To be competitive in a global marketplace we need to lower our corporate taxes. But lowering the corporate rate is just the beginning. We need to change to a territorial tax system and bring trillions of dollars back to the United States.
The US has nearly the highest corporate tax rates in the world, only exceeded by Puerto Rico and the UAE. The top bracket is 35%. Then add state corporate taxes and it is closer to 39%. If profits are distributed to shareholders, then that profit is taxed again. In essence, shareholder distributions are profits that are taxed twice.
The United States also has a worldwide corporate tax for American companies that earn profits from international operations. Foreign profits are taxed at 35%, less any corporate tax paid to the foreign country.
The only other countries that still have worldwide corporate taxes are Chile, Greece, Ireland, Israel, South Korea, Mexico, and Poland. All these countries, though, have a much lower corporate tax rate than the US.
Most advanced economies now have territorial tax policies. In this system, corporate taxes are only due on profits earned domestically. Profits earned from foreign operations are not taxed.
Broken Tax Policy
The worldwide corporate tax policy of the United States is broken. The result has led US companies to keep their foreign profits offshore instead of bringing these profits back home to the US. The amount parked outside the US is currently estimated at over two trillion dollars.
Multinational corporations park their profits offshore to avoid paying US corporate taxes. US policy is that these businesses are only required to pay the tax owed once they repatriate that money back to the United States.
If brought back home, it could be reinvested in a company’s domestic operations, which would create jobs. If not reinvested, it would be distributed to shareholders who then could either spend it or invest it somewhere else. Any of these three outcomes would be great for our economy.
Because of our outdated policy, companies are reinvesting their profits directly in other foreign countries instead of the US. Or they are parking their profits in low tax countries like Bermuda to sit and collect interest. None of it is going into the hands of shareholders to spend or invest in the United States.
Opponents of lower taxes correctly state that multinational companies do not pay the 35% corporate tax and their effective tax rate or actual tax rate is much lower. But the effective tax rate is lower, in large part, because of these un-repatriated funds sitting overseas. The actual taxes paid by multinational companies are low compared to their earnings because of the portion that represents offshore earnings have tax liability that's been deferred. US businesses that just have domestic profits are the ones paying our high 35% corporate tax rate.
Territorial Tax Solution
Donald Trump wants to lower the federal corporate tax rate from 35% to 15%. If he can convince Congress, it will stimulate our economy by freeing US companies that currently pay the 35% rate on domestic profits.
It will also stimulate our economy for US companies that have foreign profits. By lowering the rate to 15%, it will dramatically reduce any future tax deferments and almost eliminate the need to offshore profits. That’s because many foreign tax rates are higher than 15%, effectively making the US tax liability zero on foreign profits. Instead of parking this money overseas like is done today, companies will bring that money back to the US.
Since lowering the rate to 15% gets us almost there anyway, the US should join the other advanced economies in the world and change our tax system from worldwide to territorial. This would forever eliminate overseas parking of company profits to avoid taxes.
On paper, the US would lose billions in future corporate tax revenue. But if we move to a territorial tax system, multinational companies could immediately bring their foreign profits home to the US to reinvest in our economy and create jobs. If they instead just distribute the profits to shareholders, then the shareholder profits will be taxed at the personal level. Shareholders will then spend or invest whatever is left over. The influx of these foreign profits will grow our economy and create real tax revenues in the process. This is much better than watching it sit overseas collecting dust.
By lowering the corporate tax rate to 15% and by not taxing foreign profits, there would be no need for tax avoidance schemes like tax inversion. Tax inversion is when a US business merges with a small foreign company to change, on paper, the company’s legal headquarters. This is done in a foreign country with a very low tax rate and permanently shelters company profits from US taxation.
What to do with the two trillion currently sitting offshore? If our government believes that it can have a tax holiday to bring that money back to the US, then go for it. Otherwise, we should wipe the taxes due off the books. This would still pump two trillion real dollars into our economy and be a stimulus that would return jobs and tax revenue.
Congress should pass Donald Trump’s plan to reduce corporate taxes to 15%. If they do, then it almost gets us at the territorial tax position. Our government should take the next step and eliminate worldwide tax policy altogether in favor of a territorial tax policy. It will put real dollars into the US economy and will allow companies to focus on growing their business instead of conniving on how to avoid US taxes.
Photo by woodleywonderworks