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May 06. 2014

Myth Buster: EPI’s “Simple Fix” Ignores the Need for American Companies to be Globally Competitive

ACT Supports Tax Reform to Modernize U.S. International Tax Rules

By ACT Staff

There is one thing ACT and the Economic Policy Institute agree on: our international tax system is broken and it’s time to update the rules. But while EPI argues that the United States should repeal deferral on the foreign earnings of American businesses – a system used by no other advanced economy in the world – ACT believes the United States should transition to the type of tax system used by all other G-7 countries and 28 of the 34 OECD countries: a modern, hybrid international tax system under which American businesses pay taxes on the income earned abroad to the country where they are doing business. This would remove the penalty American businesses – small and large – face today when they try to reinvest foreign earnings back into the U.S. for growth, innovation and job creation.

Current U.S. tax laws allow businesses to defer income earned by their operations abroad to level the playing field for American businesses in the global economy. In the absence of deferral, American companies doing business in foreign markets would be at a significant tax disadvantage relative to their foreign competitors. American companies operating abroad would be subject to immediate taxation at the highest corporate tax rate in the developed world, while their foreign competitors would owe tax only in the local jurisdiction where profits are earned.

Over time, this tax disadvantage would result in lost sales, causing American companies to reduce employment in the United States, as the many domestic activities that support foreign operations would no longer be needed. U.S. exports, R&D, and headquarters activities would all contract, ultimately resulting in lower U.S. wages.

Real-world experience, in this instance, is instructive. New Zealand repealed deferral from 1988 until 2009 and the results were clear: the country experienced a relative decline in New Zealand headquartered companies and domestic investment.  Foreign investment in New Zealand stagnated even as it increased around the world, and studies showed the real GDP per capita fell behind the OECD average. After experiencing these adverse consequences, New Zealand reversed course and adopted a competitive territorial system like most of our trading partners.  It is also worth noting that New Zealand did not adopt an extreme, anti-competitive CFC anti-abuse rule when adopting a territorial system.

EPI’s proposal would also increase the number of American companies that would move their headquarters abroad.  Often accomplished through acquisition by foreign competitors, these corporate relocations allow formerly U.S.-based companies to compete abroad on a level tax playing field.  As a result, communities that are long-supported by the jobs and philanthropic activities of their locally headquartered companies would lose this vital support when a company relocates abroad.

Adopting a modern, hybrid international tax system with elements of the territorial tax systems of other major countries would enhance the competitiveness of American companies in the foreign markets in which they operate and end the “lock out” effect under which foreign earnings are trapped abroad due to tax penalties for bringing these earnings home.  A recent analysis by Dr. Laura Tyson, an ACT economic advisor, and the Berkeley Research Group (BRG), finds that adopting such a system would generate economic growth and create jobs in the United States, while boosting the competitiveness of American businesses. This study estimates near-term increases of at least 1.46 million jobs and further increases of 154,000 new jobs annually thereafter.

EPI’s proposal to repeal deferral would imperil the competitiveness of American companies and risk American jobs and growth. In fact, we’ve seen this movie before: The United States first cut back and then completely repealed deferral for international shipping income in 1986. These changes resulted in a precipitous decline in the U.S. market share of the international shipping market, falling from more than 25% in 1975 to less than 5% by 2004.  In response to this drastic loss of us competitiveness, Congress restored deferral for international shipping income in 2004 and the U.S. market share has begun to rebound.

Enhancing the competitiveness of American companies through corporate tax reform can spur U.S. economic growth, job creation and investment in the U.S. Adopting a modern hybrid international tax system like that of other advanced economies can help American businesses and workers compete in the global economy.