The Wall Street journal reports that Senate Finance Committee Chairman Max Baucus (D-MT) plans to release a draft proposal on taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. reform, possibly as soon as today.
It is thought that his draft will focus on corporate tax reform, specifically the international treatment of United States based companies.
Currently, U.S. companies that operate internationally are taxed under a worldwide system of taxation. This means that no matter where a company earns its profit, it is still subject the U.S. Corporate tax rate of 35 percent. The U.S. is one of only a few countries in the world that still operates under the worldwide system of international taxation.
For example, let’s say a U.S. based company operates in the United Kingdom, which has a corporate rate of 23 percent, and earns a profit of $100. This company pays $23 dollars in taxes to the U.K. When the company brings that money home to the United States, it must make up the difference between the U.K.’s rate of 23 percent and the U.S. rate of 35 percent, so it pays $12 dollars to the U.S. Treasury, for a total of $35 in taxes on the $100 of profit earned in the U.K.
This makes U.S. headquartered companies less competitive internationally. A U.S. company that operates in a country like England competes with companies that are subject to only the U.K. rate of 23 percent. Using the example above, U.S. based companies that must pay the 35 percent rate are left with $12 less profit. Companies use profits to reinvest and grow, and without those additional profits the U.S. based companies are less able to compete.
To make matters worse, the U.S rate of 35 percent is the highest in the industrialized world, further exaggerating the problem.
The best fix would be to cut the corporate rate significantly and move to a territorial system of taxation. Under a territorial system, companies are only taxed in the country in which they earn their profits. For the U.K. example, this means that U.S. based companies operating in England would face a 23 percent tax rate, just like all the other companies operating there.
This would allow U.S. based companies to compete and move the U.S. more in line with the competition (see chart below). Currently, almost all industrialized nations (28 out of 34) use this type of system, with many moving to a territorial system in the last few years to improve competitiveness.
A more competitive international tax system, with a lower rate and a shift to territorial, would enable U.S companies to expand at home and abroad, leading to more jobs and more high-paying jobs here at home.