The Economy

Corporate-tax Reform in America: An Offer They Could Refuse

The president's plan for business tax reform makes no sense.
Economist StaffFebruary 6, 2015

Imagine $2 trillion in untaxed corporate income. What politician could resist? Not Barack Obama. This week, as part of his latest budget proposal, he suggested both a one-time levy of 14% on the profit hoard American firms keep abroad, and a recurring tax on future foreign profits of 19%.

These proposed taxes stem from one of the many peculiarities of America’s tax code: unlike the vast majority of rich countries, America levies tax on firms’ (and people’s) income no matter where in the world it is earned. The corporate-tax rate, at 35%, is the highest among the 34 members of the OECD, a club of mostly rich countries. Currently, however, corporations pay tax on foreign earnings only when they repatriate them. No wonder, then, that the amount American firms stash abroad has been growing steadily for years (see chart). GE alone has more than $100 billion squirrelled away. Economisttaxreform

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Politicians are unanimous that America needs corporate-tax reform. And Mr Obama says he would spend the increased revenue improving America’s shoddy infrastructure—another bipartisan cause. Most Republicans abhor the idea of new taxes of any sort, so to sweeten the deal Mr Obama suggested lowering the corporate-tax rate on domestic earnings to 28%. All this ecumenicalism is important, since the president needs the approval of the Republicans who control Congress to raise or spend any money. But it is probably inadequate: the Republican response has ranged from lukewarm to hostile.

There is a certain logic to Mr Obama’s proposals. Since America is an attractive place for big businesses—half of the world’s 20 biggest listed companies are based there—Mr Obama feels his country is uniquely able to tax their foreign earnings. Moreover, by lowering tax on repatriated profits, he doubtless hopes to lure some foreign-gotten gains back home.

That bet is probably wrong. The current system allows American multinationals to exclude a good chunk of their earnings from tax. The new one would not. Rather than seeing a 19% rate as a bargain, many would view it as an incentive to reincorporate abroad. As it is, some American firms have shed their nationality, and thus lowered their tax bill, through “inversions”, a form of reverse takeover.

American firms with largely domestic operations, meanwhile, would probably see the new tax system as a reason to shift more of their work abroad. That would lower the effective tax rate on any operations they relocated, without any impediment to bringing the profits back home.

America would do better to shift to a “territorial” system, whereby it taxes firms only on money earned within the country. Some worry that such a system would induce firms to shift operations abroad to avoid tax altogether. However, a transition to a territorial system could lead to the repatriation of about $1 trillion, according to one estimate. That would give the economy a one-off boost as firms either invest more or hand cash back to their owners. If shareholders cough up on capital gains, the tax take could even go up.

© The Economist Newspaper Limited, London (February 7th, 2015)