The United States has the worst corporate tax system in the developed world, according to the Tax Foundation’s 2016 International Tax Competitiveness Index. The report, which analyzes the tax codes of all 35 developed countries, placed the U.S. tax code 31st overall.
In ranking the tax code of each developed country the report, authored by Kyle Pomerleau, divides each countries' tax code into five different categories – corporate taxes, consumption taxes, property taxes, individual taxes, and international taxes.
The report further divides each category into subcategories. For corporate taxes, the report includes three subcategories: the top marginal rate, cost recovery (to what extent the corporate tax system allows business expenses to be deducted), and the incentives and complexity in the code.
The U.S. ranks poorly in all three categories – our tax code is ranked last in the top marginal rate subcategory, 20th of 35 for cost recovery, and 27th of 35 in the incentives and complexity subcategory.
The corporate tax is a tax directly on labor and capital, so reducing it would benefit workers and the economy, not just businesses. As noted by the Congressional Budget Office, domestic workers bears 70 percent of the corporate tax, while shareholders bear the other 30 percent.
Reducing the corporate income tax to 20 percent, as the House Republican “Better Way” Tax Reform blueprint proposes, would have strong, positive economic effects. A 20 percent rate, like the blueprint calls for would create more than 600,000 full time jobs and increase GDP by more than 3 percent over the long term.
Top Marginal Rate
With the highest corporate tax rate in the world at 35 percent (plus a state average of 4 percent), it is unsurprising that the U.S. finishes last in the marginal rate ranking.
America’s corporate income tax rate is close to 15 percent higher than the average in the developed world. The tax rate has barely changed since tax reform was passed 30 years ago in 1986. At the time, we lowered our rate to 39 percent – below the developed average of 44 percent. Since then, other countries have cut their rates aggressively.
32 of the 35 developed countries have reduced their corporate rates since 2000. Only the U.S. and Chile have higher corporate tax rates than they did in 2000. Our high rate makes it difficult, if not impossible for our businesses to compete with competitors that have much lower rates Canada (26.3 percent), the United Kingdom (20 percent), and Ireland (12.5 percent).
The high rate has resulted in close to 50 American businesses leaving the country through an inversion in the past decade, according to data compiled by Democrats on the Ways and Means Committee. The uncompetitive code has also resulted in a net loss of more than $700 billion in assets that have been acquired by foreign competitors according to a report by Ernst and Young.
The ideal tax policy from a cost recovery perspective would be allowing businesses to immediately expense the cost of investments from taxable income. But this is not the system the U.S. uses.
Instead of full business expensing, American businesses have to deduct, or “depreciate,” business costs over several years depending on the asset they purchase, as dictated by complex and arbitrary IRS tables. These rules create needless complexity, and force business owners to make decisions based on tax, not management reasons.
With the existing depreciation schedules, business purchases are treated differently under the tax code, with no clear pattern or common theme. Businesses have two different systems of depreciation and investments can be depreciated over 3, 4, 5, 7, 10, 12, 14, 15, 20, 25, 27.5, 30, 35, 39, 40, or 50 years depending on the system used and the asset purchased.
Implementing full business expensing would eliminate needless complexity in our tax code, and it would also lead to strong economic growth. According to past research by the Tax Foundation, full business expensing would result in 5.4 percent higher long-term GDP, would create more than 1 million full time jobs, and would increase after-tax income by 5.3 percent.
Incentives and Complexity
Tax policy should treat all economic decisions neutrally by minimizing the number of distorting credits and deductions in the code. At close to 75,000 pages the U.S. tax code is exceedingly complex. An estimated 8.9 billion hours and $409 billion will be spent complying with IRS tax filing requirements this year.
Clearly, there is a need to simplify the code and this should be done within pro-growth tax reform that lowers tax rates for all Americans and eliminates many credits and deductions in an overall net tax cut.
Making the tax code simpler and fairer also has the added benefit of taking power from the IRS. With the existing, byzantine code, the IRS or a similar agency is necessary, but making the code simpler can make the agency obsolete.