Recent scandals have given corporate taxes — usually not the hottest topic around — some buzz and given politicians fodder for some breast-beating populism.
Today’s villains are U.S. companies that re-incorporate offshore, in such places as Bermuda, and businesses, such as Enron, that pursue complex tax avoidance schemes. Democratic presidential contender Howard Dean, not a typical pol, promises to “crack down” on corporate tax shelters and blasts “Enron economics” — whatever that is.
The scandals obscure the fact that most American corporations actually pay the government huge amounts of tax. Wal-Mart, for example, forked out $3 billion in federal income taxes last year. Indeed, there is growing concern that because corporations must pay so much in taxes, American companies are at a competitive disadvantage in world markets. Consider that the combined U.S. federal and average state corporate tax rate is 40 percent. That’s much higher than the 31 percent average for the 30 top industrial countries.
In recent years, most of our trading partners have cut their corporate tax rates to boost competitiveness. Smart countries, such as Ireland, have recognized that sharp corporate tax cuts will attract foreign investors. While numerous factors affect investment flows, America’s uncompetitive corporate tax drives away domestic and foreign firms whose investments would create U.S. jobs and spur economic growth.
The issue of “tax competitiveness” is finally attracting attention. The House and Senate are considering a response to a World Trade Organization ruling that a $5 billion tax break America gives to exporting companies is illegal. The Europeans have threatened the United States with trade retaliation unless it repeals the so-called “FSC/ETI” tax break by the end of the year.
How should the United States respond? Leading bills in Congress would replace FSC/ETI with a targeted tax break for manufacturing. An across-the-board rate cut would be better. Nonetheless, the House bill sponsored by Ways and Means Chairman Bill Thomas includes many useful reforms and does cut taxes overall. The Senate bill does not cut taxes, having as many “revenue raisers” as tax cuts.
Revenue-raising provisions to close supposed loopholes don’t give a boost to the economy and often increase tax code complexity. More complexity will result in more tax sheltering, not less. Consider that a congressional report on Enron’s controversial tax shelters concluded that Enron “excelled at making complexity an ally.” A 1999 study by the Clinton Treasury expands on that point: “Efforts by Congress to rein in specific tax shelters often make the Code more complex, creating a vicious cycle. The legislative remedies themselves create the complexity that the next generation of tax shelters exploits.” Thus, “loophole closing” provisions may generate more elaborate tax shelters later on.
The reality is that Enron’s tax avoidance and corporate interest in Bermuda’s sunny tax climate represent “canary in the mineshaft” warnings to Congress that the corporate tax code is overdue for a fundamental overhaul. The first step needed to reduce high corporate tax rates is to make tax sheltering less attractive. Ways and Means member Mac Collins of Georgia has the simplest tax reform bill. It would simply cut the federal corporate tax rate from 35 to 30 percent. His measure offers no special favors for particular businesses, yet it would be good for every industry in every state.
A longer-term goal should be reducing the corporate tax rate to 20 percent to make this country a business tax reform leader. We are now laggards — even socialist countries, such as Denmark and Sweden, have lower corporate tax rates than we do. By retaining a high rate, the U.S. cedes mobile investment capital to other countries, ultimately hurting American workers because less investment means lower productivity and reduced wages.
Congress should steal Howard Dean’s thunder by giving the United States the most simple and efficient corporate tax code in the world. That way, executives could focus on making better products, not better tax shelters.