The United States is losing the battle in tax competiveness
Tax day will be upon us within days. This year it is April 18, due to a government holiday in Washington, D.C.
The presidential campaign has been focused on other issues and not necessarily on tax policy. We can thank the 24-hour news channels for shining a spotlight on the drama and not necessarily the real issues. This is unfortunate given the many issues, particularly tax and fiscal policy, that face our country. The U.S. is losing the battle in tax competiveness.
This isn’t the case elsewhere in the world. In recent weeks, several of our major trading partners have proposed budgets with tax changes included in the proposals. For many of them, tax policy is a component of economic development policy.
Over the past 25 or so years, we have seen many countries use low corporate tax rates to draw business investment to their country. Corporate tax rates and other incentives are primary tools in this effort. The U.K. has taken note of this trend and has changed its tax policy and created some tax initiatives that incent research and development activities.
Since 1990, the U.K. has reduced its corporate rate from 34 percent to a recently proposed rate of 17 percent in 2020. Meanwhile, the U.S. federal corporate tax rate has increased from 34 percent to 35 percent, and, when state income taxes are considered, the effective tax rate is closer to 39 percent.
In recent years, the U.K. also changed from a worldwide income and foreign tax credit system (similar to the current U.S. system) to a participation exemption system where qualifying earnings from foreign subsidiaries are not taxed when repatriated back to the U.K.
Canada has undergone a similar corporate tax transformation. Over the past 25 years, it has reduced corporate tax rates from 43 percent to approximately 26 percent (dependent on the province in which the company conducts business). In addition, Canada doesn’t generally tax repatriated earnings from foreign subsidiaries from tax treaty jurisdictions with active business income. This exempt surplus system, as it is referred to, allows foreign earnings to be repatriated free of any of Canadian corporate income tax.
Other trading partner countries have similar participation exemption systems and include Germany, France and Japan. All of these jurisdictions currently have lower corporate tax rates than the U.S. They have focused on the benefits of a competitive tax system.
The current U.S. corporate tax rate, the U.S. taxation of foreign earnings and other items have driven some companies to consider whether strategic merger inversions may be beneficial. Many in Washington realize the benefits of corporate tax reform, but the legislative climate in Washington has not been very conducive to moving tax or other legislation forward.
There is also the political reality of explaining slashing corporate taxes for large corporations as part of any reform. Wall Street and corporations have been slammed repeatedly by some during the recent political campaigns. Managing this fallout makes any tax reform or overhaul more difficult.
The sky isn’t falling, however. There have been some recent U.S. legislative changes regarding taxes that are beneficial to many corporate taxpayers and corporate shareholders.
As we discussed earlier this year, the research credit was finally made a permanent fixture of the tax code without the need for a renewal every one or two years. Other items in the tax code regarding accelerated depreciation for acquisitions of fixed assets were also extended. Thus, these tax provisions reduce the effective tax rate (in cash terms) incurred by corporations. Also, the preferential qualified dividend tax rate (being tied to the long-term capital gains tax rate) has reduced the impact of double taxation on C corporation earnings when they are distributed to shareholders.
There are many models in corporate tax structures that can be evaluated by the U.S. Recently, someone pointed me in the direction of the tax system in Estonia.
Estonia has a unique tax system. It levies a corporate tax on dividends. It does not levy a tax on corporate earnings that are not distributed. Thus, the earnings can be fully reinvested to expand or grow the corporate assets and income. The Estonia corporate tax rate on distributed earnings is 20 percent, which is approximately half of the current U.S. corporate tax rate. Estonia has a thriving technology sector. This may be, in part, the result of the corporate tax policy.
We have seen this before. Ireland has had success with its low tax rate and other incentives during the past 20 or 25 years. We have also seen various state incentives entice businesses to move current operations across state lines or to locate new operations in states that offer very favorable state and local tax incentives.
The corporate tax rate is also on the minds of business executives. Corporate tax rates in this country and the U.S. taxation of foreign income impact the financial performance and drive investment decisions of U.S. businesses.
A recent BDO Technology Outlook Survey of technology company chief financial officers confirms this. In the survey, 50 percent of the CFOs believe the U.S. tax system hinders their global competiveness, and 49 percent indicate the corporate tax rate is the leading corporate tax issue.
The reasons for these CFO perspectives are some of the same reasons we have seen an increased interest in corporate inversions and other tax-planning strategies that occasionally grab a headline. The Base Erosion and Profit Shifting initiatives adopted by the Organisation for Economic Cooperation and Development may impact some tax planning. However, BEPS initiatives don’t actually change domestic law regarding tax rates and the taxation of foreign earnings. This activity is left to the legislatures in each jurisdiction. And, here in the U.S., it is Congress that initiates any tax legislation.
Once the distractions of the current campaigns are over, the focus hopefully will turn to comprehensive tax reform. Only time will tell.
Bill Roth is a tax partner with the local office of accounting firm BDO Seidman LLP. The views expressed are those of the author and not necessarily of BDO Seidman. The comments are general in nature and not to be considered specific tax or accounting advice and cannot be relied upon for the purpose of avoiding penalties. Readers are urged to consult with their professional advisers before acting on any items discussed herein.