Why 20% Should Be New 25% In Reforming Corporate Rate

Investors Business Daily by Ryan Ellis –

If there’s a common denominator in tax reform and economic growth packages, it’s this: the corporate rate is too high, and needs to come down for the sake of keeping our employers competitive internationally. Even most on the Left have accepted this.

The most common tax-rate target is 25%. Because of how the world has been moving in the direction of low corporate tax rates, however, this is no longer good enough — and might even result in a worse outcome than the status quo.

First, a little background. A generation or two ago, the entire developed world had high corporate income-tax rates. In 1981, the developed nation average was 47%. Canada had a 51% rate. The United Kingdom levied a rate of 52%.

Then, capital got mobile. Rather than being physically stuck in a country, capital could go anywhere around the world. The fall of Soviet communism and the opening markets of China and India meant that capital suddenly was the belle of the ball. Everyone wanted to court her with lower tax rates.

State Taxes Too
Rates plummeted around the world, and haven’t stopped falling. The United States, however, has had basically the same corporate income-tax rate since the 1986 Tax Reform Act.

The U.S. now has the second-highest corporate income-tax rate in the developed world at 39.2%, behind only Japan at 39.5%. (The odd numbers come from the need to integrate state-level corporate income-tax levies into any international comparison). The average among developed nations is about 25%. This is where the 25% target of tax reformers comes from.

There’s just one problem — this target is a decade out of date.

Ten years ago, the developed-nation average corporate tax rate was 31.6%. Since then, it has declined to 25.5%. That means that international tax competition is shaving about one-half of one percentage point off of the international average every year. As a result, the target has moved.

Corporate tax reformers also tend to forget the U.S. has state-level corporate income taxes that must be taken into account.

Our average state corporate income-tax rate is 6.4%. When integrated with a new federal corporate tax rate of 25%, we would have an internationally-comparable corporate tax rate of 29.8% — still higher than major trading partners Canada and the U.K. We would only be on par with Germany and Mexico, and would only be ahead of France and Japan.

If this inadequate rate reduction is paired with corporate tax base-broadening, the result would be disastrous. Our companies would face the worst of both worlds — a rate that doesn’t beat out that many more countries than today, and where all the deductions and credits that make high tax rates tolerable have disappeared.

Beating Our Partners
The target for corporate tax reform has moved in the past decade. It used to be 25%. It is now no higher than 20%. With a 20% federal tax rate, our employers would beat out all our major trading partners — Canada, Mexico, Japan, the U.K., Germany and France.

Getting rid of most deductions and credits in this setup would be tolerable or even welcome for most companies. We can expect the rest of the world to respond and move their rates down, so we can’t take another few decades off. The U.S. corporate tax rate should always be lower than each of our major trading partners.

To their credit, GOP presidential candidates Rick Perry, Newt Gingrich, Herman Cain and Ron Paul have all have proposed a 20% or lower tax rate on corporations.

A few caveats here — some base-broadening is highly inappropriate if your policy goal is a consumption base, as it should be. For example, lengthening depreciation lives of business asset purchases would be moving in the wrong direction — we should have permanent full business expensing instead.

No Double Hit
We should also end the international double-taxation regime of our worldwide tax system and move toward territoriality, with a repatriation round this year to get this started.

Finally, something has to be done about the double-taxation of retained after-tax corporate profits (capital gains) and distributed after-tax corporate profits (dividends). We also should not take away credits and deductions from “pass-through” businesses without also giving them equal rate-cut benefits.

Policymakers need to brush up on their corporate tax reform talking points. When it comes to reform, 20 is the new 25.

HT: IBD.com (read full article)