On December 22nd, 2017, President Donald Trump signed the “Tax Cut and Jobs Act” (TCJA) into law, which made a number of changes to the United States’ 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. code. The enacted law made changes to both the corporate and individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. codes and it is expected to improve the overall ranking of the United States on the International Tax Competitiveness Index.
The new tax code is projected to improve the United States’ current ranking from 30th among the 35 Organisation for Economic Co-operation and Development (OECD) countries to 25th, an improvement of five places.
|Overall Rank||Corporate Tax Rank||Consumption Taxes Rank||Property Taxes Rank||Individual Taxes Rank||International Tax Rules Rank|
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The International Tax Competitiveness Index (ITCI) seeks to measure the extent to which a country’s tax system adheres to two important aspects of tax policy: competitiveness and neutrality. A competitive tax code is one that keeps 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. s low. A neutral tax code is simply one that seeks to raise the most revenue with the fewest economic distortions.
The United States’ expected change in rank will be driven primarily by improvements to its 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, from last place (35 out of 35 countries) to 26th. Two changes are expected to drive the improvement to the U.S.’s corporate income tax. First, the statutory corporate tax rate (federal plus the average of state and local taxes) declined from 38.9 to 25.7 percent, which is slightly higher than the 24 percent average among all OECD nations. Second, the new bill enacted 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. —the ability for companies to fully deduct new investments the year in which they were put in place—for machinery and equipment.
The improvements in the corporate tax were somewhat muted by 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. ; the elimination of loss carrybacks; and 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.
The United States also is expected to improve with respect to its “International Tax RuleInternational tax rules apply to income companies earn from their overseas operations and sales. Tax treaties between countries determine which country collects tax revenue, and anti-avoidance rules are put in place to limit gaps companies use to minimize their global tax burden. s” from 33rd to 32nd. The TCJA introduced a number of 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 TCJA did alter individual income taxes, but the changes offset one another, resulting in no improvement. As such, the United States rank is expected to remain at 25. The TCJA reduced the top marginal tax rate (including payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. ) from 48.6 to 47.4 percent. At the same time, the average tax wedgeA tax wedge is the difference between total labor costs to the employer and the corresponding net take-home pay of the employee. It is also an economic term that refers to the economic inefficiency resulting from taxes. on labor declined slightly from 31.7 percent to approximately 30 percent. Offsetting those slight improvements, 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/local taxes paid, mortgage interest, and charitable contributions. .
There is no change expected to the United States’ ranking in property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. es or consumption taxA consumption tax is typically levied on the purchase of goods or services and is paid directly or indirectly by the consumer in the form of retail sales taxes, excise taxes, tariffs, value-added taxes (VAT), or an income tax where all savings is tax-deductible. es. 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. . However, the Index does not currently consider granular changes to estate and inheritance taxAn inheritance tax is levied upon an individual’s estate at death or upon the assets transferred from the decedent’s estate to their heirs. Unlike estate taxes, inheritance tax exemptions apply to the size of the gift rather than the size of the estate. es. No changes were made to consumption taxes as they are governed by state and local governments.
The TCJA made many other changes that may have an impact on the United States’ ranking, but will require additional data. For example, much of the tax law will undoubtedly alter the complexity of the tax system and will have a direct effect on compliance costs. Those changes will be incorporated once that data is available.
According to the International Tax Competitiveness Index, the TCJA made several improvements to the United States’ tax code. However, the Index also shows that there are many parts of the tax code that still require examination.Share