Joseph Mason is the Moyse/LBA Chair of Banking at the Ourso School of Business at Louisiana State University and a senior fellow at the Wharton School of the University of Pennsylvania.
United States-based companies and hardworking Americans face a steadily growing problem, one oddly self-imposed by Uncle Sam. Our current tax system puts businesses and workers at a competitive disadvantage in the global market and discourages companies from investing in operations here at home.
On Sunday, April 1, Japan lowered its corporate tax rate, leaving the United States with the highest effective rate among developed countries: 39.2 percent.
Under the "worldwide" tax system the United States employs now, companies' profits generated abroad are subject to taxes both domestically and in the country they were earned. Certain provisions are built into the tax code to alleviate that burden, but even those protections are being challenged by members in Congress who seem ensconced on repealing these important incentives for U.S. industry. According to a 2011 Business Roundtable report:
American companies can face a tax rate on their remitted foreign earnings a full 16 percentage points higher than the rate faced by their foreign competitors.
Operating under a higher tax rate automatically puts U.S. based firms at a competitive disadvantage to their foreign counterparts. Developments in technology and greater global integration have opened international boundaries. Companies today have fewer deterrents from relocating their operations to areas that provide the most economically conducive environment, putting an inestimable pressure on nations to create commerce-friendly conditions. We've already seen this at a state by state level.
California, which boasts one of the most burdensome state tax systems, has witnessed companies relocate at an accelerating pace. In 2011, companies moved out of California at an average of about five a week. Altron Inc., an information technology company laid off 74 employs to open headquarters in South Carolina. CGI Federal Inc. fired 170 people to move to Canada. Petco, the well-known supplies retailer, shut down its headquarters in San Diego to move to Texas. The list goes on and on.
American companies that operate internationally directly sustain over 22 million U.S. jobs and a further 41 million indirectly. Additionally, the average U.S. company operating globally buys $3 billion in goods and services from small businesses here at home, with a cumulative impact of more than $1.52 trillion. Unreasonable tax policies put all of that at an unnecessary risk.
Moreover, monitoring the tax activity of U.S. based multinationals under the current system creates sizeable costs. Both government agencies and private firms devote valuable time and resources to tracking and taxing foreign income. According to the Tax Foundation, the IRS estimates American companies and individuals spend 7 billion hours a year filing tax forms. Under a simplified "territorial" system, governments would see gains that would offset most, if not all, short-term reductions to tax revenue. Moreover, the long-term gains caused by increased economic activity and decreased compliance costs would dwarf any immediate losses.
Taxing U.S. companies on profits earned abroad also discourages managers from repatriating profits, thereby reducing domestic investment. Similarly, hefty taxes deter foreign investment in the United States since prospective financers recognize the drag they will create on revenues.
The business world is becoming increasingly global. In 2007, international commerce accounted for 35 percent of worldwide Gross Domestic Product. But America is failing to keep pace. Today, U.S. investment in foreign firms is three times greater than in American companies, and in 2010, only six of the 20 largest global companies were U.S. based, down from 13 in 1985.
Switching to a territorial tax system offers the United States a practical way to bolster international trade, increase tax revenues, and re-establish itself as a leader of global innovation and commerce. Many U.S. leaders espouse this view and a growing number recognize its practicality. For the sake of our domestically based businesses and workers, it's important we carefully reconsider our current tax policy.