THE UNITED STATES NEEDS A MORE COMPETITIVE CORPORATE

TAX SYSTEM

1 – The United States Needs a More Competitive Corporate Tax System

Introduction and FindingsThe United States holds the unenviable position of having a higher statutory corporate tax rate1 than any of our major trading partners—and all OECD countries. Among 135 nations, the U.S. rate is exceeded only by the United Arab Emirates. While skeptics point to the array of provisions that allow a reduction below the top-line statutory rate, many ignore the additional burden created by state and local taxes. It is abundantly clear that, when compared to the rest of the developed world, the U.S. rate is out of step at best and uncompetitive at worst. The current global tax system in the United States puts manufacturing firms at a disadvantage inside and outside foreign countries. If the United States converted to a territorial system as part of comprehensive tax reform, it would remove the current barrier to corporate repatriations (transfers in foreign subsidiaries’ profits to U.S. parent companies), promoting a marked rise in domestic investment.

The profits of C corporations (entities taxed separately from their shareholders) are taxed once at the corporate level at the corporate income tax rate and again when the after-tax profit is distributed back to shareholders at personal income tax rates. The already high corporate tax rate, coupled with double taxation of dividends and capital gains, reduces economic efficiency by discouraging capital formation and broader economic growth.

The bottom line is that the U.S. corporate tax code should change from a worldwide to a territorial system, and statutory rates should be reduced to competitive norms. When business decision making is based on profit maximization and growth goals rather than tax strategies, the result is enhanced economic performance of the U.S. economy.

THE UNITED STATES NEEDS A MORE COMPETITIVE CORPORATE TAX SYSTEM

The already high corporate tax rate, coupled with double taxation of dividends and capital gains, reduces economic efficiency.

The current global tax system in the United States puts manufacturing firms at a disadvantage inside and outside foreign countries.

Other countries are lowering their statutory corporate tax rates while the U.S. rate remains high and thus detrimental to competitiveness.

1 See Corporation Income Tax Brackets and Rates, 1909-2002, available at http://www.irs.gov/pub/irs-soi/02corate.pdf.

National Association of Manufacturers – 2

The U.S. Corporate Tax Rate Is UncompetitiveThe United States has held firm on its statutory corporate tax rate for more than two decades while the rest of the world substantially lowered their rates. In 1986, the U.S. corporate tax rate dropped from 40 percent to 34 percent effective from 1988 to 1992, and then the highest bracket rose to 35 percent in 1993. The 35 percent federal rate remains today.2

State and local governments also levy profit taxes. The rates range from zero to 12 percent, with the top marginal rates averaging about 7.5 percent. Corporations, however, deduct state and local income taxes when computing federal taxable income. Consequently, the net effective corporate tax rate from all government levels is about 40 percent, including federal, state and local taxes.

During the past two decades, corporate tax rates declined in most countries3 while the U.S. rate remained unchanged. What may have been a competitive rate 20 years ago has been uncompetitive for a long time. Table 1 shows the statutory corporate tax rates for the United States, our nine-largest trading partners, the 34-country average of OECD economies and the global average.4 In 2006, only Japan’s rate of 40.7 percent exceeded the U.S. rate in a ranking of OECD countries. Among 135 nations, the U.S. corporate tax rate was the fourth highest, behind Japan, Kuwait (55 percent) and the United Arab Emirates (55 percent). As of 2014, the U.S. corporate tax rate ranked first in the OECD membership and was second in the world (the United Arab Emirates holds the top spot).

2 The marginal federal corporate income tax rate on the highest income bracket of corporations (currently above USD 18,333,333) is 35 percent.

3 See http://www.kpmg.com/global/en/services/tax/tax-tools-and-resources/pages/corporate-tax-rates-table.aspx.

4 OECD members span the globe. They include many of the world’s most advanced countries as well as emerging countries, such as Mexico, Chile and

Turkey.

