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We’re Number One!

3 min readBy: Scott Hodge, Chris Atkins

Americans like to be number one. We boast the most Olympic medals, the mightiest military, and the most powerful economy in the world. But there’s one area where being number one isn’t something to be proud of: America’s high corporate taxes.

In recent years, while countries from Ireland to Estonia have been cutting corporate taxes to attract new jobs and investment, the U.S. has fallen drastically behind the wave of 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. reform.

Today, the combined U.S. corporate tax rate stands at 39.3 percent. That means America now has the highest statutory 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. rate in the world—even higher than socialist Sweden and welfare-states Germany and France.

Even our effective tax rates (that is, the rate companies actually pay after deductions and credits) are high. According to the C.D. Howe Institute, the U.S. effective tax rate on manufacturing and services is 37.7 percent, which is fourth highest in the world. Only China, Canada and Brazil rank more highly.

It wasn’t always this way. The Tax Reform Act of 1986 reduced the U.S. corporate income tax rate from 46 percent to 34 percent, the largest reduction since the tax was enacted in 1909. This change, along with an earlier move in the United Kingdom, started a wave of corporate income tax reduction worldwide.

But in recent years we’ve lagged behind. One of the ironies of the Bush presidency is that five years of tax-cutting have left the federal corporate income tax rate unchanged. The reason? It’s hard enough to overcome “tax cuts for the rich” rhetoric when individual income taxes are cut. Imagine the political opposition to corporate tax cuts.

However, the rest of the world (and, in particular, Europe) is apparently more enlightened when it comes to corporate tax reform. According to the Organization for Economic Cooperation and Development (OECD), the average OECD nation has reduced its corporate income tax rate by 13 percent since 2000. In contrast, neither the federal government nor any state government has cut is corporate income tax rate since 2000.

Other countries are cutting corporate tax rates because they’ve learned the importance of having a competitive tax climate. Nations won’t attract new business and job creation if their corporate income taxes are significantly higher than comparable nations.

This is especially true in Europe, where new EU members have slashed corporate tax rates to compete for investment with high-tax countries like France and Germany.

Ireland reduced its corporate tax rate to 12.5 percent and has enjoyed large inflows of foreign investment as a result. Estonia levies a zero-rate corporate income tax on retained earnings. Hungary (16 percent) and the Slovak Republic (19 percent) also have comparably low corporate income tax rates, in an effort to become the “Ireland” of Central Europe.

Recently, leaders from the European Roundtable of Industrialists encouraged Turkey—a country vying for EU membership—to lower its corporate tax rate to encourage new foreign investment. The Turkish government is only too happy to comply, and is signaling that it will lower its corporate tax rate from 30 to 23 percent at the beginning of 2006.

You won’t hear talk like this in the U.S. Historically, our dominant economy and oceans on either side have insulated us from economic competition with much of the world. But in today’s age of mobile labor and capital, we can no longer count on being shielded from global competition.

The President’s Advisory Panel on Federal Tax Reform recently proposed several reforms to our corporate tax system. The most ambitious suggestion would cut the federal corporate income tax rate to 30 percent from the current 35 percent.

While this reform would begin to restore America’s international tax competitiveness, it doesn’t go nearly far enough. In our recent study of corporate tax rates, we found that a 25 percent federal rate would be necessary to place the U.S. in the middle of OECD countries rather than first.

This is hardly a radical tax cut, but one that would radically improve our attractiveness to global companies. And it would finally relieve America of the stigma of being “number one.”

Chris Atkins is staff attorney and Scott A. Hodge is president of the Tax Foundation.