An Anniversary We Shouldn't Be Celebrating

It reads like a cruel joke- but it’s not. April 1 marks the second anniversary of the U.S. having the world’s highest corporate tax rate. Two years ago we won this undignified honor after Japan enacted tax reforms.

Currently at 39 percent (a combination of the 35 percent federal rate and the average rate levied by U.S. states), America’s tax code is much higher than the 25 percent OECD average.   Several of our trading partners including Ireland, the United Kingdom and Canada, have reformed their tax codes and brought down their corporate rates substantively in the last three decades.  America has not followed suit.  America’s status as number one in corporate tax rates is hurting our ability to compete in today’s global economy.

There is considerable evidence to show that investment is highly sensitive to tax rates. According to a recent Ernst & Young study, U.S. GDP in 2013 was estimated to be reduced by 1.2 to 2.0 percent as a result of our world-leading corporate tax rate. Several studies have also concluded that foreign direct investment is highly mobile and sensitive to differentials in corporate income tax rates between countries. As a result, in the past few years, nearly 50 U.S. companies have re-incorporated abroad, with 20 of those occurring since 2012[1]. The specific term for this controversial practice is “tax inversion” whereby U.S. firms move their headquarters and sometimes-key assets abroad to a country with a lower corporate tax rate.  A recent illustration of this practice is the case of Actavis, a Nevada-based company with over 80% U.S. revenue, who chose last year to be acquired by an Irish-based parent holding company.  According to the Wall Street Journal, as a result of the merger, the company’s annual tax burden dropped from 28% to 17%.

America can no longer afford to cede U.S. firms to other nations because of our outdated and overly complex corporate tax code.  Comprehensive tax reform that lowers the rate to an internationally competitive level and simplifies the tax code would encourage economic job growth and foreign investment. The last time serious reform took place was in 1986, under the leadership of President Ronald Reagan and House of Representatives Speaker Tip O’Neil.

While there is a lot of skepticism for when and how tax reform will happen, substantive bipartisan support for tax reform from the Administration and key members of Congress means there still may be a chance for tax reform to occur in the near term.   House Ways & Means Committee Chairman Dave Camp recently offered the most comprehensive proposal to date with the introduction of the Tax Reform Act of 2014.  Under his proposal, the tax rate would be lowered to 25% and subsidies and deductions would be reduced. Using macroeconomic analysis, the Joint Committee on Taxation (JCT) scored his plan and found encouraging results: GDP would increase between 0.1% – 1.6% over the 10-year budget period and federal revenues as a result of economic growth would increase by $50-$700 billion.

This anniversary is a reminder that Congress must take the necessary action to make the U.S. more globally attractive. This means reforming our archaic tax code, making the system simpler and fairer, and lowering our uncompetitive tax rate.  Right now, the high U.S. corporate income tax rate is leading to income shifting (in the form of tax planning and avoidance), which is estimated to decrease income taxes collected by as much as $300 billion annually.  Tricks that can be employed by the wealthy and the well connected not every citizen.

On this anniversary it’s time to mark a new path forward.  The path forward should be to get rid of a multitude of the preferences, deductions and credits in the tax code in order to simplify and lower the tax rate. If America plans to stay competitive globally we need tax reform.