Thankfully, GOP tax plan retains bold corporate rate cut

The Republican tax reform plan that began with much boldness is getting watered down as legislation moves through Congress. The Tax Cuts and Jobs Act released by the Ways and Means Committee won’t cut the top individual income tax rate, won’t kill the death tax until 2024 and won’t fully repeal the state and local tax deduction.

What began as a simple framework has morphed into a complex 429-page bill. So-called “pass-through” businesses, for example, won’t get a clean rate cut from 40 to 25 percent.

Instead, they will only get the cut on part of their income, and that part will become a battle line between taxpayers and tax authorities. The GOP are making complex compromises as they shoehorn their reforms into a fixed $1.5 trillion package over 10 years.

The good news is that the most important reform — the corporate tax rate cut — remains intact. The bill slashes the rate from 35 to 20 percent rate. As the bill is evolving, the individual tax changes are getting messier and the pro-growth effects weakened, but the corporate tax changes remain on track to drive the U.S. economic expansion in coming years. 

About half of the nation’s output is produced by companies paying the corporate tax, and those big companies are big purchasers of the intermediate goods produced by millions of pass-through businesses.

The central goal of corporations is to earn profits, and they do that by building more factories, buying more intermediate goods and hiring more workers. If they can keep more of their profits, they will build, buy and hire more, raising incomes across the entire economy.

Critics of the GOP plan say, “Corporations are already sitting on a pile of cash, so why do they need a tax cut?” The answer is that businesses make investment decisions looking forward five or 10 years or more.

Whether they build their next car plant here or in Mexico depends on their estimate of how much of their profits the government will grab. Cutting our tax rate on that whole stream of future profits from 35 to 20 percent will make a huge difference.

With globalization, small differences in corporate tax rates drive large flows of cross-border investment. Because of advances in container shipping, logistics, communications and other technologies, many industries have the choice of where to locate among dozens of competitive industrial nations. Economically, America is not unique anymore, and so we have to try harder. 

Corporate tax rates are not just drivers of investment flows, but also drivers of tax avoidance. Ireland’s famous 12 percent corporate tax rate has not only spurred an investment boom on the Emerald Isle, but has attracted piles of paper profits from global corporations.

One winner has been the Irish government, which collects a higher share of GDP in corporate tax revenues at a 12 percent rate than our government does at a 35 percent rate.

The benefits of the GOP corporate rate cut will be enhanced by allowing expensing, or immediate deduction, of equipment investment. That GOP reform would make the U.S. a great location for capital-intensive businesses. Expensing would expire after five years under the bill, but the provision would likely get renewed.

The GOP’s final building block for corporate reform is switching from taxing firms on their global profits to taxing them on their U.S. profits, which is called territoriality. Nearly all industrial countries use territorial systems, which help attract the headquarters of global businesses. Our current system repels corporate headquarters, prompting corporate inversions. The GOP reforms would end that.

The GOP plan includes some dissonant elements, including new anti-avoidance rules, such as a minimum tax on excess income in low-tax countries and rules to deter companies from shifting income from their U.S. to foreign operations.

These rules would add complexity, and they are probably unneeded because our reduced tax rate would make us a magnet for investment and reported profits.

The Republican reforms cannot come too soon as tax competition intensifies. The average corporate tax rate in industrial countries plunged from 34 percent in 2000 to just 24 percent today, according to KPMG.

France has announced it will cut its rate from 33 to 25 percent, while the Netherlands plans to trim its rate from 25 to 21 percent. 

We should not let France, the Netherlands and other countries out-compete us on corporate taxes. The GOP tax plan would put America’s businesses and workers back in the game, and allow our economy to reap the full benefits of globalization.

Chris Edwards is director of tax policy and editor of www.DownsizingGovernment.org at the Cato Institute.