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September 27. 2016

ACT Tax Facts: Whether it’s the Effective Rate or the Statutory Rate, U.S. Businesses Face an Uncompetitive Tax Rate

It is a simple, well-known fact: The 35-percent U.S. corporate tax rate is the highest in the developed world and, adding in state taxes, is 14.7 percentage points above the unweighted average of the other 34 OECD member countries, including Japan, the UK, France, Germany, and Canada. A lesser known fact is that the effective tax rate of American businesses also is significantly higher on average than their foreign competitors.

Democrats and Republicans alike understand that having a corporate tax rate so out of line negatively impacts the ability of American companies to sell products, provide services and hire workers.

The House Republican Blueprint for Tax Reform states: “Therefore, lowering the corporate tax rate would have significant economic benefits – faster growth and higher employment, investment, productivity, and wages.”

Democratic Senator Chuck Schumer has said: “To preserve our international competitiveness, it is imperative that we seek to reduce the corporate tax rate from 35 percent and do it on a revenue-neutral basis. This will boost growth and encourage more companies to reinvest in the United States.”

It’s widely understood that the actual tax rate paid by companies can vary as a result of tax incentives enacted by Congress to advance important U.S. priorities including investment in research and development, domestic manufacturing and acceleration of economic growth during the slow recovery from the past recession, for example.

A recent study by PricewaterhouseCoopers (PwC) provides insights into how tax provisions reflecting Congressional economic priorities can reduce a company’s effective tax rate. The PwC study looks at a hypothetical company with a 35-percent tax rate before considering the effect of various incentives, such as the research credit and the domestic manufacturing deduction. With the deduction for state and local taxes – provided to prevent double taxation of the same income – the study shows the federal effective tax rate for the hypothetical company is 25.8 percent, about 9 percentage points below the 35-percent statutory rate.

These credits and deductions, and many others in the code, were designed to encourage economic activity and investments in the U.S. to support growth, innovation and job creation. When enacted and extended, these provisions have received extensive support from both sides of the aisle. For example, the research credit was made permanent in 2015, as requested in President Obama’s budget, with strong Congressional support.

Additionally, the PwC report reviews four recent independent studies that compare the corporate effective tax rates of American and foreign-based companies. The PwC report finds that, similar to the statutory tax rate, the U.S. corporate effective tax rate (ETR) is significantly out of step with international standards:

“All four studies conclude that the US corporate ETR ranks in the highest 12 percent of the respective comparison countries and thus is relatively high by international standards…Among these four studies, the US corporate ETR was between 26 percent and 114 percent higher than the average for the comparison countries.”

Moreover, countries across the globe are in a hurry to lower their corporate tax rates even further. Denmark, Israel, Norway, Spain and Japan have lowered their corporate tax rates this year. Four other OECD countries have announced plans to lower their rates within the next five years. The Tax Foundation recently released a map that makes clear how out of line the U.S. corporate tax rate is, noting “The GDP-weighted worldwide average is just under 30 percent [compared to 38.9 percent in the United States including state taxes]. With most countries falling under the average, the United States faces strong competition for business investment.”

What is clear – whether you are looking at the effective tax rates or the statutory tax rates– is that American companies are paying significantly more in taxes than their global competitors. This high rate discourages business investment and ultimately hurts American businesses and workers through lower wages and a less favorable economic environment.

In a recent opinion piece, Kevin Hassett, a tax expert from the American Enterprise Institute, looks at the impact of the high U.S. corporate tax rates on wages. Because high corporate tax rates reduce investments that make workers more productive, Hassett notes: “Wage growth will continue to be disappointing as long as the U.S. has the world’s highest corporate tax rate.”

The facts are clear: U.S.-based corporations are laboring under both high statutory and effective corporate tax rates and an outdated international system that disadvantages U.S.-based companies in the global marketplace.

Tax reform that includes a corporate tax rate that is in line with the rest of the world will strengthen our economy, create opportunities for workers and establish a climate that allows businesses to grow in the U.S. and succeed around the world. A recent study from Rice University Professors John Diamond and George Zodrow looks at the economic benefits of Former Ways and Means Chairman Dave Camp’s comprehensive tax reform approach (also known as H.R. 1) that lowers the corporate rate to 25 percent and adopts a modern international tax system on a revenue neutral basis and finds:

  • “GDP increases by 0.9 percent two years after the enactment of reform, by 2.2 percent after 10 years, and by 3.1 percent in the long run;”
  • “After years of stagnant wages in the United States, after-tax wages for American workers increase by 2.3 percent two years after the enactment of reform, by 3.8 percent after 10 years, and by 6.1 percent in the long run;”
  • “Consumption increases by 1.6 percent two years after reform, by 2.9 percent after 10 years, and by 4.0 percent in the long run;” and
  • “U.S. domestic investment increases by 1.8 percent two years after reform, by 6.5 percent after 10 years, and by 6.8 percent in the long run.”

In order to compete with the rest of the world, it’s time to enact tax reform that includes setting a competitive corporate tax rate, establishing a modern international tax system, and ending tax breaks and preferences to pay for it. While the rest of the world rushes to attract companies to their shores, the U.S. lags behind, and American businesses, workers, and our economy pay the price.

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