Renewing America Progress Report: Corporate Tax Policy

The Renewing America initiative is publishing today the latest in our Progress Report and Scorecard series, “Standard Deductions: U.S. Corporate Tax Policy.” This is one of those rare issues on which there is actually something of a broad consensus in Washington--corporate taxes, most Republicans and Democrats agree, should be low enough to attract investment, high enough to raise a reasonable share of federal revenues, and reasonably immune to tax avoidance strategies by companies.

On all three tests, the current U.S. corporate tax system, which was last overhauled in 1986, fails. The statutory corporate tax rate in the United States is now the highest in the developed world, yet it raises less revenue than in most other rich countries. And U.S. companies are increasingly adept at reorganizing, sheltering profits offshore, and using dozens of other legal schemes to reduce their tax burden. A better system, most agree, would lower the statutory tax rate and eliminate most, if not all, of the special deductions.

Beyond those generalities, however, it has proved enormously difficult for Congress to find a way forward on tax reform. Dave Camp, the Republican chairman of the House Ways & Means committee, recently released the most comprehensive, honest, and courageous proposal for tax reform in many years, and then promptly announced he was not running for re-election. The reaction from his own colleagues, and from much of the business community, made it clear that his proposal was dead on arrival.

Our report, and a companion op-ed that appears today in Fortune, suggest some reasons why. While U.S. multinational companies often complain that the U.S. tax system puts them at a competitive disadvantage, the numbers suggest otherwise. Despite the high statutory U.S. corporate tax rate--about 39 percent including federal and state taxes--very few companies pay anything close to that. The average effective tax rate is about 27 percent, which is roughly on par with what other corporations pay in similar advanced economies. And the share of total U.S. tax revenues paid by corporations has been flat for the past three decade even as corporate profits have risen to record levels. And as our 2012 CFR backgrounder on corporate tax reform showed, compared with the 1950s and 1960s corporate tax revenue today is small fraction of what it once was.

U.S. corporations benefits from a range of deductions. The biggest is the deferral of taxes for profits earned overseas; U.S. taxes are not due on those profits unless they are repatriated, and as a result many companies retain those profits offshore, a stash that currently exceeds $2 trillion. The effective U.S. tax rate on foreign profits is extremely low, about 3 percent. The results are not entirely fair: corporations with large overseas operations, or those with large intangible assets like patents and trademarks that can report profits in low-tax jurisdictions like Bermuda or Ireland, pay much lower taxes than domestic retailers or service firms. Manufacturers also enjoy significant tax breaks for capital investments and R & D. Yet since these are the companies most exposed to international competition, the lower effective rate may make sense from a competitiveness perspective.

All of which underscores why Rep. Camp’s blueprint did not win much corporate acclaim. In order to reach the long-sought goal of bringing down the statutory corporate federal tax rate from 35 percent to 25 percent without further reducing the overall corporate tax share, he had to close many of these deductions, as well as raising taxes on large banks and some other powerful sectors. They have pushed back hard, and the Republican leadership has made it clear that Camp’s proposal is going nowhere.

But it has changed the conversation certainly. My hope is that other ideas long deemed politically impossible, like creating a federal value-added tax (VAT) on consumption, might now find their way on to the table as a more palatable alternative. This was one of the recommendations of CFR's 2011 Independent Task Force on U.S. Trade and Investment Policy, for which I served as co-project director.  VATs are used in every other advanced economy, and they have allowed those countries to cut corporate tax rates below U.S. rates. And under World Trade Organization rules they can also be rebated for exports, which would further help U.S. international competitiveness. And a VAT could probably be designed in ways that do not make the tax system more regressive.

We conclude in the report by citing polls that suggest there is strong public support for tax reform. There are certainly potential gains for the politicians that can make it happen. But there is still a long road ahead, and at the moment, no end in sight.