America’s international tax system is leaving our companies behind

There is perhaps no single policy priority more important than permanent, structural tax reform that provides incentives for firms to innovate, invest, grow, and hire in the United States. Indeed, the need to improve U.S. international tax competitiveness by moving toward a territorial system with a lower rate is among the few areas of bipartisan agreement.

So it was with considerable dismay that I listened to the remarks of Reed College professor Kimberly Clausing at the recent Ways and Means hearing on tax reform. They strike me as so far out of the mainstream as to merit specific response.

{mosads}She begins by asserting, “By any broad measure, our nation’s businesses are incredibly successful … our companies are dominant on the lists of the world’s most important companies, as measured by the Forbes Global 2000 list.” To say the least, this is a rosy view of the situation. The attractiveness of the U.S. continues to decline.

Since 2000, the number of U.S.-headquartered companies in the Forbes 500 list of global companies has declined by over 25 percent, from 202 in 2000 to 147 in 2016. Moreover, foreign acquisitions of U.S. companies were over three times greater than U.S. acquisitions of foreign companies measured by deal value in 2015.

She then asserts that if there are any problems with our tax system, “High tax burdens for multinational corporations are not one of them.” This is at odds with the data. University of Pennsylvania professor Michael Knoll recently reviewed the evidence on the tax competitiveness of U.S. multinational corporations and reached the bottom line: “Thus, it would appear that U.S.-domiciled [multinational coroporations] face among the highest [effective tax rates] of companies domiciled in any country.”

Accordingly, if the impact of taxes on a company’s competitiveness can be measured by the company’s global effective tax rate, U.S. domiciled multinationals appear to be at a tax disadvantage relative to multinationals domiciled in many other jurisdictions. That is because U.S.-domiciled multinationals have higher average global effective tax rates than multinationals domiciled in most other advanced economies.”

Making the argument slightly differently, Clausing asserts, “U.S. corporate tax revenues are lower than the corporate tax revenues of our peer trading partners by about 1 percent of GDP.” This misses the big picture. In the U.S., and unlike our peer trading partners, the majority of business income in the United States is earned by so-called “pass-through entities.” These are not subject to the corporation income tax.

Rather, such partnerships, S corporations, and other entities are taxed via the U.S. individual income tax. As these entities have become more popular, the share of business income subject to corporate tax in the U.S. has fallen from 79 percent in 1980 to 46 percent in 2011. In contrast, for our trading partners, lower corporate rates make it more attractive for businesses to organize as entities subject to corporate income tax, resulting in a higher share of corporate tax revenues to GDP.

U.S. multinationals are not undertaxed, and the U.S. is increasingly an unattractive place to headquarter a company. The combination of high tax rates and worldwide tax base puts U.S.-headquartered firms at a severe disadvantage. True, deferral postpones tax on active income earned in foreign countries. But having the income only subject to U.S. income tax once it is repatriated, gives an incentive for companies to reinvest earnings anywhere but the U.S.

This system distorts the international behavior of U.S. firms and essentially traps foreign earnings that might otherwise be repatriated back to the U.S. In contrast, our competitors have shifted toward territorial systems that exempt entirely, or to a large degree, foreign source income. Of the 35 economies in the Organization for Economic Cooperation and Development (OECD), for example, 28 have adopted such systems — including recent adoption by Japan, the United Kingdom, and New Zealand.

Clausing would have one believe that the difference is illusory, arguing, “Our trading partners that use purportedly ‘territorial’ systems of taxation frequently tax more foreign income than we do, due to their tougher base erosion protections.” She went on to say that some countries “have very broad [controlled foreign corporation] laws that go beyond currently taxing passive foreign income. Active foreign income is also currently taxed, when such income is insufficiently taxed in the source country. The French benchmark for insufficient taxation is less than half the French rate. The Japanese benchmark is less than 20 [percent].”

Certainly France and Japan have controlled foreign corporation rules targeted at income earned by foreign subsidiaries in low-tax jurisdictions. But both also have exceptions for active trade or business income. And for French multinationals, the controlled foreign corporation rules do not apply to subsidiaries in other European Union jurisdictions unless the arrangement is wholly artificial.

This is, in part, why an index of the stringency of controlled foreign corporation rules developed by professors Kevin Markle, then at the University of Waterloo, and Lesley Robinson of Dartmouth found that the United States was in the middle of the pack among the 18 countries evaluated.

The bottom line is simple: the U.S. corporation income tax imposes an uncompetitively high effective tax rate, traps earnings offshore, and causes headquarters to be located outside the U.S. It is time for real reforms to address these problems, encourage businesses to invest in the United States, grow our economy, and create jobs.

Douglas Holtz-Eakin is president of the American Action Forum, an organization focused on building a strong economic future and promoting free-market solutions to create a smaller, more efficient government. He served as director of the Congressional Budget Office during under President George W. Bush from 2003 to 2005.

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