America the Uncompetitive

Wall Street Journal
Friday, August 15, 2008

The new international tax rankings are out for 2008, and congratulations to Washington, D.C., are again in order. Our political class has managed to maintain America's rank with the second highest corporate tax rate in the world at 39.3% (average combined federal and state).

Only Japan is slightly higher overall, though if you are silly enough to base a corporation in California, Iowa, New Jersey, Pennsylvania, or other states with high corporate levies, your tax rate on business income is even higher than in Tokyo. For the first time, the U.S. statutory rate is now 50% higher than the average of our international competitors, continuing a long-term trend as the rest of the world keeps reducing corporate tax rates. (See nearby chart).

Economists argue over how much this tax penalty on corporate profits injures U.S. competitiveness and drives capital overseas. We've long believed that it hurts a lot. And now even the folks at the Paris-based Organization for Economic Cooperation and Development (OECD) say they agree.

A new OECD study, "Taxes and Economic Growth," examines national tax burdens and their impact on growth and incomes in member countries. It concludes that "corporate taxes are most harmful for growth, followed by personal income taxes, and then consumption taxes." The study adds that "investment is adversely affected by corporate taxation," and that the most profitable and rapidly growing companies tend to be the most sensitive to high business tax rates.

In Washington, meanwhile, the politicians are still living in their own populist alternative universe. Last week Senator Byron Dorgan of North Dakota waved around a new politically generated study by the Government Accountability Office (GAO) finding that 28% of large U.S. corporations paid no income tax in 2005. "It's time for big corporations to pay their fair share," Mr. Dorgan roared.

Well, the Tax Foundation looked at those numbers and found that, among the large companies that paid no taxes, 85% of them also made no profits that year. American Airlines and General Motors escaped income tax for 2005 through the clever tax dodge of losing $862 million and $10.5 billion, respectively. How unpatriotic.

The GAO data only add to the case for cutting U.S. corporate rates. America now has the worst of all worlds: high corporate tax rates, but also lots of loopholes passed by Congress at the behest of favored businesses to avoid the confiscatory rate. This imposes huge compliance costs as businesses scramble to exploit the loopholes, with the result of less revenue for the government.

The average European nation has tax rates on corporate income 10 percentage points lower than the U.S., but those countries on average raise 50% more as a share of GDP in corporate taxes than does the U.S., according to a 2007 study by the Treasury Department. Ireland with its 12.5% rate captures a higher share of its GDP (3.4%) in corporate taxes than the U.S. does (2.5%) with its 39.3% rate.

To correct this revenue dearth, Barack Obama and Democrats in Congress are proposing to pry more tax money out of U.S. companies that have profitable affiliates outside the U.S. Mr. Obama is also shamelessly taking the Byron Dorgan line that the problem is venal U.S. CEOs rather than the nutty U.S. tax code.

One proposal would tax foreign profits when they are earned, rather than waiting until the dollars are brought back to the U.S. This may raise more revenue in the short term, but it would also accelerate the trend of U.S. companies moving entirely offshore, or being bought out by Asians and Europeans so they can escape onerous U.S. taxes.

John McCain has proposed cutting the 35% federal corporate tax rate to 25%. That's a good start, but even that would leave the U.S. with a combined state and federal rate nearly five percentage points above the global average. With corporate tax rates falling around the world, and with its damage to investment increasingly obvious, abolishing the U.S. corporate income tax should be on the table. Senator Jim DeMint of South Carolina and Congressman Paul Ryan of Wisconsin have proposed replacing the corporate tax with a value-added consumption tax. We worry about a VAT turning into a runaway money machine for government, but something has to give on the corporate tax.

Every month that goes by without tax reform, America is a relatively less attractive place to do business. Over the past 18 months, nine of the 30 most developed nations and 20 countries world-wide -- from Israel to Germany to Turkey -- have cut their corporate tax rates. Nations are slashing rates to attract capital and jobs from the U.S., and the tragedy is that our politicians keep making it easy for them.