U.S. Lags Behind Rest of World in Corporate Tax Reform

Published December 1, 2004

Although many nations that compete economically with the United States have implemented important reforms in recent years to reduce corporate tax burdens, Congress, President George W. Bush, and Democratic standard-bearer Sen. John Kerry have failed to put forth proposals for similar reforms here.

Today the U.S. has the second-highest corporate tax rate in the 30-nation Organization for Economic Cooperation and Development (OECD). The U.S. corporate rate is 40 percent, including the 35 percent federal rate and the average state rate.

By contrast, Figure 1 shows the average rate in Asia, Europe, and Latin America is 30 percent or less. The figure is based on data for countries listed in Table 1. The average corporate tax rate in the OECD fell from 37.6 percent in 1996 to just 30.0 percent in 2004.

Average Corporate

Since the late 1990s, many Eastern European countries have sharply slashed their tax rates to attract investment. For instance:

  • Poland cut its tax rate from 40 to 19 percent;
  • Slovakia cut its rate from 29 to 19 percent;
  • The Czech Republic cut its rate from 39 to 28 percent;
  • Hungary cut its rate from 33.3 to 16 percent; and
  • Russia cut its rate from 35 to 24 percent.

In August, Greece announced it will cut its corporate rate from 35 to 25 percent, and the Netherlands announced it will cut its rate from 34.5 to 30 percent.

Corporate Income

Election Failed to Address Issue Squarely

Before the November 2 general election, Bush promised to consider tax reform if he won re-election, but he did not reveal a plan for the corporate tax. He is allowing to expire a pro-growth tax provision that allows firms to deduct, or “expense,” half the cost of qualified capital investments.

Bush’s challenger for president, Sen. John Kerry (D-MA), addressed the tax rules on foreign investment during the campaign, noting in speeches and campaign literature that the rules are “almost completely broken” and acknowledging that other nations have corporate taxes that average one-third lower than those of the U.S.

Kerry’s solutions, however, probably would have done more harm than good, as a closer look suggests.

Damaging Corporate Tax Plan

The Kerry plan would have cut the U.S. corporate tax rate of 35 percent by 1.75 percentage points. To fund that small cut, however, Kerry proposed to increase taxes on foreign subsidiaries of U.S. firms. Under current rules, the regular business profits of subsidiaries are not taxed until repatriated to the United States.

For example, most of the 30 nations in the OECD, of which the United States is a member, have “territorial” tax systems that generally do not tax foreign business profits at all. The Kerry plan would have broken from those norms by immediately taxing subsidiaries of U.S. firms on their sales to other countries.

For example, a U.S. electronics firm selling goods from its Taiwanese subsidiary to consumers in Japan would have faced a new U.S. tax burden, and a relatively punitive one.

If Kerry’s rules were to be enacted, U.S. companies would lose market share to foreign competitors with lower tax costs, and some subsidiaries would be sold to foreign companies. As their global sales declined, many of those firms would downsize their U.S. operations, such as research, marketing, and management personnel. Some U.S. firms would move their headquarters to more tax-friendly countries. Others would be taken over by foreign companies. All of those effects would probably cost U.S. jobs.

Kerry’s plan and others like it assume foreign subsidiaries of U.S. firms hurt the U.S. economy. In fact, however, they mainly complement U.S. production–for example, by being a primary conduit through which U.S. goods are exported abroad. By damaging the competitiveness of foreign subsidiaries of U.S firms, the Kerry plan would impair U.S.-based activities that depend on expanded foreign business opportunities.

Tax Cuts Likely to Shift International Investment

Cuts in corporate tax rates probably will continue overseas, because of the benefits countries gain from attracting foreign investment. As much as $1 trillion of direct investment crosses international borders each year, and research shows those flows are increasingly sensitive to corporate taxes.

In contrast to this global economic trend, U.S. policy rests on the assumption that America can have high growth and good jobs without a competitive tax climate. But many economists contend our complex and costly corporate tax system will have an increasingly negative effect on U.S. productivity, wages, and growth and will create a breeding ground for further Enron-style tax scandals.

Chris Edwards ([email protected]) is director of tax policy studies for the Cato Institute.