For better or worse, efforts to pass an economic stimulus package appear tobe dead. But the stimulus debate did raise some important issues about howthe tax code puts barriers in front of capital investment through suchprovisions as depreciation and the alternative minimum tax. Business taxreform continues to be needed in these areas.
Business tax reform is being put on the agenda again with a recent ruling bythe World Trade Organization against a $4 billion tax break provided to U.S.exporting companies, variously called “FSC” or “ETI.” This ruling hasprovided policymakers another opportunity to move ahead with business taxreforms to spur U.S. economic growth.
Some recent studies also indicate that we need to focus more on improvingthe U.S. business climate. London’s Economist Intelligence Unit placed theU.S. second, behind the Netherlands, for the “best place in the world toconduct business” in a recent study. And a study by GrowthPlus, a Europeanthink tank, compared ten major countries to determine which had the bestenvironment for entrepreneurial growth companies. Again, the U.S. finishedsecond, this time behind Britain.
Coming in second isn’t bad, but we don’t have an automatic claim on thehighest living standard in the world unless we have the best possible taxclimate. In recent years we’ve done little to improve that climate. Forexample, while the U.S. was a world leader in tax cuts in the 1980s, wehiked taxes in the 1990s. The average corporate tax rate in Organizationfor Economic Cooperation and Development (OECD) countries fell from 41percent in 1986 to 31 percent today. That means our 35-percent corporaterate is now 4 percentage points higher than the average of our main tradingpartners. Britain’s corporate rate is now 30 percent, and even Sweden has acorporate tax rate of just 28 percent.
Tax rates are being cut because there is growing appreciation that highrates reduce savings, investment, and economic growth. Governments are alsofeeling the squeeze from globalization, which is increasing “tax competition” between countries. During the past decade, global directinvestment flows rose from $204 billion to $1.3 trillion, and portfolioflows rose from $219 billion to $1.4 trillion. If countries don’t get theirtax rates down to competitive levels, these huge flows of capital will fleeto more attractive economic climates.
Right now the U.S. tax system is a negative factor in attracting inflows ofbusiness investment. Not only do we have a high corporate tax rate, butalso the complex way that the federal government taxes corporations putsU.S. firms at a disadvantage in world markets. For example, because federaltax rules burden the foreign earnings of U.S. companies, the U.S. is not agood place to establish headquarters of a global company. UncompetitiveU.S. tax rules played a role in the merged Daimler-Chrysler choosing Germanyfor its headquarters rather than Michigan. The solution is to move toward a“territorial” tax system whereby U.S. firms could compete in overseasmarkets on an equal footing with foreign companies.
The WTO decision against the FSC tax break is a setback to U.S. companiescompeting in world markets. If we move to repeal FSC, we should also removethe substantial tax penalties that U.S. firms face. These include the highcorporate tax rate, complex and unfair taxation of foreign businessoperations, and outdated depreciation rules.
All these measures would move us toward adoption of a low-rateconsumption-based tax. Ultimately, that’s where international taxcompetition pressures are leading every country that wants to maximizegrowth. The United States should get out in front of the trend and leadworld tax reform as it did in the 1980s.