Taxed to the Max

Hefty tax rates continue to penalize U.S. companies, and the calls for reform are growing louder.

As 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 That alarms many business advocates, who fear that current tax policy is outdated and will cripple U.S. companies if global growth resumes later this year or early next.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.

U.S. companies suffer as domestic tax rates stay high while overseas rates decline.

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.

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