Urgency on Corporate Tax Reform

The U.S. Treasury held a conference today regarding the growing uncompetitiveness of the U.S. corporate tax system.

Scholars and heads of large corporations have been pointing out the serious problems with the corporate tax for more than 15 years. There is now a growing consensus that the complex and high-rate corporate tax needs to be overhauled.

Here are some of the themes discussed today:

  • Europe is on a corporate tax-cutting binge. Today, the U.S. federal plus average state corporate tax rate stands at 40 percent, which is much higher than the average rate of 24 percent in the European Union. It appears that foreign rates will keep on falling for some time, putting an ever greater squeeze on U.S. competitiveness.
  • Intel Corporation stressed that tax costs are an important consideration when they locate new semiconductor plants. Over a 10-year time frame, Intel figures that it costs $1 billion more to build and run a plant in the United States over competing countries such as Ireland and Malaysia. About 70 percent of the U.S. cost disadvantage stems from taxes.
  • General Electric noted that taxes are not the key issue in determining where it builds new plants. Instead, in GE’s case, tax rules on foreign income determine whether, say, a U.S. or German company ends up owning a new facility in other countries such as Brazil. From a tax perspective, the United States is a bad place to locate the headquarters of a multinational corporation. Most economists believe that damages the U.S. economy.
  • There is a trend toward “territorial” corporate tax systems, with about two-thirds of countries having such systems today. A U.S.-style “worldwide” system is less and less popular because it puts home-country corporations at a disadvantage in global markets.
  • Several speakers stressed that a greater share of corporate value is in the form of intangible property such as patents. Intangible property is more mobile than tangible property, and thus easier to relocate to low-tax jurisdictions.
  • Peter Merrill of PricewaterhouseCoopers noted that because of higher capital mobility, a greater share of the U.S. corporate tax burden is falling on U.S. workers. Kevin Hassett of the American Enterprise Institute has shown statistically that higher corporate tax rates mean lower worker wages.
  • Supply-side economists have long pushed for tax breaks on new capital investments. But there was widespread agreement at the Treasury roundtable that getting the corporate tax rate down is more important than incentives such as investment tax credits. A lower corporate rate reduces all the distortions in the corporate tax code and directly responds to the challenges of growing global capital mobility.

The only red herring I noticed was a repeated suggestion that we should “broaden the base” of the corporate tax to pay for a corporate rate cut. But there is very little broadening that we could do that wouldn’t be economically damaging. There are not a great number of obvious loopholes in the corporate income tax. (There is lots of tax avoidance, but that is a different issue.) The Treasury listed some targeted loopholes in a recent report, but I bet most people at the conference today would object to repealing most of those, such as “deferral of income from controlled foreign corporations.”  

Anyway, kudos to Treasury Secretary Henry Paulson for the important conference and beginning some momentum for corporate tax reform. 

See here for more background on international tax competition and corporate tax reform.