By Laura Tyson
Sept. 6, 2017
Corporate tax reform is one of the few issues that attract bipartisan support in Washington. Lawmakers from both sides agree that the current system is deeply flawed. Because the U.S. has not updated its tax code in 31 years, Congress has a once-in-a-generation opportunity to level the playing field for American businesses and workers.
When U.S. multinationals sell products abroad, it spurs production, employment and income at home. Facing the highest corporate tax rate in the developed world 38.9% on average, including state taxes and a system of taxation that follows them wherever they go, U.S. companies are at a disadvantage in global markets. This discourages investment, innovation and job creation back home.
In 2013, U.S.-based multinationals directly employed 23 million Americans and supported another 53 million American jobs through their domestic supply chains and employees spending. To serve global markets, U.S. multinationals locate significant shares of their world-wide economic activities in the U.S. more than two-thirds of their value added, their capital expenditures, and their research and development, and just under two-thirds of their employment in 2014.
U.S. multinationals face increasing global competition from businesses in developed and emerging-market economies. Between 2000 and 2016, the number of U.S.-headquartered companies in the Forbes 500 declined more than 25%. The outdated U.S. corporate tax system was partly to blame.
The U.S. corporate tax rate was among the lowest among developed countries after the 1986 tax reform. It is now the highest. A recent study confirms that even after accounting for deductions, credits and other tax-reducing provisions, U.S. multinationals face among the highest effective tax rates in the world. Many U.S. companies opt out of the corporate tax system by organizing as partnerships and pass through businesses. In 2013, corporations accounted for only 44% of business income in the U.S. compared with about 80% in 1980.
The world-wide American corporate tax system subjects U.S. companies foreign earnings to the U.S. corporate tax, with the amount owed offset by credits for taxes paid in foreign jurisdictions. In contrast, 29 of the 35 countries in the Organization for Economic Cooperation and Development have adopted territorial systems, which largely exempt the foreign business earnings of their multinationals from home-country taxation. This puts U.S. multinationals at a competitive disadvantage when doing business abroad. They face the high U.S. corporate rate on their earnings in foreign markets while their global competitors face the much lower local rates. This difference translates into a sizable cost advantage for foreign multinationals, allowing them to charge lower prices and capture market share from U.S. companies.
Current law allows U.S. multinationals to defer U.S. tax payments on foreign earnings until they are repatriated. Most American companies take advantage of this option for at least some of their foreign earnings. As foreign earnings have grown and foreign corporate tax rates have plummeted, the deferral option has become more attractive. An estimated $2.6 trillion of U.S. companies foreign earnings is now trapped abroad. This is money that might otherwise be used to finance investment, job creation and domestic growth.
Tax considerations also influence corporate decisions about how acquisitions are financed and where merged or acquired entities are headquartered. The combination of a high corporate tax rate and an outdated world-wide system has caused some U.S. companies to move their headquarters overseas or pursue an acquisition by a foreign competitor. It has also reduced U.S. companies competitiveness in cross-border acquisitions.
In such acquisitions, a U.S. purchaser of a foreign company owes U.S. tax on the resulting foreign income stream. That tax that wouldn't be owed by a foreign purchaser headquartered in a country with a territorial tax system. According to an analysis of Thomson Reuters data, foreign acquisitions of U.S. companies were more than three times as great in deal value than U.S. acquisitions of foreign companies in 2015. That suggests the U.S. is no longer the country of choice for global companies headquarters and activities.
The competitive dynamics of the global economy were different in 1986, when the U.S. last reformed its tax code. It is time for comprehensive reform that reduces the corporate rate, broadens the tax base, simplifies the system, and adopts a modern territorial approach with safeguards to protect the U.S. tax base. Lawmakers on both sides should work together to craft reforms that will benefit Americas workers, companies and economy.
Ms. Tyson is a distinguished professor of the Graduate School at the University of California and serves as an economic adviser to the Alliance for Competitive Taxation. She headed the Council of Economic Advisers and the National Economic Council during the Clinton administration.