The year was 1986. The Oprah Winfrey Show made its debut. Mike Tyson became the youngest heavyweight champion of all time. And in October, the Tax Reform Act of 1986 was signed, marking the last time the United States federal tax code underwent large-scale reform. The global economy has changed drastically since 1986: free trade is more prevalent, the world financial system is more integrated, and capital is much more mobile. Yet the tax code has remained largely unchanged.
Both Congress and the Trump Administration have said it is a priority of theirs to pass fundamental tax reform this year. Based on the House GOP Blueprint for Tax Reform that was released last summer, any legislation passed by this Congress will likely have a positive effect on the global competitiveness of the United States. Reform focused on increasing the competitive stature of the United States will involve reducing the corporate income tax rate, simplifying the tax code, and replacing the archaic international tax system.
Cutting the Corporate Tax Rate
The highest federal marginal corporate income tax rate in the U.S. is currently 35%. Combined with state rates, which vary by state, the average top marginal tax rate on corporate income is 38.9%. This is the highest in the developed world. In recent decades, the trend amongst developed countries has been to reduce their corporate income tax. The Organization for Economic Cooperation & Development (OECD) average rate has declined from 32% to 25% since 2000. But the United States has remained an outlier with its constant rate, with some politicians even calling to raise it.
As the rest of the developed world has lowered its corporate income tax rate, corporations have left the United States, moving to these lower tax jurisdictions. According to a 2014 Congressional Research Service Report, 47 U.S. corporations have reincorporated overseas through inversions since 2004. In total, 75 corporations have inverted since 1994. The willingness of other developed countries to reform their tax systems has led to the United States losing its standing as an attractive place to do business.
Simplifying the Tax Code
Tax reform must also simplify the complex federal tax code. According to PricewaterhouseCoopers, businesses in the United States spend 87 hours per year on the necessary paperwork to comply with the corporate tax code. One of the reasons that it takes so long to comply is the number of loopholes and exemptions that it has. It is estimated that tax compliance and lobbying expenses were between $215 billion and $987 billion in 2012. By spending in these areas, firms are spending resources that could otherwise be used on production. Tax reform that reduces compliance time and reduces the incentive to spend resources on lobbying will make the United States a more attractive location for businesses to invest.
Moving Away from Worldwide Taxation
Lastly, the United States must change the way it taxes income that is earned outside of the country. Currently the U.S. has a worldwide tax system. This allows the IRS to collect taxes on profits from U.S. businesses located abroad, even after they have paid taxes in their host country. This system of taxation has led many multinational corporations to keep profits overseas, not repatriating their income in order to avoid paying taxes on it for a second time. By maintaining this worldwide approach, the U.S. is putting its businesses around the world at a competitive disadvantage by subjecting it to double taxation. Nearly all other developed countries have moved away from this system and adopted territorial taxation, taxing the profits earned within their borders but not those earned abroad. Shifting away from worldwide taxation will catch the U.S. up to other developed nations while making its businesses more competitive.
There is much that needs to change in the tax code in order to make U.S. businesses more competitive in the global economy. A great starting point would be cutting the corporate income tax rate, simplifying the tax code through eliminating loopholes and needless deductions, and moving away from worldwide taxation. Members of Congress have already introduced proposals to do this, including the Border Adjustment that is favored by Ways & Means Chairman Rep. Kevin Brady. Now Congress needs to come together to pass meaningful, lasting tax reform that will improve the United States’ position in the global economy.
Note: The Border Adjustment has since been withdrawn.