Over the holiday weekend, former president Bill Clinton called for lowering the corporate tax rate and broadening the base as a means of brokering a deal over the debt ceiling. Clinton described the corporate 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. rate as “uncompetitive,” saying, “We should cut the rate to 25 percent, or whatever’s competitive, and eliminate a lot of the deductions so that we still get a fair amount [of revenue], and there’s not so much variance in what the corporations pay.” Later that week, he also voiced support for a “repatriationTax repatriation is the process by which multinational companies bring overseas earnings back to the home country. Prior to the 2017 Tax Cuts and Jobs Act (TCJA), the U.S. tax code created major disincentives for U.S. companies to repatriate their earnings. Changes from the TCJA eliminate these disincentives. holiday” on corporate earnings being held abroad.
Currently, U.S. corporations are taxed at a combined federal and state rate of 39.3% and by what is known as a worldwide system of corporate taxation. The U.S. corporate tax rate is the second-highest in the world, surpassed only by Japan’s top rate of 39.54%. High corporate rates hinder economic growth and reduce the competitiveness of American firms within the global marketplace. But high rates are merely a problem within the even bigger problem of how U.S. corporations are taxed on foreign income.
In the worldwide system the U.S. employs, companies wishing to bring back (repatriate) income earned abroad must, upon repatriation, pay the difference between its highest statutory U.S. tax rate (35% for most multinational corporations) and the rate at which taxes have already been paid to the host government. Nearly every other country in the OECD uses a territorial system of taxation in which only income earned within the country’s borders is taxed. Moving to a territorial system of taxation is crucial, but it should be a permanent move rather than a holiday. Plenty of reasons for this exist, ten of which appear in the May 11, 2011 Tax Foundation Special Report, “Ten Reasons the U.S. Should Move to a Territorial System of Taxing Foreign Earnings,” by Tax Foundation President Scott Hodge.
If lawmakers believe that moving to a territorial system will help economic growth, they should write it into a long-lasting law. Uncertainty slows investment decisions and thereby hinders economic growth, and companies will undoubtedly wonder when the next holiday will be unless the change is considered permanent. Creating uncertainty within an economy can have serious long-term, adverse effects (see “Uncertainty and Investment Dynamics,” Review of Economic Studies, Bloom et al, 2007).
Clinton’s explicit support for a reduction in the corporate tax rate and implicit support for a territorial system of taxation of corporate earnings constitute what would be a sound move towards comprehensive tax reform. Lowering corporate rates and broadening the tax base would stabilize the distribution of the corporate tax burden, enhance the competitiveness of American companies, and engender conditions for sustainable economic growth.
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