Lifting the Handicap

By lowering the corporate tax rate, can the United States regain a competitive edge?

The race is on to cut corporate tax rates around the world. Last year, eight countries, including Germany and the Netherlands, cut their corporate tax rates. The year before, five countries did the same. Now the question is: Will the United States join the competition — and if so, when?

“Right now the U.S. has the second-highest marginal tax rate,” says Mark A. Weinberger, Americas vice chairman–tax services at Ernst & Young LLP. That needs to be reevaluated, he argues, “if we are looking to keep jobs and businesses here.”

According to the Treasury Department, the top corporate tax rate in the United States, including state taxes, is 39 percent. The average for other industrialized countries? Only 31 percent. Because “our current system for taxing businesses and multinational corporations has developed in a patchwork fashion spanning decades,” the agency wrote in a 52-page report prepared for a July conference on the matter, the result is “a web of tax rules that can harm the competitiveness of U.S. companies.”

To address the issue head-on, in October Rep. Charles Rangel (D–N.Y.), chairman of the House Ways and Means Committee, introduced the Tax Reduction and Reform Act of 2007. The main feature of the legislation is a drop in the corporate tax rate to 30.5 percent. But the proposal comes with a laundry list of offsets (see “Wrangling Over Rangel” at the end of this article), including the permanent repeal of the deduction for domestic production activities and the last-in, first-out (LIFO) inventory accounting method. It contains so many offsets, in fact, that Financial Executives International (FEI) has indicated concern over “the impact some of the revenue offsets in this bill could have on the global competitiveness of U.S. companies.”

Obtaining both a lower rate and limited offsets in a “pay-as-you-go” legislative environment, which requires that any new spending be offset by new sources of revenue or cuts, will not be easy. Getting Corporate America to back a single proposal may be next to impossible. Finance chiefs and tax directors, after all, care more about their effective tax rates than the official rate. And they have been very adept at using the myriad allowances and deductions in the tax code to their advantage — achieving a 24 percent effective rate on average. Any tax overhaul that waters down or eliminates precious deductions will have a tough time garnering universal corporate support. In fact, says Mark Prysock, FEI’s general counsel, the only thing it guarantees is that there will be “winners and losers.”

No Easy Fix

The last round of real tax reform dates back to the Reagan era, when the Tax Reform Act of 1986 slashed the top corporate tax rate from 46 percent to 34 percent. By 1993, however, that rate had crept back up to 35 percent. Adding state taxes to the mix pushes it to the current 39 percent.

How much the rate deters international business from coming into the United States is subject to debate. But there is a growing sense that rate creep has fueled the lowering of rates elsewhere — which in turn attracts U.S. dollars overseas. A recent study by Michael Devereux and Ben Lockwood of the University of Warwick found that when an EU country cuts its corporate tax rate by 10 percent, it can expect a 60 percent increase in investment by U.S. multinationals — at least in the short term.

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