Time for US to lead on international tax policy
In recent days, the new Speaker of the House Paul Ryan (R-Wis.) signaled a priority for international tax reform in 2016. And if the newest recommendations from the Organization of Economic Cooperation and Development (OECD) are any indication of what’s ahead on the global tax scene for American businesses, it should be number one on the legislative agenda when Congress returns in January.
The OECD released the findings of its Base Erosion and Profit Shifting (BEPS) project, and delivered them to the G20 Summit in Lima, Peru in October. The project is rooted in the belief that multi-national corporations (MNCs) are not paying enough tax – even when they observe the laws of each country where they do business.
The timing is unfortunate, since the world desperately needs more investment by large firms, not less, and higher tax burdens will not inspire greater investment.
But since tax policy only changes at glacial speed, it’s worth examining the long-term implications of the BEPS project. Like every rational firm, MNCs adjust their affairs to reduce tax burdens. This is particularly true of MNCs headquartered in the United States, because the U.S. imposes almost the highest corporate tax rate in the world. If the BEPS project has a bullseye, it is painted on the backs of U.S. MNCs.
A new working paper prepared with my colleagues at the Peterson Institute reviews the 15 BEPS “actions” through the lens of American economic interests. While some of the 15 actions might be useful (or at least not harmful), their dominant thrust would damage the United States. Not surprisingly, the chairmen of the House and Senate tax-writing committees have raised serious concerns.
The United States, more than any other advanced nation, has a history of undermining its own competitiveness through its international tax practices. The U.S. taxes its MNCs more heavily than other countries while providing far fewer incentives for research and development – R&D. The United States also utilizes an outdated “worldwide” system for taxing its MNCs – a system long abandoned by other members of the OECD. And nearly every Congressional term brings proposals to further increase MNC taxes. To cite just one example, a new energy plan floated by Senate Democrats seeks to restrict foreign tax credits by American oil and gas companies operating overseas.
If the recommendations offered in the BEPS project were layered on top of the already burdensome U.S. tax regime, more American MNCs would opt to relocate their headquarters to friendlier tax jurisdictions, offshore their R&D activities, and otherwise divert their growth to foreign locations. Why? Because global profits derived from innovation and risk-taking would be more heavily taxed since U.S.-based MNCs could no longer get relief from high U.S. tax rates by reporting income in lower tax jurisdictions.
But the harmful impact of BEPS is not just hypothetical. Already several countries are drawing on the BEPS recommendations to raise their own taxes prospectively or even retroactively on U.S. MNCs. Such measures not only harm U.S. firms, they also threaten to drain revenue from the U.S. Treasury.
To ensure its future competitiveness, the United States should get its own corporate tax house in order by aligning with other OECD nations. This means reducing the corporate tax rate from 35 percent to 25 percent or lower. It means shifting its business tax regime to the global norm of territorial taxation (only taxing income earned at home). And it means encouraging domestic R&D activities through a “patent box” (reduced rate) system for taxing intellectual property income.
The United States is a global leader by nearly every other economic standard. It can also lead in international tax policy. Congress should dramatically improve the tax competiveness of U.S. firms operating at home and abroad. Once that is achieved, the United States can and should turn its attention to multilateral efforts to ensure that business tax rules reduce distortion and foster growth.