LONDON—Here in the UK the corporate tax rate is a flat 20 percent, and anyone with a small business incorporates to take advantage of it. Prime Minister Theresa May wants to lower that rate to 17 percent in 2020.
So President Trump’s plans to lower the corporate tax and small business tax rates to 15 percent do not seem radical from this side of the Atlantic.
A 15 percent rate would bring the United States rate below the OECD average of 25 percent, making American firms more competitive. Lower rates would attract jobs back to America. During the campaign Mr. Trump called for a top individual income tax rate of 33 percent, down from a rate of over 40 percent on investment income. His new plan calls for individual rates of 10 percent, 25 percent, and 35 percent, and elimination of the estate tax and the alternative minimum tax.
These rates would change the status quo, under which firms have every incentive to keep profits abroad and little incentive to repatriate earnings, and individuals have less incentive to work and to invest.
House Speaker Ryan would reduce the corporate tax rate to 20 percent. Perhaps Ryan and Trump could compromise on 17 percent—the level that Britain might reach in 2020. And with Theresa May headed for a five-year term with a renewed majority, her 17 percent rate is within reach.
America used to be more business-friendly than Britain, but now has the highest corporate tax rate in the industrialized world at 35 percent. America does not want to copy Britain’s 20 percent value added tax, which raises the price of most UK products. But keeping up with the Brits, and the other countries, is becoming increasingly urgent.
The gap between American and foreign rates is widening, as foreign countries are lowering their rates as the U.S. rate stays the same. In order to raise U.S. levels of investment, the corporate tax rate should be reduced to the range of Trump’s 15 percent to House Speaker Paul Ryan’s 20 percent.
Not only is the level of the U.S. corporate tax an outlier, but U.S. corporations are taxed on their worldwide income—a path taken by only 7 of the 34 Organization for Economic Cooperation and Development countries (including the U.S.). This places America at a competitive disadvantage.
Tax and fiscal reform should raise sustainable potential growth rather than provide a temporary boost. Trump’s tax plan is important not because it is likely to present anything new—it is not likely to differ in significant respects from his campaign plan—but because it will signal to Congress that he is serious about reform.
Four percent GDP growth might be possible for some periods, but lifting sustainable potential growth anywhere close to three percent would be an enormous achievement. It would have a large and compounding effect on production, employment and wages and purchasing power, and it would raise living standards throughout the income distribution.
A global (or worldwide) tax system is uncompetitive with high tax rates because it imposes a high income tax rate on all profits, regardless of where they are earned. If an American company operates in the United States and Britain, its domestic affiliate pays U.S. taxes of 35 percent and its foreign affiliate pays U.S. taxes at 35 percent and UK taxes at 20 percent.
America allows companies to deduct the taxes paid to foreign governments from U.S. taxes owed to the Internal Revenue Service, but this means that corporations always pay the full U.S. rate and are unable to take advantage of low-tax jurisdictions.
In contrast, a territorial tax system, common to most of our competitors, taxes only the income earned domestically. Our American company operating in Britain and America would pay U.S. taxes on its domestic income and British taxes on its British income. In this way companies can take advantage of low-tax jurisdictions. Business decisions can be made more efficiently, since bringing profits back domestically will not result in those profits being taxed again – thus, capital can go where it is most needed.
No one knows how much of the $2.6 trillion of earnings US companies hold offshore would be repatriated with a lower U.S. tax, but even 10 percent to 25 percent would add to investment and employment.
President Trump’s tax plan will show Congress that he is serious about tax reform. For support on lower rates, perhaps he could call Prime Minister Theresa May.
Diana Furchtgott-Roth is a senior fellow and director of Economics21 at the Manhattan Institute. Follow her on Twitter here.
Interested in real economic insights? Want to stay ahead of the competition? Each weekday morning, E21 delivers a short email that includes E21 exclusive commentaries and the latest market news and updates from Washington. Sign up for the E21 Morning Ebrief.
Photo by Pool / Getty