Table 1 – Statutory Corporate Tax Rates

Year Percentage Points

2014 2006 2006 to 2014 Change2014 Difference

with the United States

China 25.0 33.0 -8.0 -15.0

Canada 26.5 36.1 -9.6 -13.5

Mexico 30.0 29.0 1.0 -10.0

Japan 35.6 40.7 -5.1 -4.4

Germany 29.6 38.3 -8.7 -10.4

South Korea 24.2 27.5 -3.3 -15.8

United Kingdom 21.0 30.0 -9.0 -19.0

France 33.3 33.3 0.0 -6.7

Brazil 34.0 34.0 0.0 -6.0

United States 40.0 40.0 0.0 0.0

Nine-Country Trade-Weighted Average

27.9 33.6 -5.7 -12.1

OECD Trade-Weighted Average

27.9 32.3 -4.4 -12.1

Global Average 23.6 27.5 -3.9 -16.4

Source: KPMG

3 – The United States Needs a More Competitive Corporate Tax System

The United States is losing competitiveness through inaction. Between 2006 and 2014, several of our major trading partners made significant changes to their rates:

� Canada: -9.6 percentage points

� China: -8.0 percentage points

� Germany: -8.7 percentage points

� Japan: -5.1 percentage points

� South Korea: -3.3 percentage points

� United Kingdom: -9.0 percentage points

During this time, France and Brazil left their lower rates unchanged, and Mexico raised its rate by 1 percent. The trade-weighted average of our nine key trading partners declined 5.7 percent, the OECD average fell 4.4 percent, and the global average dropped 3.9 percent. In 2015, the averages for these two groups will fall even more5:

� The United Kingdom will reduce its corporate tax rate from 21 percent to 20 percent.

� Portugal and Spain are planning reductions.

� Japan will lower its combined national and local tax rate from 34.6 percent to 32.1 percent.

The gaps between the U.S. statutory corporate tax rate and those of other countries are strikingly large:

� Canada: 13.5 percent lower

� China: 15 percent lower

� Mexico: 10 percent lower

� United Kingdom: 19 percent lower

The nine-country trade-weighted average is 12.1 percentage points lower than the U.S. rate, and the global average is 16.4 percentage points lower.

Inaction on Statutory Rates Led to a Narrowing Base Because U.S. rates are uncompetitive, Congress has narrowed the tax base to shrink the difference in the effective tax rates. Special credits, deductions, exemptions and special tax rates give preference to certain behaviors. According to the Congressional Research Service, the revenue cost of these corporate tax provisions totaled $154.4 billion in 2014. The five largest provisions are the following:

� Deferral of active income of controlled foreign corporations: $83.4 billion

� Deduction for income attributable to domestic production activities: $12.2 billion

� Deferral of gain on like-kind exchanges: $11.7 billion

� Exclusion of interest on public purpose state and local government bonds: $9.3 billion

� Deferral of gain on non-dealer installment sales: $6.9 billion

Countries differ in their treatment of depreciation, investment taxes, R&D expenses and other factors affecting the amount of income subject to tax. Jack M. Mintz and Duanjie Chen recently published6 statistics on the marginal effective tax rates on capital (METR) that account for lower effective rates but make the calculation based on the investment burden. METR is a summary measure of the extent to which taxes impinge on investment decisions. It reveals the share of the pretax return to capital that would be required to cover all taxes7 on the capital that generated the income.

5 See Opportunities and Challenges Ahead: 2015 Tax Policy Outlook, available at http://www.pwc.com/en_US/us/tax-services/publications/insights/

assets/pwc-pwc-2015-tax-policy-outlook-opportunities-challenges-ahead.pdf.

6 See The 2014 Global Tax Competitiveness Report: A Proposed Business Tax Reform Agenda, available at http://www.policyschool.ucalgary.ca/sites/

default/files/research/tax-competitiveness-chen-mintz.pdf.

7 Includes the corporate tax rate, sales taxes on capital purchases and other capital-related taxes (financial transaction taxes and asset-based taxes).

METR does not include property taxes.

