By Joe Kennedy
October 9, 2017 at 5:00 am ET
Republicans have issued a new framework for tax reform calling for, among other things, a significant reduction in the corporate tax rate. But opponents of corporate tax reform claim that all is well in that part of the code, arguing that, while the U.S. statutory rate may be high, the actual rate that companies pay is quite modest. They are wrong.
Both the statutory and average effective tax rates for U.S. corporations are very high by global standards and need to be cut to restore U.S. competitiveness. Lower rates would boost competitiveness and economic growth. That is why corporate tax reform needs to be passed even if it increases the deficit on a static basis.
The United States has one of the highest statutory corporate rates in the world, especially when state taxes are added in. Although most other countries have lowered their rates significantly, the U.S. rate of over 39 percent has not changed appreciably in more than three decades.
Moreover, unlike virtually all of its competitors, the United States applies this high rate to all income companies earn anywhere in the world when it is brought back home. So the statutory rate figures prominently when U.S. companies are deciding where to declare their income. It should be no surprise that a number of companies have used so-called “inversions” and other profit-shifting strategies to legally declare more income abroad.
Opponents of lower corporate taxation make a number of counterarguments. The most common is that America’s high statutory rate does not really matter because few if any firms pay it. Because the tax code contains a large number of deductions, exemptions and credits, a company’s actual tax liability can be significantly lower.
And opponents claim that on this measure the United States fares quite well. For example, the Institute on Taxation and Economic Policy argues this in a report titled “The 35 Percent Corporate Tax Myth.” But these kinds of studies cherry pick the data to either focus on a relatively small number of corporations or on particular years where corporate profits were low because of a downturn in the business cycle.
When studies look at a broad array of U.S. corporations for typical years the findings are quite clear: The U.S. average effective corporate tax rate is still high compared to other nations’ effective rates. Indeed, a number of studies show that U.S. companies face among the highest average effective rates in the world.
A recent report by the Congressional Budget Office estimated that, at 29 percent, the United States had the third-highest rate among Group of 20 members in 2012. (The top countries were Argentina and Indonesia at 37.3 percent and 36.4 percent, respectively.) Most other developed countries had average rates that were at least 9 percentage points lower. Germany and the United Kingdom were at 14.5 percent and 10.1 percent, respectively.
Little has changed in the intervening years. A study by the Department of the Treasury estimated that the U.S. effective average tax rate was 34.1 percent in 2014. The average of other Group of 7 countries was 27.4 percent.
Some studies have argued that the effective tax rate for corporations in the United States is roughly equal to the OECD average. But these studies often do not include corporate losses. Since most companies expect to post losses at some point in their histories, those should be offset against profits when computing total corporate earnings. Excluding them artificially lowers the effective rate, especially during a recession.
A second issue in comparing tax rates internationally is whether to include U.S. taxes prior to repatriating foreign income. Those opposed to lowering corporate taxes often try to have it both ways on this question. In order to show low effective rates, they often omit deferred taxes until the foreign income is actually repatriated, thus lowering their calculation of the actual tax burden.
On the other hand, they either want Congress to end deferral of foreign source income or make up the revenue losses if it moves to a so-called “territorial” system in which companies only pay taxes in the jurisdictions where they earn revenue and do not have to pay U.S. tax on foreign income, too. An accurate measure of average rates would assign at least a portion of future U.S. tax liability to the estimated $2.4 trillion in overseas profits now held offshore.
Finally, there is a good argument that Congress should focus on those developed countries with the lowest rates, especially in the European Union, and not just on the average among countries. It should also acknowledge that the long-term trend is for even lower rates. Just as water flows to the lowest point rather than the average point, companies often focus on countries with below average rates when making decisions about where to invest or declare profits.
That is why small countries such as Ireland and the United Kingdom attract such a large volume of corporate activity. The United States is unlikely to become the preferred place for high-value-added, globally mobile investment if it settles for the average of its competitors rather than the best in class.
Despite data and modeling issues, a growing body of academic research shows that corporate tax rates do have a major effect on the location and volume of corporate investment. These findings have led to a growing bipartisan consensus that some form of corporate tax reform is necessary.
Yet a small group of opponents continue to argue that corporate tax rates are not all that important in determining corporate investment and that, even if they are, the United States is not really an outlier. The evidence suggests it is they who are the outliers. For tax reform to be fully effective, it must do more than just lower than statutory corporate rate; it needs to lower the effective rate while moving to a territorial tax system.
Joe Kennedy is a senior fellow at the Information Technology and Innovation Foundation, where he focuses on tax and regulatory policy.
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