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Corporate tax reform debate needs to be resolved
July, 08th 2013

No one is satisfied with the US corporate tax system.

From one perspective the main problem is that at a time when corporate profits are extraordinarily high relative to GDP, tax collections are very low relative to GDP. And many very successful companies pay little or nothing in taxes at a time when the budget deficit is a major concern and when hundreds of thousands of defense workers are being furloughed and lotteries are being held to determine which children the "Head Start" program can no longer afford to help.

From another perspective, the main problem is that the United States has a higher corporate tax rate than any other major country and, unlike other countries, it imposes severe taxes on income earned outside its borders. Many argue that this unfairly burdens companies engaged in international competition, discourages the repatriation of profits earned abroad, and benefits foreign workers at the expense of their counterparts because of the patterns of investment that result.

These two perspectives on corporate taxes seem to point in opposite directions with respect to reform. The former perspective points towards the desirability of raising revenues by closing loopholes, whereas the latter perspective seems to call for a reduction in corporate tax burdens. Little wonder, then, that corporate tax reform debates are so divisive. Many can 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 center of the issue is the taxation of global companies. Under current law U.S. companies are taxed on their foreign profits, with a credit for taxes paid to other governments, only when they repatriate these profits to the United States. Right now U.S. companies are holding nearly $2 trillion in cash abroad. The companies argue, with some validity, that current rules burden them by making it expensive to bring money home without raising much revenue for the government because it has no claim against foreign profits that are not repatriated. They 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. The debate continues.

The companies make their point while others rail against the idea that companies who have used what could politely be called aggressive accounting practices to locate income in low-tax jurisdictions should be given further relief.

In the meantime, what is a corporate treasurer to do? With the possibility of some kind of relief looming, there is every reason to delay repatriating earnings to the United States even if the company has no good use for the cash abroad. And so the debate encourages exactly what everyone can agree should be avoided. Corporate cash is kept abroad to the detriment of companies and to no benefit for the American Treasury.

A homely example makes the problem clear. Imagine a library where many books have been borrowed and are long overdue. There is a case for an amnesty 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. Yet something very similar is where we are in our corporate tax debate.

A clear and unambiguous commitment that there will be no rate reduction or repatriation relief for the next decade would be an improvement over 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.

 
 
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