An Order of Tax Reform, with a Side of Frites
When a special unit of police officers went to a French McDonalds west of Paris in May, they didn’t come out with Le Big Mac and Frites—they came out with documents and computers. Their raid was in response to a government accusation that the company shifted profits in order to avoid paying French taxes.
McDonalds was not alone. Days later, reports surfaced that 100 police officers, five magistrates, 25 computer experts, and 100 tax officials raided Google’s Paris office for the same reasons. In fact, American companies operating abroad—from Starbucks, to Amazon, to Apple—have come under increased pressure from European authorities claiming the companies owe hundreds of millions in unpaid taxes.
These crackdowns have increased as the populist tide has risen in Europe. There is reason for the U.S. government to push back, and it has—most recently with U.S. Treasury Secretary Jack Lew raising concerns with the European Commission. But it’s really hard for the U.S. to do so credibly when it is stuck in the 1980s with its own outdated international tax policy. The U.S. should join the rest of the world in modernizing our tax code, but our worldwide system of taxation combined with our deferral regime incentivizes multinationals to keep cash and assets overseas. Thus, our efforts to protect U.S. companies abroad from tax raids would have more credibility if the U.S. were to adopt competitive tax reform for the 21st century instead of the current system that only feeds the international perception that our largest multinational corporations make money everywhere but pay taxes nowhere.
The way to address this is though bipartisan business tax reform that both cracks down on the use of tax havens and reduces the incentive to shift profits—that is, by simplifying the code and lowering the corporate rate to an internationally competitive level, so that the economic rationale on the part of multinationals is tilted more towards returning foreign business income back to the United States. If we had a tax code that was simpler, fairer, and more conducive to the 21st century, we would have a broader tax base and multinationals could devote less resources to tax planning and more on growing their companies—bringing more jobs and growth to the U.S.
The goal of the U.S. international corporate system is to collect revenue but, because the tax code is a complex maze of deductions and exemptions passed by Congress, it generates comparatively small amounts of revenue and results in tremendous administration and compliance costs. Perhaps low revenue collection could be tolerated if the system’s incentives were generating positive outcomes. After all, some taxes are designed to influence behavior more than to reap revenue. But on the incentive front, the corporate system is failing.
After earning profits, some U.S. companies have a major disincentive to bring that money back to the United States. The result is that companies keep much of their foreign-earned profits on the books of their overseas subsidiaries or reinvest those profits in overseas operations. Put another way: the current structure of our tax code makes capital investment a challenge in the United States, which leads to opportunities for foreign economies.
This lockout effect is the result of three features of the current tax code that work together to block the flow of capital back into the U.S. The U.S. statutory rate, the highest among OECD countries, acts as a significant additional tax obligation on U.S.-bound profits that were already subject to taxation abroad
Our worldwide system ensures returning profits will be subject to our high tax rates. And deferral allows companies an outlet to not pay taxes on their active overseas profits the year they are earned. When all signs point to keeping money overseas, it leads to a growing stockpile of much needed capital outside of our borders.
Solving the problem isn’t as simple as just removing one of the three policies. Simply lowering the rate to 15% or moving to a territorial system could create other problems, and simply eliminating deferral would make U.S. companies less competitive abroad. Reform must carefully address the lockout effect in a way that both improves U.S. competitiveness and protects the U.S. tax base.
So let’s do just that. Both parties in the next Congress should work together to advance tax reform that lowers corporate statutory rates, broadens the base, removes incentives to accrue cash overseas, and makes U.S. corporations more competitive internationally with foreign multi-nationals that do not face comparable tax burdens. Reform should at least maintain overall revenue and make the U.S. a more attractive place to invest for both American and foreign companies. Reform that shifts some amount of corporate taxation from the entity level to the individual shareholder level is an example of a change that would allow lowering of the corporate top rate, would better reflect today’s global economy, and would end the cat and mouse game of chasing profits overseas.
