Why U.S. Companies Shouldn't Whine About Taxes

To hear some people talk, the United States is the scourge of the Fortune 500. Despite all the tax cuts that President Bush and Congress have passed in the last five years, business groups and their supporters in Washington complain that the United States imposes higher tax rates on corporate profits than almost any other industrialized country.

"Foreign-based competitor companies operate under tax rules that are often more favorable than our own," warned R. Glenn Hubbard, a former economic adviser to President Bush and now dean of the Columbia Business School, at a House hearing two weeks ago. "Current law can result in circumstances that harm the competitiveness of U.S. companies."

Around Washington, the rumblings are growing for "reform" of corporate taxes to improve the global competitiveness of American companies.

Henry M. Paulson Jr., the incoming Treasury secretary, declared at his confirmation hearing that he wanted to increase "competitiveness" in the tax code.

Can it be true that the United States, where bare-knuckled capitalism is a romantic ideal and being nouveau riche is a badge of honor, is harder on big corporations than "old Europe" welfare states like Germany, France and Sweden?

Don't believe it. There are plenty of problems with the corporate tax code — rococo complexity, perverse incentives, antique ideas — but overly high taxes is not one of them.

By most measures, the corporate tax burden is lower in the United States than it is in the European Union or in Japan or most other industrialized countries.

The political danger, at least from a fiscal standpoint, is that arguments for corporate tax reform will be hijacked to justify another round of corporate tax cuts. That was what happened with the corporate tax overhaul of 2004, which became a grab bag of tax breaks to almost every corner of business, at a net cost of $60 billion over 10 years.

Those who see the American corporate tax as oppressive point to a striking fact: the standard corporate tax rate of 35 percent is now higher than that of most other industrialized countries. The average top rate is 25.8 percent in the European Union, where most nations have cut rates to attract investment.

But official tax rates are not the same as actual tax burdens. What American companies lose in high tax rates they more than make up in higher tax breaks.

One indicator of the true tax burden is corporate tax revenue as a share of gross domestic product. According to the Organization for Economic Cooperation and Development, a research organization based in Paris and financed by governments of industrialized nations, corporate taxes in 2003 were 2.1 percent of G.D.P. in the United States, 3.2 percent in the European Union and 4.3 percent in industrialized countries in Asia.

Though comparisons of true tax rates are treacherous, the evidence suggests that the United States more than makes up for high statutory rates with generous tax breaks. Robert S. McIntyre, director of Citizens for Tax Justice, has calculated that the average corporation paid taxes of about 18 percent in 2004.

The European Commission, using a more theoretical approach, calculated that the average effective tax rate in 15 Western European nations has hovered between 20 and 22 percent since 1998. When the 10 new Central European members of the European Union are included, the average corporate tax bite was 17.7 percent.

"There is good reason to believe that the corporate tax burden in the United States could be less than the rest of the world because the rest of the world has been broadening their tax bases while we have been cutting ours," said Martin A. Sullivan, an analyst at the journal Tax Notes.

To be sure, many experts contend that the American tax code does impose some competitive disadvantages. One big complaint is that the United States is one of the very few countries that taxes corporate profits worldwide. Almost all other nations use "territorial" systems, taxing only profits inside their borders.

The difference is significant. Thyssen-Krupp, the German steel conglomerate, owes no German taxes on profits from its operations in Brazil, China or Poland. And European value-added tax on domestic sales does not apply to exports to the United States. United States Steel, by contrast, potentially owes American taxes on profits from its subsidiary in Slovakia and must also charge value-added taxes on exports sold in Germany.

In practice, the disadvantage is smaller than it appears. For one thing, American companies receive tax credits for taxes paid in other countries. More important, American companies have proved extremely adept at shifting profits into low-tax countries like Ireland and then deferring the American taxes on those profits by keeping them outside the United States.

Under current federal law, companies can postpone taxes on foreign profits until those profits return to the United States. By some estimates, American multinationals had accumulated more than $400 billion in profits outside the country.

Last year, Congress rewarded that behavior. First, it widened companies' ability to claim tax credits against their foreign taxes, at a cost to the Treasury of almost $40 billion over 10 years. Second, it gave companies a one-time chance to repatriate their vast hoard of overseas profits at a tax rate of only 5.25 percent — a bonanza for many pharmaceutical and electronics businesses.

"The current U.S. rules, while complex, represent the best of all worlds for multinational taxpayers," declared Stephen E. Shay, a former international tax counsel to the Treasury Department, at a hearing last month of a House Ways and Means subcommittee.

Many analysts agree that today's rules are a mess: they do not raise much revenue from foreign profits, they encourage companies to invest outside the United States, they encourage profit-shifting schemes and they probably put some American companies at a competitive disadvantage.

The challenge is to change the system without cutting taxes yet again. Michael J. Graetz, a professor at Yale Law School and a proponent of radical tax overhaul, told lawmakers last month that the top corporate tax rate ought to be cut from 35 percent to as little as 15 percent.

But Mr. Graetz said Congress would have to make up for the lost revenue. "It is not possible to achieve this kind of corporate rate reduction without a major restructuring of our domestic tax system," he said.

President Bush called for exactly such a revenue- neutral restructuring during his re-election campaign. But any overhaul would provoke intense battles between potential winners and losers. With Republicans terrified about losing control of Congress in the midterm elections this year, Mr. Bush has postponed making any proposals until at least next year.

Source:New York Times, Organization for Economic Co-operation and Development, 2006