IMF call for ‘comprehensive reform’ of US tax system

An International Monetary Fund (IMF) review has called for a comprehensive reform of the US tax system, with the aim of removing exemptions, simplifying the system, rebalancing from direct to indirect taxes, and reducing statutory rates for individual and corporate income taxes

According to its annual Article IV consultation report for the US, the current corporate tax structure is too complex; has a marginal rate that is too high; has a narrow base, rife with exemptions; favours debt financing; and incentivises a range of cross-border avoidance and tax planning mechanisms to lower US tax liabilities.

The report states: ‘Reform of the corporate income tax is badly needed and could help revitalize business dynamism and investment. In addition to rate reduction and a streamlining of business tax expenditures, tax avoidance opportunities should be reduced by tightening income-stripping rules through limits on interest deductions.’

In a separate paper looking specifically at US corporate tax reform and its spillovers, the IMF says the problems with the current US corporate tax, including its international aspects, are well known and acknowledged by both major political parties. It says: ‘the relatively high statutory tax rate of 35%, combined with several other features of the code, distorts investment and encourages avoidance’.

The paper argues that since interest is deductible from corporate earnings while dividends are not, the high US corporate tax rate strongly favours debt-financed projects. It is critical of what it calls ’the increasingly anomalous US “worldwide” regime’, and says US interest allocation rules are ‘overly permissive’, insofar as multinationals can deduct all domestic interest expense, even for debt that supports foreign investment.

The IMF says that as regards outbound investment, the US corporate tax system should adopt a territorial system but impose a minimum rent tax on the foreign earnings of US corporations.

There should also be a mandatory tax on the existing stock of un-repatriated, foreign-sourced earnings (with payment spread over the next several years).

In the accompanying paper, the IMF suggests that if this approach is too radical to implement immediately, the US should consider reducing the statutory corporate rate to a flat 25%-28%, but should avoid bringing the tax below the OECD median of 25% due to its effects on global tax competition.

It also wants the US to revise the definition of corporate residence and tighten the inversion rules.

Regarding personal income tax, the IMF says the US should move towards a more progressive structure so as to help mitigate income polarisation and assist the working poor. This could involve capping itemised deductions, including for mortgage interest, to lessen the tax benefit for the most well off.

Finally, as has been advocated in past consultations, the IMF says the US should look to generate additional revenues through the introduction of a federal level VAT and a broad-based carbon tax, including an increase in the federal gas tax (which has been 18 cents per gallon since 1993).

The report also calls for fundamental reforms of the pension system. These would include raising the income ceiling for social security contributions, indexing benefits and contribution provisions to chained consumer price index (CPI), raising the retirement age, and instituting a greater progressivity in the benefit structure.

In addition, the IMF cautions the US against relaxing any of the measures put in place to ensure financial stability after 2008.

The report states: ‘Eight years after the inception of the financial crisis, political support behind the reform of the financial system has clearly ebbed and there is a danger that the indispensable progress that has been made may stall or be rolled back.

‘Of course, it is natural to recalibrate some aspects of the oversight system as changes are seen in action. Nevertheless, it will be important to oppose any wholesale or broad-based efforts to dilute the provisions of the Dodd-Frank Act.’