Time for US tax code to catch up with competitors
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House Speaker Paul RyanPaul Davis RyanMcConnell names Senate GOP tax conferees House Republican: 'I worry about both sides' of the aisle on DACA Overnight Health Care: 3.6M signed up for ObamaCare in first month | Ryan pledges 'entitlement reform' next year | Dems push for more money to fight opioids MORE (R-Wis.) is scheduled to give what is being billed as a “major” tax reform speech Tuesday. Steeped in tax and economic policy on his way to assuming the speakership, Ryan is the ideal person to convey the importance of tax reform in jumpstarting our economy. He has rightly declared tax reform a priority this year. 

Ryan, along with his chairman of the Ways and Means Committee successor, Rep. Kevin BradyKevin Patrick BradyRyan pledges 'entitlement reform' in 2018 Senate approves motion to go to tax conference Overnight Finance: GOP delays work on funding bill amid conservative demands | Senate panel approves Fed nominee Powell | Dodd-Frank rollback advances | WH disputes report Mueller subpoenaed Trump bank records MORE (R-Texas), understands that real tax reform needs to be more than simply slashing tax rates. While rate-cutting is certainly necessary, in order for reform to be truly effective, it needs to be accompanied by a number of other significant changes, including a complete restructuring of our international tax system.

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Recognizing this need, Ryan and Brady have put forward a set of proposals to update our antiquated international tax rules. One component of their plan is to have border adjustments, which means that all goods and services consumed in the U.S., regardless of where they are produced, would be taxed, whereas exports would not be subject to U.S. tax. 

 

This proposal has been controversial, with major businesses lining up on each side of the issue. Retailers and other importers claim that border adjustments would raise consumer prices, while exporters and many economists argue that exchange rates would adjust and prevent any rise in prices. Last week, Brady tried to address some of the criticism, acknowledging that he would be comfortable with a five-year, phase-in plan.   

But, as the border adjustment controversy continues to rage, what seems to get lost is the underlying rationale for it. Border adjustments (and other international tax reforms) are designed to level the playing field, causing more companies to base their investment decisions on real economic factors (rather than tax treatment). They are expected to encourage more companies to locate their production and investments in the U.S.

Another important rationale is to deal with the erosion of the U.S. tax base due to income shifting. Also known as earnings stripping, income shifting refers to the variety of tax planning tools used by multinational companies to move their income from high-tax jurisdictions (like the U.S.) to countries that have minimal or zero tax rates. 

The issue is especially acute for intangible property, which is easier to move and harder to value. In many cases, real economic activity may also shift to these low-tax countries.  One study calculated that profit shifting by U.S.-based corporations has reduced U.S. tax revenues by over $100 billion per year.   

Our current international tax system also encourages U.S. companies to relocate their headquarters to foreign jurisdictions (a practice known as inversions) and/or sell themselves to foreign acquirers. There is also a concern that U.S. companies are disadvantaged in buying foreign companies and/or assets, as U.S. tax rules may allow foreign acquirers of those assets to enjoy higher after-tax returns than a U.S. company. 

Policymakers on both sides of the aisle have recognized the pernicious effects of our international tax system. The Obama administration, for instance, took aim at earnings stripping with its Section 385 regulations, finalized in late 2016. But their approach, which came under heavy criticism, doesn’t solve the problem. We need wholesale reform of our tax system.

So what should we do? Rates certainly need to come down. The Tax Foundation recently surveyed 43 nations and found that, at 39.1 percent, the U.S. has the second-highest statutory corporate income tax rate, behind only Colombia. Among our fellow Organization for Economic Cooperation and Development (OECD) countries — those with highly-developed economies — our rate is the highest.   

The U.S. is also one of the few countries with a worldwide tax system, which means that American multinationals pay taxes on all their income, regardless of where it is earned. Not only does this put U.S. companies at a competitive disadvantage, but it encourages these businesses to leave their profits overseas. At last count, over $2.5 trillion is reportedly stashed in these low-tax jurisdictions, rather than being deployed for more productive uses in the U.S.  

Every other Group-of-Seven (G7) country — the seven largest economies in the world — has a territorial system, meaning that income is taxed in the country where it is generated. Josh Bolten, president and CEO of the Business Roundtable, hit the nail on the head recently, when he pointed to lowering rates and shifting to a territorial system as essential elements of any reform. “I think those two changes alone, even if done completely revenue neutral, would be a big boost to our CEOs' ability to invest and hire."

So as the pundits react to Paul Ryan’s speech Tuesday, and they invariably focus on the controversies and roadblocks to reform, we should all make sure to step back and look at the big picture, which is the vital need to modernize our outdated and inefficient tax code. This is best way to bring economic prosperity to American businesses and families. 

Jeffrey Kupfer served as the executive director of President George W. Bush's Panel on Federal Tax Reform. He is currently an advisor to Beacon Global Strategies and an adjunct professor of policy and management at Carnegie Mellon University's Heinz College.


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