The TCJA Improved the United States’ International Tax Competitiveness Index Rankings

Changes made to the corporate and individual 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. codes by last year’s Tax Cuts and Jobs Act helped boost the United States’ ranking from 28^th to 24^th in our 2018 International Tax Competitiveness Index. Reductions in those tax rates led to improvements in the U.S.’s overall ranking among Organisation for Economic Co-operation and Development (OECD) nations as well as within individual tax components.

United States’ Ranking Before and After the Tax Cuts and Jobs Act (TCJA)

	Overall	Corporate Tax	Consumption Taxes	Property Taxes	Individual Taxes	International Tax Rules
Previous Rankings	28	34	4	29	27	33
New Rankings	24	20	4	28	26	32

The United States’ improvement is primarily driven by two significant changes made to the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. code, in which the component ranking jumped from 34th to 20th.

The new law lowered the statutory federal rate from 35 percent to 21 percent, which has the effect of lowering the federal and average of state and local corporate rates from 38.9 to 25.7 percent. The U.S.’s new average rate of 25.7 percent is just slightly above the OECD average of 24 percent.

Another corporate tax code change enacted in the TCJA is 100 percent bonus depreciation, or full expensingFull expensing allows businesses to immediately deduct the full cost of certain investments in new or improved technology, equipment, or buildings. It alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. . This provision improves cost recoveryCost recovery is the ability of businesses to recover (deduct) the costs of their investments. It plays an important role in defining a business’ tax base and can impact investment decisions. When businesses cannot fully deduct capital expenditures, they spend less on capital, which reduces worker’s productivity and wages. , as it allows businesses to immediately write off capital investments in things like machinery and equipment.

The improvements in the corporate tax were somewhat muted by 1) the reduction in the value of loss carryforwards, which were limited to 80 percent of taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. ; 2) the elimination of loss carrybacks; and, 3) the introduction of a special lower tax rate of 13.125 percent on what is called “foreign-derived intangible income,” which operates similarly to a 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. , but only applies to export-related intellectual property income.

On the individual side, the U.S. rank improved slightly, from 27th to 26th place. The TCJA reduced the top marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. . However, the new tax law increased the threshold at which the top rate applies from eight times average income to 9.5 times, narrowing the income tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. . The law also slightly increased marginal tax rates on capital gains and dividends by capping the state and local tax deductionA tax deduction is a provision that reduces taxable income. A standard deduction is a single deduction at a fixed amount. Itemized deductions are popular among higher-income taxpayers who often have significant deductible expenses, such as state and local taxes paid, mortgage interest, and charitable contributions. .

The United States also improved with respect to the international tax rules subcomponent, moving from 33rd to 32nd. The TCJA introduced several changes to the treatment of foreign-source income of multinational corporations. The law enacted a dividend-received deduction, or a “territorial” tax system. In conjunction with the new 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. , the law introduced new anti-base erosion rules meant to prevent companies from shifting profits to lower-tax jurisdictions. The new law made no changes to withholdingWithholding is the income an employer takes out of an employee’s paycheck and remits to the federal, state, and/or local government. It is calculated based on the amount of income earned, the taxpayer’s filing status, the number of allowances claimed, and any additional amount of the employee requests. taxes and treaty networks, which are also important to a country’s international tax system.

The only change that the TCJA made to property taxes was an increase in the exemption level of the estate taxAn estate tax is imposed on the net value of an individual’s taxable estate, after any exclusions or credits, at the time of death. The tax is paid by the estate itself before assets are distributed to heirs. . The new law did not change consumption taxes, as state and local governments govern them.

According to the 2018 International Tax Competitiveness Index, the TCJA made several important changes to the United States’ tax code which improved the U.S. ranking by four places. However, the Index also shows that there are many parts of the tax code that still require examination.

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