National Association of Manufacturers – 4

Table 2 – Marginal Effective Tax Rates in Manufacturing

Year Percentage Points

2014 2005 2005 to 2014 Change2014 Difference

with the United States

China 21.4 47.6 -26.2 -12.1

Canada 7.7 35.4 -27.7 -25.8

Mexico 18.9 18.9 0.0 -14.6

Japan 29.4 31.7 -2.3 -4.1

Germany 26.6 36.3 -9.7 -6.9

South Korea 32.4 35.3 -2.9 -1.1

United Kingdom 22.5 27.7 -5.2 -11.0

France 37.7 37.2 0.5 4.2

Brazil 34.5 34.5 0.0 1.0

United States 33.5 35.1 -1.6 0.0

Nine-Country Trade-Weighted Average

20.5 34.7 -14.2 -13.0

OECD Trade-Weighted Average

19.2 27.8 -8.6 -14.3

Source: Mintz and Chen

Table 2 compares the METR in manufacturing by country. Differences in depreciation schedules and direct taxation of investment are considerable. In the United States, relatively generous depreciation schedules contribute to a METR that is lower than the statutory rate, but this is offset somewhat by state sales taxes on capital inputs. In a METR comparison, the United States has the third-highest rate when ranked with our major trading partners. Brazil’s 2014 METR was 1.0 percentage point higher. France’s was 4.2 percentage points higher than the U.S. rate because France doubled its temporary surtax starting retroactively in 2013.

Our top-three trading partners have a significant competitive advantage in the METR applied to the manufacturing sector:

� Canada: 25.8 percentage points lower

� China: 12.1 percentage points lower

� Mexico: 14.6 percentage points lower

Canada dramatically cut its corporate tax rates between 2005 and 2009; it went from having one of the highest to one of the lowest METRs in the OECD and among our key trading partners. Unlike most countries, Canada favors manufacturing over other sectors of its economy, with a 2014 METR of 23 percent in the service sector and 7.7 percent in manufacturing.

The United Kingdom is not one of our top-three trading partners, but it is a persistent business tax reformer; the nation has lowered its tax rate and broadened its tax base since 2007. Its tax rates were relatively low in 2005, and they remained low in 2014 because the United Kingdom takes tax competitiveness seriously. Its manufacturing METR was 11.0 percentage points lower than the U.S. rate last year.

The METR in the United States was outside the norm in 2005, and a larger wedge developed in the intervening years as our competitors cut their rates while we held steadfast. Among our nine-largest trading partners, the trade-weighted average METR fell 14.2 percentage points from 2005 to 2014, and the OECD average fell 8.6 percentage points. In 2014, our main trading partners’ METR was 13.0 percentage points lower, and the OECD average was 14.3 percentage points lower than the U.S. rate. These large tax differences are hampering U.S. manufacturing firms’ competitiveness and distorting their investment decisions, all to the detriment of the U.S. economy.

5 – The United States Needs a More Competitive Corporate Tax System

The U.S. Global Tax Scheme Is Inefficient and Uncompetitive The scope of the U.S. tax system is out of touch with the rest of the world. Currently, the United States is the only country in the G-7 that taxes the active foreign earnings of its companies worldwide. Only four other OECD countries have a worldwide system—Chile, Ireland, South Korea and Mexico. The other 29 have a territorial tax system8 in which business income earned abroad by foreign subsidiaries is wholly or partially exempt from home country tax. Again, the United States fails to respond to global trends. Fourteen of 34 OECD member countries had a territorial tax system in 2000, increasing to 23 in 2005 and 29 in 2014.

Economists favor a territorial tax system to maximize9 worldwide output. In a harmonized territorial environment, taxes have no impact on where firms choose to invest. Instead, investments occur in the location offering the highest rate of return. The best business opportunity would dictate how resources were allocated, thus resulting in maximized output.

The current global tax system in the United States puts manufacturing firms at a disadvantage inside and outside foreign countries. At home, multinationals have an incentive to invest abroad to create profits in a country with a lower tax rate rather than generate domestic profit by exporting from the United States. Domestically and internationally, manufacturers in the United States compete for sales with firms with lower corporate tax rates. To achieve a comparable after-tax return on investment, U.S. domestic firms and U.S. multinationals must charge higher prices.

Congress created the largest of the tax preferences—deferral of active income of controlled foreign corporations—to compensate U.S. multinationals for the uncompetitive global tax system. With deferral, U.S. companies pay taxes to the foreign government where the profit is earned, and the U.S. tax on foreign profits is deferred until the profits are repatriated back to the U.S. parent.

Deferral is the difference between the high U.S. corporate tax on foreign profits and the lower tax rate applied in the foreign country where the profit was earned and taxed. Unfortunately, in many cases, the tax rate differences are so large that the deferred profits will never return to the United States at current tax rates. Audit Analytics10 estimated that foreign profits held overseas by U.S. corporations nearly doubled from 2008 to 2013, reaching $2.1 trillion.

