One of the more compelling reasons to pursue 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 is the fact that the U.S. has the highest corporate tax rate in the developed world. Another compelling reason is that U.S. multinational corporations (MNCs) must pay that high corporate rate on their worldwide earnings, while their foreign competitors operate mostly under territorial tax systems that largely exempt foreign earnings from domestic taxation. These two factors are behind a host of problems plaguing the U.S. economy including low investment, chronic unemployment, slow growth, and a general flight of capital leading to the loss of corporate headquarters. Recently, two very different tax proposals have been put forth to deal with these issues: one by Chairman Dave Camp, of the House Ways and Means CommitteeThe Committee on Ways and Means, more commonly referred to as the House Ways and Means Committee, is one of 29 U.S. House of Representative committees and is the chief tax-writing committee in the U.S. The House Ways and Means Committee has jurisdiction over all bills relating to taxes and other revenue generation, as well as spending programs like Social Security, Medicare, and unemployment insurance, among others. , and the other by the Obama administration in its most recent budget.
Obama’s Corporate Tax Plan: Build a Wall
Recognizing the corporate tax rate problem, the Obama administration in its latest budget, as in previous proposals, has agreed to lower the corporate rate, however, only in exchange for higher corporate taxes elsewhere. In fact, the administration specifies an overall corporate tax increase of more than $400 billion over 10 years. This completely defeats the purpose of cutting the corporate tax rate, which is to attract highly mobile corporate capital.
It is also a larger corporate tax increase than in previous Obama budgets. Many of the tax increases are aimed at multinational corporations, such as various limits on deferral of foreign income. This would move the U.S. closer to a pure worldwide tax systemA worldwide tax system for corporations, as opposed to a territorial tax system, includes foreign-earned income in the domestic tax base. As part of the 2017 Tax Cuts and Jobs Act (TCJA), the United States shifted from worldwide taxation towards territorial taxation. , where all foreign income is subject to U.S. tax, rather than a territorial tax systemA territorial tax system for corporations, as opposed to a worldwide tax system, excludes profits multinational companies earn in foreign countries from their domestic tax base. As part of the 2017 Tax Cuts and Jobs Act (TCJA), the United States shifted from worldwide taxation towards territorial taxation. , which exempts most foreign income from additional domestic taxation. Most countries use a territorial tax system, so these changes would make the U.S. even less competitive. The only country to try a pure worldwide tax system without deferral was New Zealand, which after experiencing prolonged economic stagnation switched back to a territorial tax system in 2009.
For instance, the administration proposes to end deferral for digital goods or services sold abroad, subjecting those profits to immediate domestic taxation at the 35 percent federal tax rate. Deferral has allowed companies like Apple and Amazon to compete abroad on a level playing field with companies based in territorial countries. America could very well lose its competitive edge in the digital goods sector if the administration’s proposal becomes law.
The natural response for profitable companies faced with punitive taxes is to look for a way out. Indeed, dozens of companies have already left the U.S. in recent years, often by merging with or acquiring foreign companies and “inverting” so the new parent company headquarters is outside the U.S. for tax purposes. Just today, Chiquita Banana, currently based in North Carolina, announced it is merging with the Irish Company Fyffes and the new company will be based in Ireland, where the corporate tax rate is 12.5 percent. The U.S. government has tried to prevent such moves with various penalties and restrictions, but the practice continues and appears to be accelerating.
Unfortunately, the Obama administration has an answer to this problem too: make it even more difficult to leave. The current rule says a U.S. company can invert only if the U.S. parent company would be no more than 80 percent of the new combined post-merger company, in terms of shares. Additionally, there are penalties for inverting if the U.S. parent is 60 percent or more of the combined company. That effectively prevents really big U.S. corporations, such as Apple and Amazon, from leaving, since a) it’s hard to find willing partners outside the U.S. that approach that size, and b) it’s hard to justify the costs of such a big merger. The Obama administration proposes to make it even more difficult for more companies by lowering the 80 percent rule to 50 percent. Such a rule would probably have prevented some of the recent high-profile inversions, e.g. Applied Materials and Actavis. However, it does nothing to address the ultimate problems of high corporate taxes in the U.S. and a worldwide tax system, both of which constrain U.S. investment and hiring.
Rather than the Berlin Wall approach, the U.S. should be attracting business with lower corporate taxes, which is what most countries outside the U.S. have done.
Comparison to Camp’s Proposal
Chairman of the House Ways and Means Committee, Dave Camp, offers a more competitive approach on international corporate tax reform, although it would still place a high tax burden on U.S. MNCs relative to their competitors in other countries (see our earlier discussion of some of the other problems in the Camp proposal).
Camp calls for a lower corporate tax rate of 25 percent and a 95 percent exemption of most active foreign earnings, which would put the U.S. much closer to the international norm. However, he proposes a minimum tax of 15 percent on intangible earnings, whether earned domestically or abroad, which would be a tax increase on some forms of intangible earnings, such as royalties, that are currently eligible for deferral. This “patent boxA patent box—also referred to as intellectual property (IP) regime—taxes business income earned from IP at a rate below the statutory corporate income tax rate, aiming to encourage local research and development. Many patent boxes around the world have undergone substantial reforms due to profit shifting concerns. ” approach is found in seven other developed countries, but usually with lower tax rates: Spain and France have 15 percent tax rates and the other five countries tax intangible income at 5 to 10 percent.
As well, Camp agrees with Obama that existing U.S. MNCs should pay for the privilege of having a more competitive tax system. They both would levy a retroactive “deemed 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. ” on accumulated foreign earnings, through which Camp expects to raise $170 billion over 10 years and Obama expects to raise $150 billion. Oddly, both Camp and Obama devote this revenue to the Highway Trust Fund, as if corporations are now supposed to pay for the decline in gas tax revenue. First, money raised from corporate tax reform should only be used to reduce the corporate tax rate and exempt foreign earnings. Second, retroactive tax increases are never justified.
Overall, Camp’s international corporate tax reform proposals are an improvement over current law, but some aspects are less than competitive and would put some U.S. companies at a disadvantage. In contrast, the Obama administration would take the extremely uncompetitive U.S. corporate tax system and make it worse, and then try to prevent U.S. corporations from leaving.
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