have done so since 2000. American workers are increasingly competing at a disadvantage.

The U.S. system, with its high tax rate and double taxation of foreign income, is also a poor way to collect revenue. These same features discourage undertaking profit-making investments in the United States and make the foreign operations of U.S. companies more profitably held by their foreign competitors. When U.S. companies are acquired, their headquarters often move abroad — with research and manufacturing often following — leaving too little to tax back home. The resultant narrowing of the tax base means the U.S. collects dwindling amounts of money through a system that discourages growth at home: the worst of both worlds.

U.S. tax law also locks revenue out of the American economy. Currently, American companies have $2 trillion in earnings that they cannot invest in the United States without incurring a tax penalty; that's money our economy desperately needs. The benefits are obvious: That $2 trillion can fund research and development in the U.S. so that the next great product can be American-designed. It can expand domestic production facilities. It can hire American workers. Today, 95 percent of the world's consumers are outside of the U.S. We should want our businesses to sell American workers' products to them. And when they do, we should want the profits to come back home.

It's clear the current system of international taxation discourages economic growth and hurts American businesses. But over the past few decades, as other countries have modernized their international taxation rules to keep homegrown businesses from relocating abroad and to help attract new companies, the United States has stuck to its antiquated ways. This stubbornness is not without cost: The U.S. gross domestic product has shrunk by 1.2 percent to 2.0 percent as a result, and foreign acquisitions of American companies have outstripped American acquisitions of foreign companies by more than $500 billion since 1990.

And while the United States unfairly disadvantages its workers and firms, other countries are eager to compete.

After Japan adopted its territorial tax system in 2009, the country enjoyed a 31 percent increase in cross-border acquisitions. The United Kingdom declared its intention to modernize its corporate tax code by saying it would “send out the signal loud and clear that Britain is open for business.” The Canadian government was even more explicit, writing that its mission “is to create a meaningful tax advantage over the United States.” And Germany, in pursuit of a simpler tax code, has cut its corporate income tax rate more than 20 percentage points since 1998.

Success, then, is a choice. The evidence is in: The status quo isn't working. To better compete, it is time to learn from what is working for other countries. There is no single blueprint for the territorial system to adopt; each country has adapted its tax code to find what works best for it. The United States should follow suit. What are we waiting for?

Douglas Holtz-Eakin is former director of the Congressional Budget Office and economic adviser to the Alliance for Competitive Taxation, a group of 42 leading American businesses supporting comprehensive tax reform.