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America’s Tax Competitiveness Problem

Article by Matthew Denhart March 7, 2012 //   5 minute read

Tax rates matter for growth. Entrepreneurs have many options when considering in which country to locate a business, and tax rates are a major factor that sway decisions. In this sense, a competition exists among countries to offer the best business environment. Unfortunately, the U.S. appears to be losing the tax competition, at least when it comes to corporate tax rates. The World Bank’s “Doing Business 2012” report ranks the ease of paying taxes in 183 countries. Due largely to its high tax rates, the U.S. comes in at 72nd. Last week’s edition of The Economist featured a chart comparing the U.S. statutory corporate tax rate (I’ll discuss effective and marginal rates in a future post) to the average rate for OECD countries from 1981 through 2010. In 2010, the combined (federal, state, and local) statutory rate was 39.2% in the U.S., nearly 10 percentage points higher than the weighted average rate for the rest of the OECD. It was not always this way. During the first half of the 1980s, the U.S. and the OECD had similarly high corporate tax rates of nearly 50%. However, in the years following President Ronald Reagan’s signing of the Tax Reform Act of 1986, the U.S. rate dropped. By 1988 the American rate was 38.6%. In response, the other OECD countries lowered their rates as well. Throughout the 1990s, the corporate tax rates were similar, but U.S. rates were slightly lower. However, since 1999 the average rate for the OECD has fallen every year — to 29.6% in 2010 from 40.8% in 1998. Meanwhile, the U.S. rate has held constant at around 39%. The U.S., unlike other countries, taxes worldwide income. This means that a company earning profits abroad must pay taxes to the foreign country as well as to the U.S. government. While tax payments made to foreign governments can be deducted from the amount owed to the IRS, since the U.S. rate is higher than most other countries’, additional taxes are usually owed here at home.  This further undermines the competitiveness of the U.S. venue. In contrast, many OECD countries base their taxation on a “territorial system.” Under this system international earnings are taxed only by the foreign country in which they were earned. In 2009, Japan and the United Kingdom adopted the territorial system. Many argue the time has come for the U.S. to follow suit and stop imposing a competitive disadvantage on U.S. companies working abroad. Lowered corporate tax rates could possibly also increase total government revenues. In a 2007 paper, Alex Brill and Kevin A. Hassett (both of the American Enterprise Institute) find that the relationship between corporate tax rates and government tax revenues exhibits a Laffer Curve relationship. This means that as corporate tax rates increase so do tax revenues, but only to a point. After the corporate tax rate exceeds a certain rate (which they estimate to be around 26% for OECD countries), revenues actually begin to fall because of the unintended negative impact of the high tax rate on the economy. In another paper, published in 2008, Brill cautions that this finding cannot necessarily be generalized to the U.S. given the country’s disproportionate size. However, he notes, “Nevertheless, it is plausible that a reduction in the U.S. corporate tax rate need not result in a reduction in tax revenue. In fact, given that the U.S. rate is so high, a lower rate could lead to higher tax revenues.” The thought of lowering the corporate tax rate makes many lawmakers in Washington squeamish. This is understandable considering our nation’s massive debt, but, some of us think that lower rates could make more companies operate here and could actually increase total tax revenues.