June 08, 2016, 10:51 am, By Pascal Saint-Amans and Thomas Neubig
Most American policymakers believe the U.S. corporate tax system needs reforming – and the facts back up their view The United States' 39 percent combined statutory corporate tax rate is the highest among the largest 50 economies. The American tax and accounting system has trapped over $2 trillion of deferred taxable income as “permanently reinvested” offshore. It encourages the acquisition of U.S. headquartered companies by foreign companies, and then allows foreign companies to strip taxable income from the US activities. This system is bad for domestic job creation, penalizes the entire U.S. economy, and needs to be fixed urgently.
Despite widespread agreement about these deficiencies, the push for U.S. corporate tax reform has been all talk, with no action for 30 years. But now, a project that had caused much consternation in American tax policy circles may offer a way forward for this vital effort.
The OECD/G20 Base Erosion and Profit Shifting (BEPS) Project is an example of successful political negotiation and agreement among more than forty countries, including the United States, to work together to repair the international tax system. Over time, gaps between national tax systems, the deficiencies of international tax rules – including transfer pricing and tax treaties – and aggressive –but legal – corporate tax-planning by some multinational enterprises has resulted in double non-taxation or has significantly reduced effective tax rates to the tune of $100-$240 billion of global revenue losses annually.The goal of the BEPS Project's 15 actions, adopted by G20 leaders in Turkey last November, was to realign the taxation of profits with the location of economic activities. Now, the project's completion has established conditions that can actually help U.S. policymakers move toward badly-needed corporate tax reform. This positive effect is occurring in three ways.
First, with the internationally-coordinated OECD/G20 BEPS Project, as other nations change their tax systems in response to the BEPS Project, the United States can also act to combat base erosion and profit shifting with less concern about loss of competitiveness, jobs and investments. It is difficult for a single country to adopt tough anti-avoidance rules against global companies threatening to move jobs and investments. However, when most countries move together in closing unintended gaps, the playing field can remain level. Countries that don't toughen their anti-avoidance rules will experience even greater revenue losses.
For the United States to benefit from the leveling effect of this coordinated global effort, it will also be necessary to do something almost every lawmaker agrees should be done: reduce the high statutory corporate tax rate that makes the United States less competitive in the first place.
Fortunately, a second effect of the BEPS Project is that its recommendations could pay for much of the cost of business tax reform. Economist Kim Clausing of Reed College recently estimated that current erosion of the base and shifting of profits is reducing U.S. tax revenue by $94-$135 billion by 2016. If profit-shifting from the United States is reduced, U.S. tax revenues will increase. This will enable the lowering of the corporate tax rate and the enactment of other business tax reforms. For example, firms can easily reduce U.S. tax by borrowing from related companies in lower tax rate jurisdictions. The United States has relatively weak “earnings-stripping” rules, while the BEPS Project's recommended best practice would significantly reduce such profit shifting. It is time for U.S. taxpayers to stop subsidizing foreign multinational enterprises, as well as aggressive tax planning– a notable effect of weak anti-avoidance rules.
Finally, stopping or slowing profit-shifting will level the playing field between multinational and Main Street companies, helping to restore trust in the American tax system's fairness and effectiveness. In many countries, the juxtaposition of reduced services from cash-strapped governments and evidence that some of the most successful firms were paying little or no corporate tax can undermine voluntary tax compliance by households and businesses.
The BEPS Project links taxable income to where the economic activity generating the income occurred, rather than where a paper contract is held in a safety-deposit box. The transfer-pricing recommendations will ensure that tax is paid in the U.S. for the income generated by the creativity and workers in Silicon Valley and other U.S. locations, rather than seeing the tax base disappear to countries where little economic value is generated.
The BEPS Project can help American policymakers make the case for tax reform with a lower corporate tax rate, tough territorial international tax rules, and tax base protection. As the project brings together all OECD and emerging countries, accounting for more than 90% of the world economy, American companies can now compete globally with a set of rules that put an end to double non-taxation while also reducing double taxation with improved tax dispute resolution procedures. In addition to improving tax transparency and curtailing profit shifting, the OECD is now focusing on tax policies for inclusive innovation-driven growth with greater tax certainty.
The U.S. has tremendous economic strengths and a large economy, so it does not have to match the lowest tax rates of other countries to retain and attract new investment and jobs. But it will require a more competitive tax system and greater protection of its tax base. The lessons and recommendations of the OECD/G20 BEPS project can support efforts to make U.S. corporate tax reform happen, to the benefit of American firms and families alike.