The Tax Bill Miracle
It’s a fitting time of year for miracles, and the Tax Cuts and Jobs Act, passed by Congress today fits that description.
Granted, the first major tax overhaul in more than three decades is not a panacea. It’s come under an increasing amount of criticism from many factions. First, it’s not really tax “reform” – it does little to simplify the U.S. tax code, which still runs more than 2,600 pages and will still require many citizens to hire professional accountants just to file their annual returns, and several key provisions are only temporary. Many analysts estimate that the provisions will benefit the rich more than the middle class. Residents of high-tax states will likely have to pay more in taxes. And after all is said and done, even its proponents project it will only add 1.7% to the U.S. economy over the next decade.
And yet at the same time, it accomplishes two remarkable long-time objectives of proponents of business growth: reducing U.S. corporate rates and transitioning away from worldwide tax reporting to a territorial system.
First, the tax rate: At 38.9% the United States has for years had the highest top marginal corporate income tax rate among industrial countries. In fact, America has a higher corporate income tax rate than any other country in the world – industrial or developing – except the United Arab Emirates. The worldwide average tax rate is 22.5%. The new tax law lowers corporate rates to 21%.
Corporate tax rates matter for many reasons, but the primary one is that it makes a country’s economy more or less attractive for investment. As economists of all political stripes will tell you, attracting domestic or foreign corporate investment in industrial infrastructure, R&D, and people is the foundation for economic growth. In a world where global competition for investment is greater than ever before, reducing corporate tax rates is one of the most effective ways to attract capital.
Some opponents, of course, argue that few if any companies truly pay the top marginal rate. Even so, strategic planning for in-country investment decisions starts with the corporate tax figure. By reducing the rate to a level that is no longer “worst in class,” Congress has helped level the playing field for the United States as it competes against China, Germany, South Korea, India, and other nations hungry for business.
If pro-business advocates thought that reducing the corporate tax rate was a long-shot, shifting to a territorial reporting system would be a miracle. The IRS has historically used a worldwide reporting system, which requires businesses to pay taxes on all income earned around the world. On the other hand, a territorial system only taxes companies on income earned within a country’s borders.
Many economists here have long argued for a transition to a territorial system, but the concept was never seriously contemplated by Congress until this year. Meanwhile, the number of Organization for Economic Cooperation and Development (OECD) member countries adopting some form of territorial system increased from less than 30% to more than 80% since the early 1990s. Those governments understood that in a global economy in which companies sell in markets across the world, there is more incentive under a territorial system than a worldwide system to repatriate those overseas earnings in their own home country.
U.S.-based companies are leaving their money overseas because of our worldwide system. Rather than repatriating overseas income and paying the higher U.S. corporate tax rate on it, U.S. companies today are holding well over $2 trillion in profits offshore. Shifting to a territorial reporting system can change that.
Many partisans in Washington have expressed skepticism, and even dismay, over the Tax Cuts and Jobs Act. This may have been a rush job done for politically expedient purposes. But for those who are advocates of business – and economic – growth in this country, it’s a holiday miracle.