If the United States converted to a territorial system as part of comprehensive tax reform, it would encourage an increase in corporate repatriations (transfers in foreign subsidiary profits to U.S. parent companies) that would promote a marked rise in domestic investment. Faster growth in business investment in U.S. plants and equipment would generate faster economic growth and employment.

High Corporate Tax Rates Distort Business Structure DecisionsThe corporate income tax applies to C corporations, for which profits are taxed once at the corporate level at the corporate income tax rate. Distributing corporate profits back to the owners in the form of a dividend or realizing a capital gain in the value of the stock creates income that is taxed again at the shareholder (individual) level at personal income tax rates. Taxing the same profit at both levels means that corporate profits are subject to double taxation. The actual tax on corporate profits, therefore, is the combination of corporate and personal income taxes on dividends and stock capital gains.

8 See U.S. International Corporate Taxation: Basic Concepts and Policy Issues, available at http://fas.org/sgp/crs/misc/R41852.pdf.

9 See The Corporate Income Tax System: Overview and Options for Reform, available at https://www.fas.org/sgp/crs/misc/R42726.pdf.

10 See http://www.reuters.com/article/2014/04/09/us-usa-tax-offshore-idUSBREA3729V20140409.

National Association of Manufacturers – 6

Firms can choose a business structure that avoids this double taxation. Non-corporate structures encompass sole proprietorships and partnerships, where profits pass through the personal income tax system.

The S corporation11 is another option with limited personal liability protection in the corporate structure; business profits pass through to individual personal taxation only. The downsides of an S corporation are that it has the same legal, governance and regulatory requirements C corporations must follow, it is limited to a maximum of 100 shareholders, and it can have only one class of stock. The latter two rules severely restrict S corporations’ ability to raise capital and thus limit the size of the business. In addition to ongoing challenges with the corporate tax rate, it is also important to note that S corporations and other pass-through entities, which pay taxes at the individual rate, also face significant tax burdens—in some cases paying federal statutory rates that exceed 40 percent.

When tax policy distorts business structure decisions and growth opportunities, economic resources are not put to their most productive use. Corporate tax reform integrated with personal tax reform designed to minimize the economic distortions of tax gaming and arbitrage will promote economic growth and efficiency.

ConclusionThe Tax Foundation12 maintains an international tax competitiveness index for the 34 OECD countries. Key principles of tax policy examined in the rating system are the competitiveness of the tax code, its neutrality between consumption and savings and whether it favors one industry over another. On all counts, the United States scores poorly, placing 32 out of 34 in the 2014 index.

As outlined above, U.S. corporate tax rates, both statutory and marginal effective, are higher than tax rates in our major trading partners, making it harder for U.S. companies to compete in the global marketplace. Similarly, the U.S. worldwide tax system, an outlier when compared to tax systems in most other developed countries, puts U.S. global companies at a competitive disadvantage vis-à-vis their competitors outside the United States. Converting from a global to a territorial tax system would make U.S. rules more internationally competitive and unlock an estimated $2.1 trillion in stranded profits held abroad by U.S. multinationals.

Our tax code is also biased, favoring consumption over saving (through high capital gains and dividends taxes, high estate taxes and high progressive income taxes). Furthermore, double taxation of corporate profits discourages firms from electing the C corporation structure that has wider access to capital markets.

To be efficient, the tax code should be relatively simple, but it is instead exceedingly complex and lengthy. Wolters Kluwer’s Standard Federal Tax Reporter13 compiles statutes, regulations and case law on the tax code. The publisher considers its Standard Federal Tax Reporter volume to be representative of the tax code, because an expert needs to know all 74,000 pages to understand the code.

Lower corporate tax rates, changing from a global to territorial system, more neutrality and a less complex tax code are the significant changes policymakers can make that would immediately improve the manufacturing sector’s cost competitiveness.

11 See http://www.entrepreneur.com/encyclopedia/subchapter-s-corporation.

12 See http://taxfoundation.org/article/2014-international-tax-competitiveness-index.

13 See Federal Tax Law Keeps Piling Up, available at http://www.cch.com/TaxLawPileUp.pdf.

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