Com­pet­ing on cor­po­rate tax

Financial Mirror (Cyprus) - - FRONT PAGE -

Cor­po­rate tax re­form has emerged as an area of po­ten­tial bi­par­ti­san ac­tion in the United States Congress over the next few months. But fun­da­men­tal ques­tions about the right ap­proach re­main.

There is wide­spread agree­ment that the US cor­po­rate tax sys­tem is deeply flawed. The rate is too high; the base is too nar­row; it is costly to ad­min­is­ter; and it is rid­dled with cred­its, de­duc­tions, and spe­cial pref­er­ences that dis­tort de­ci­sions, harm­ing the econ­omy.

De­spite the high rate, cor­po­rate tax rev­enues com­prise a rel­a­tively small share of gov­ern­ment rev­enue, partly be­cause a ris­ing share of to­tal busi­ness re­ceipts – cur­rently more than 30% – flows through so-called “pass-through” busi­ness or­gan­i­sa­tions, which are not sub­ject to cor­po­rate tax. In­deed, most cor­po­rate tax rev­enues are paid by a small num­ber of large multi­na­tional com­pa­nies that earn more than half of their in­come from their for­eign op­er­a­tions.

Th­ese com­pa­nies com­pete in global mar­kets with firms head­quar­tered in coun­tries that use busi­ness-friendly tax poli­cies to at­tract the in­vest­ments, in­come, and as­so­ci­ated ex­ter­nal­i­ties of multi­na­tional com­pa­nies. The prob­lem for the US is that de­vel­oped and emerg­ing economies have been slash­ing their rates, leav­ing the US – which had one of the de­vel­oped world’s low­est cor­po­rate tax rates af­ter the 1986 tax re­form – at a se­ri­ous dis­ad­van­tage.

Most re­cently, the United King­dom re­duced its rate to 20%, half of the com­bined US fed­eral and av­er­age state rates. And, since 2013, the UK has ap­plied a spe­cial tax rate on in­come from patents, which will fall grad­u­ally to 10% by 2017. Twelve Euro­pean Union coun­tries cur­rently have or are im­ple­ment­ing sim­i­lar spe­cial tax regimes, or “patent boxes,” for in­come from in­tel­lec­tual prop­erty, which is taxed at rates of 5-15%.

The US statu­tory cor­po­rate tax rate, at 39% in to­tal, is more than 14 per­cent­age points above the OECD av­er­age – mak­ing it the high­est in the de­vel­oped world. Th­ese dif­fer­ences af­fect cor­po­rate de­ci­sions about how much to in­vest, how to fi­nance in­vest­ment, and where to do busi­ness.

The pro-growth ra­tio­nale for a siz­able re­duc­tion in the US rate has gar­nered bi­par­ti­san sup­port – a rar­ity in to­day’s Congress. Obama has pro­posed a rate of 28%, with a pref­er­en­tial rate of 25% for man­u­fac­tur­ing, and ad­di­tional spe­cial pro­vi­sions to pro­mote in­vest­ment in re­search and devel­op­ment and clean en­ergy.

An­other area of con­tro­versy is how to re­form the tax­a­tion of Amer­i­can multi­na­tion­als’ for­eign earn­ings. Ev­ery other G-7 coun­try, and 28 of the other 33 OECD mem­bers, have “ter­ri­to­rial” tax sys­tems, which al­low glob­ally en­gaged com­pa­nies to repa­tri­ate most of their ac­tive for­eign earn­ings with­out pay­ing a sig­nif­i­cant ad­di­tional do­mes­tic tax. By con­trast, the US ad­heres to a “world­wide” model, which sub­jects Amer­i­can com­pa­nies’ for­eign earn­ings to US cor­po­rate tax, with a credit for taxes paid in for­eign ju­ris­dic­tions.

Amer­ica’s high cor­po­rate rate and world­wide ap­proach to tax­ing the for­eign earn­ings of its multi­na­tion­als un­der­mine their com­pet­i­tive­ness in global mar­kets and in cross-bor­der ac­qui­si­tions. Cur­rent US law at­tempts to blunt th­ese com­pet­i­tive dis­ad­van­tages through de­fer­ral, al­low­ing US multi­na­tion­als to de­lay tax pay­ments on their for­eign sub­sidiaries’ earn­ings un­til they are repa­tri­ated to the US.

But de­fer­ral has costs. De­ferred earn­ings are “locked out” of the US econ­omy, mean­ing that the gov­ern­ment re­ceives no tax rev­enues from them and they are not di­rectly avail­able for do­mes­tic use by the US par­ent com­pa­nies. And th­ese com­pa­nies in­cur a cost of about 7% of their in­cre­men­tal de­ferred for­eign in­come as a re­sult of sub­op­ti­mal use.

The Obama ad­min­is­tra­tion pro­poses end­ing de­fer­ral, re­quir­ing in­stead that US com­pa­nies ei­ther pay an ef­fec­tive tax of at least 22.4% on their earn­ings in ev­ery for­eign ju­ris­dic­tion where they op­er­ate, or pay an ad­di­tional tax to the US on this in­come at the time it is earned. A key goal is to mod­er­ate the in­cen­tives for US multi­na­tion­als to “shift their prof­its to tax havens.”

But most of the earn­ings sub­ject to the min­i­mum tax would not be the re­sult of profit-shift­ing to tax havens; they would be gen­er­ated by real eco­nomic ac­tiv­ity to serve for­eign mar­kets. The af­fected earn­ings would in­clude, for ex­am­ple, a sig­nif­i­cant share of for­eign in­come earned by US multi­na­tion­als in the EU, which ac­counted for about 45% of US multi­na­tion­als’ to­tal for­eign in­come in 2012. Six­teen of the 28 EU coun­tries have statu­tory tax rates be­low 22.4%, and ef­fec­tive tax rates are likely to be even lower.

Fur­ther­more, while non-US com­pa­nies can take ad­van­tage of the gen­er­ous patent boxes in 12 EU coun­tries, US com­pa­nies would be sub­ject to the much higher min­i­mum rate, un­der­min­ing their abil­ity both to com­pete in th­ese mar­kets and to ac­quire for­eign com­pa­nies with de­sir­able in­tel­lec­tual prop­erty. They would in­stead be­come more at­trac­tive tar­gets for for­eign ac­quir­ers and would have even stronger in­cen­tives to move their head­quar­ters, R&D, and fu­ture in­tel­lec­tual prop­erty to lower-tax ju­ris­dic­tions with ter­ri­to­rial sys­tems.

In a world of mo­bile cap­i­tal – es­pe­cially prof­itable in­tan­gi­ble cap­i­tal with R&D ex­ter­nal­i­ties – the US should adopt a “hy­brid” ter­ri­to­rial sys­tem that in­cludes base-pro­tec­tion mea­sures con­sis­tent with those suc­cess­fully used by other de­vel­oped coun­tries. And it should pro­mote mul­ti­lat­eral mea­sures to com­bat profit-shift­ing to tax havens.

As the US em­barks on cor­po­rate tax re­form, pol­i­cy­mak­ers should bear in mind that other coun­tries are us­ing car­rots, not sticks, to com­pete for the ac­tiv­i­ties and in­come of global com­pa­nies. Amer­ica should do like­wise.

Newspapers in English

Newspapers from Cyprus

© PressReader. All rights reserved.