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October 16. 2014

A Band-Aid Approach Will Never Fix the U.S. Tax Code

By ACT Staff

The U.S. tax system, both domestic and international, is one big, anti-competitive mess. Economists, policymakers and pundits, and editorial boards across the country agree that our corporate tax system is in desperate need of reform.

Companies in the U.S. are subject to the highest corporate income tax rate in the developed world. In 1986, bipartisan tax reform set a competitive rate, but we have failed to keep up with other nations in the global economy.

At the same time, our international system is outdated and stifles economic growth. The U.S. is one of the few remaining developed countries that hasn’t adopted a modern international tax system that would permit American businesses to bring home their foreign profits without paying a penalty. According to a recent study by the Berkeley Research Group, fixing our international tax system would produce significant economic growth and create jobs:

“Transition to a territorial system will lead U.S. MNCs to repatriate about $1 trillion … This additional repatriation will increase domestic consumption and investment. We estimate that the additional consumption and investment will lead to a one-time increase in U.S. GDP by at least $208 billion and create at least 1.46 million new U.S. jobs. Following the transition, we estimate that the treatment of foreign source earnings in the stylized territorial system will increase annual repatriations by about $114 billion, leading to an increase in U.S. GDP by at least $22 billion per year and to the creation of at least 154,000 new U.S. jobs per year.”

We can’t expect U.S. companies to out-compete the globe while operating under a dysfunctional international system and the highest corporate income tax rate in the developed world. These are the issues at the root of our current predicament, and tax reform can address them. Band-Aid solutions will not fix the problems that lie at the heart of the tax code.

The limits of a Band-Aid approach are clear. Our current tax code is a patchwork of special breaks and preferences that have been stitched together for three decades, yet the anti-competitive effects of the tax code have continually been left unaddressed. What we are left with is complicated mess that still fails to help American businesses, large and small, compete in the modern, global economy.

Recently, the administration took action to address a recent spate of tax inversions. Already, we are seeing the unintended consequences of this side step around reform. The Wall Street Journal reports that the new rules have created “a huge advantage” for foreign companies seeking to acquire American companies. Recent attempts to acquire the California-based company Allergan are coming from foreign companies that already enjoy the benefits of modern tax systems. American companies, stifled by the U.S. tax code, are unable to make competitive acquisition offers. Any U.S. company that acquired Allergan would have to pay U.S. corporate income taxes on all profits earned by Allergan anywhere in the world; a foreign acquirer, benefiting from a modern hybrid international system, would owe U.S. taxes only on U.S. profits. This makes Allergan – and other American companies – much more attractive to foreign acquirers than they are to potential domestic bidders. As the Journal notes:

“The fact is the Treasury action gives companies that escaped U.S. extraterritorial corporate tax before September 22 a significant advantage in the competitive bidding process for U.S. companies that can be folded into their grandfathered structures.”

The only long-term solution is competitive tax reform. Band-Aid approaches will continue to disadvantage U.S. employers, workers and our economy. Other nations have been reforming their tax codes and creating competitive environments for the past thirty years. Washington has done the opposite – choosing instead to make our tax code more complicated and less competitive.

However, if leaders in Washington fix the competitive defects at the heart of our current tax code, they will eliminate the incentives for companies to leave. We can look to other OECD nations and see what has worked and what has not. The lessons of the past thirty years are clear: if tax reform sets a competitive corporate tax rate and modernizes our international system, then it will eliminate the economic advantages of locating abroad and create greater economic growth here at home.

We can’t continue to kick the can down the road – it’s time for competitive tax reform.