Daily Archives: July 7, 2013

U.S. Currency Production At The Bureau of Engraving and Printing©Bloomberg

No one is satisfied with the US corporate tax system. From one perspective, the main problem is that, while corporate profits are extraordinarily high relative to gross domestic product, tax collections are very low. Many very successful companies pay little or nothing in taxes at a time when the budget deficit is a serious concern; and when hundreds of thousands of defence workers are being furloughed, or sent on unpaid leave; and when lotteries are being held to determine which families cease to receive help from the Head Start pre-school education programme.

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From another perspective, the main problem is that the US has a higher corporate tax rate than any other leading economy and, unlike other countries, imposes severe taxes on income earned outside its borders. This is thought to burden unfairly companies engaged in global competition, to discourage the repatriation of profits earned abroad and – because of the patterns of investment that it causes – to benefit foreign workers at the expense of their US counterparts.

These two perspectives on corporate taxes seem to point in opposite directions. The first points towards the desirability of raising revenues by closing loopholes; the latter perspective seems to call for a reduction in corporate tax burdens. It seems little wonder that corporate tax reform debates are so divisive.

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Lawrence Summers

Many get behind the idea of “broadening the base and lowering the rate” – but consensus tends to collapse when the issue becomes the means to broaden the base. Indeed, a principal objective of many business-oriented reformers seems to be narrowing the corporate tax base by reducing the taxation of foreign earnings through movement to a territorial system.

Where, then, should the debate go? Despite the tension between the critical perspectives on corporate tax reform, the current debate has landed us in so perverse a place that win-win reform is easy to achieve. The centre of the issue is the taxation of global companies. Under current law, US companies are taxed on their foreign profits (with a credit for taxes paid to other governments) only when they repatriate these profits. Right now American businesses are holding nearly $2tn in cash abroad. The companies argue – with some justification – that the current rules are a burden on them: they make it expensive to bring money home and at the same time the tax raises little revenue. This is the case with respect to the corporate tax.

The problem is made worse by an odd feature of the tax debate that a homely example might help illustrate. Imagine a library where many books have been borrowed and are overdue. There is a case for an amnesty to allow the culprits to bring the books back and move on. There is a case for saying that rules are rules and fines must be paid. But the worst strategy is to keep indicating that an amnesty may come soon without ever introducing it. Something similar is where we are in our corporate tax debate.

Companies hope for, and call for, relief, arguing that it will help them bring money home – at a minimum for the benefit of their shareholders and possibly to increase investment. Others campaign against the idea. They ask why companies that have used what could politely be called aggressive accounting practices to locate income in low tax jurisdictions should be given further tax relief.

So, in the meantime, what is a corporate treasurer to do? Hoping for some kind of relief, there is every reason to delay repatriating earnings to the US, even if the company has no good use for the cash abroad. And so the debate encourages exactly what everyone can agree on the desirability of avoiding – corporate cash is kept overseas to the detriment of companies and to no benefit for the American fisc.

A clear and unambiguous commitment that there will be no rate reduction or repatriation relief for the next decade would be an improvement on the current situation, because companies would know that they were going to have to pay taxes on their foreign profits if they wished to make them available to shareholders and would no longer have an incentive to delay.

But this would not be the best outcome. As a very general rule, improvements are possible whenever taxpayers complain that a tax imposes a substantial burden without generating substantial revenue for the government. One can cut back red tape while getting them to pay more. Policy makers can make them better off and help the fisc. That is what should be done with corporate taxes.

The US should eliminate the distinction between repatriated and unrepatriated foreign corporate profits for US companies and tax all foreign income (after allowance for taxes paid to other governments) at a fixed rate well below the current US corporate rate of 35 per cent, perhaps about 15 per cent. A similar tax should be imposed retrospectively on accumulated profits held abroad.

Such a proposal could easily be designed to raise revenue relative to the current baseline, encourage the repatriation of funds to the US, and reduce the competitive disadvantage faced by American multinationals. It is a fair compromise between businesses and reformers. It is as close to a free lunch as tax reformers will ever get.

The writer is Charles W. Eliot university professor at Harvard and a former US Treasury secretary

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