VideoAs jobs vanish and Washington mulls a vast range of economic policy options, one that's conspicuously absent is corporate tax reform. That alarms many business advocates, who fear that current tax policy is outdated and will cripple U.S. companies if global growth resumes later this year or early next. "At this pivotal moment in history," warns David Lewis, chief tax executive for Eli Lilly and Co., "the U.S. must embrace an internationally competitive corporate tax system."
Exactly how badly higher tax rates harm U.S. companies is hard to measure and has long been a point of contention because the gap between nominal and effective rates can be substantial. But critics say that rapid globalization makes reform more urgent. More than two decades have passed since Congress overhauled corporate taxes. During that time global competition has surged and the United States has seen a fourfold increase in imports and an even larger jump in exports, two vital signs of a much more interconnected globe.
Canada, Germany, New Zealand, Spain, Italy, Switzerland, the United Kingdom, the Czech Republic, and Iceland all chopped their corporate tax rates last year. The U.S. business sector now grapples with the second-highest statutory income tax rates among the 30 industrialized nations in the Organization for Economic Co-operation and Development (OECD). Only Japanese companies face higher rates, by a slim margin. (To see the tax rate for all 30 OECD countries, click here.)
Failure to align U.S. tax policy with reality imperils our industrial base, experts warn. "Ultimately, it means U.S. multinationals are probably going to lose market share to foreign multinationals," says Peter Merrill, director of the National Economics and Statistics Group at accounting firm PricewaterhouseCoopers. "And they may become takeover targets of foreign multinationals."
Partisans of sweeping corporate tax reform insist the math should end any debate. Uncle Sam taxes U.S. corporate income at a top 35 percent rate, while states, on average, tack on 4.3 percentage points. The average among OECD countries is 26.6 percent. Thus, for every dollar earned in the global marketplace, U.S. companies appear to surrender nearly 13 cents more than a typical OECD member.
As mentioned, it's not quite that simple: the U.S. tax system rests on a vast hodgepodge of incentives, credits, exemptions, and loopholes that can lower rates to a more competitive level. Eli Lilly's effective U.S. income tax rate was 23.8 percent in 2007, 22.1 percent in 2006, and 26.3 percent in 2005.
So why complain? Because an idiosyncratic corporate tax code filled with exceptions imposes widespread inefficiency and inequality. The resulting friction, critics say, erodes business income, shrinks tax revenues, hampers strategic planning, and impedes competition. Some tax exceptions stem from the best intentions, to be sure, but more often they owe much to political clout.
At best, the effects are uneven. "If you do everything the IRS requires of you to take advantage of certain types of incentives, you can reduce your tax rate significantly," concedes Mark Weinberger, global vice chairman and head of the tax practice for accounting firm Ernst & Young. "But," he warns, "those incentives are for particular industries and particular size companies, so there are a lot of winners and losers depending on what type of company you are."
As international tax inequities go, the combination of high statutory corporate income tax rates plus the taxation of U.S. corporations' overseas income at those higher rates garners perhaps the loudest complaints. Only three OECD nations, including the United States, impose a tax on active corporate income outside their borders. The other two, Japan and the United Kingdom, are mulling an end to the practice.
The biggest reason to adopt a system that taxes U.S. multinational corporations on income earned at home and apply only foreign tax rates to income earned overseas is because it would help U.S. corporations to compete on equal footing with their global counterparts. Moreover, encouraging U.S. companies to repatriate profits stored overseas might inject some badly needed liquidity into the domestic economy for payrolls and capital expenditures.
As rules stand now, Uncle Sam imposes U.S. taxes on top of taxes paid in the foreign jurisdictions when that money is brought home. In 2004, when the tax rate on repatriated earnings was cut to a low 5.25 percent on a one-time basis, the impact was significant: some $362 billion of an estimated $804 billion domiciled offshore was lured home. "It could be very helpful in relieving some of the stress," says Lewis at Eli Lilly. "Even if companies just deposited their repatriated dollars in banks, it would help the financial system."
Regardless of the tax breaks it may enjoy as a pharmaceutical company (a sector that has benefited from a number of perks, such as incentives to invest in Puerto Rico), Eli Lilly kicks less money into U.S. coffers than it might, in large part because, like many of its multinational counter- parts, it simply finds ways to keep the money earned overseas working there. As of the end of 2007, according to Lilly's 2008 annual report, the company had $8.8 billion of unremitted earnings in foreign subsidiaries, all of which, it said, had been or were intended to be permanently reinvested in foreign operations. That may help to keep the tax bill low, but it limits flexibility, thus granting a competitive advantage for its global rivals.
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