March 5, 2012

It's Time Corporate Tax Reform Became A Top Campaign Issue

Jason J. Fichtner

Former Senior Research Fellow
Summary

It's an election year and politicians want your vote. In the race for the White House, the incumbent and the two leading Republican challengers have offered proposals for reforming the corporate income tax. But how will we know a good reform plan when we see it?

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This article was originally published in Investor's Business Daily and co-authored with James Carter

It's an election year and politicians want your vote. In the race for the White House, the incumbent and the two leading Republican challengers have offered proposals for reforming the corporate income tax. But how will we know a good reform plan when we see it?

The answer may surprise you. We will know the plan holds merit when the corporate income tax it advocates resembles those employed by most other countries, including Canada, Germany, and the United Kingdom.

Unbeknownst to most Americans, corporate taxation outside the U.S. has, for more than two decades, undergone a revolution. As the Tax Foundation highlighted last summer:

"Our major trading partners have been moving toward a fundamentally different model of taxing business income. The basic tenets of this new model are lower tax rates and the exemption of foreign earnings. In the past four years alone, 75 countries have cut their corporate tax rates to make themselves more competitive."

And with Japan scheduled to cut its corporate income tax rate April 1, the U.S. is poised to have the highest corporate tax rate among industrialized countries.

Why are so many countries abandoning worldwide taxation and slashing their corporate income tax rates? Two reports produced by the Organization for Economic Cooperation and Development (OECD) suggest an answer.

The first report, released in 2008, examined the impact of tax structures on economic growth. It concluded: "Corporate taxes are found to be most harmful for growth ... ." A second report released two years later reached the same conclusion.

Short of abolishing the corporate income tax, rate reductions mollify the economic damage. The central aim of U.S. corporate tax reform should be to lower the corporate tax rate, including the tax imposed at the state level, to a level no higher than that borne by our international competitors.

But that is only the beginning. Corporate tax reform should also pursue:

Territoriality. When Japan and the U.K. adopted territorial systems three years ago, they announced they were doing so to become competitive. Twenty-six of the 34 OECD countries employ territorial systems that exempt at least 95% of foreign earnings from repatriation taxes. The U.S.' stubborn adherence to worldwide taxation places U.S.-headquartered corporations at a substantial disadvantage.

Simplicity and transparency. The complexity and murkiness of the corporate income tax raises the cost of tax compliance. President Obama's Economic Recovery Advisory Board (aka "the Volcker Commission") reported in 2010 that U.S. corporations spend more than $40 billion annually on corporate tax compliance — all for a tax that generated less than 8% of federal revenue last year.

Permanency and predictability. Economic behavior is influenced not only by the tax code as it exists today, but also by the tax code that may exist tomorrow. Between the Bush-Obama tax cuts, the R&E tax credit, and some 64 other tax extenders, much of the tax code has been put on a year-to-year lease. This churning creates uncertainty, hampers planning, and impedes economic growth.

Efficiency. Economists argue the best tax systems have the least impact on economic decision-making. Decisions to work, save and invest should be driven by economic, not tax, considerations. What then can be said about the Obama, Romney and Santorum plans?

Obama's "Framework for Business Tax Reform" deserves praise for acknowledging some of the problems with our corporate tax system and proposing to lower the rate. But its stated desire to limit deferral and impose a minimum tax on overseas income would only worsen the tax disadvantage faced by U.S. businesses.

Romney's plan would lower the corporate tax rate to 25% and, unlike Obama's plan, would transition the U.S. to a territorial tax system that would help businesses compete at home and abroad. Though short on specifics, the plan is a serious step in the right direction.

Santorum's plan would lower the corporate tax rate to 17.5% and eliminate the corporate income tax on "manufacturing activity." While eliminating the corporate income tax is a good idea, the government should not give preferential treatment to one industry over another.

The good news is that there is now a consensus among the leading presidential candidates that our corporate income tax system is harming U.S. competitiveness and stunting economic growth and job creation. Perhaps, just perhaps, good policy will triumph over political posturing and corporate tax reform will become a reality regardless of whoever recites the presidential oath next January.