If there’s one issue that politicians could take on that would have overnight economic impact, it’s corporate tax reform.
A new Harvard Business School study on competitiveness concluded that tax reform is the single most powerful step to improve America’s economic trajectory. And the impacts would be felt almost immediately.
“Tax reform is the great unexploited opportunity we have to change the game at this point,” Professor Mihir Desai told Yahoo Finance. “We’ve been monkeying around with monetary policy for a long time, basically pushing on a string at this point. And tax policy is actually the great opportunity to do something that can actually move the economy onto a different trajectory.”
Meanwhile, it’s been 30 years since any tax reform has been enacted. During this time, the economy has changed dramatically and other countries have modernized their systems.
“There are a lot of global realities which our tax system just doesn’t match up with,” Desai said. “So there’s a huge opportunity.”
Mihir added that good tax policy should be driven by the goals of increasing economic efficiency, achieving greater equity, and reducing complexity.
“The forces of globalization have amplified the inefficiencies and complexities of the current tax system,” according to the report.
The problem with the US corporate tax rate
For corporations, the US statutory tax rate is currently 10 percentage points higher than the average OECD rate, hurting domestic investments. Meanwhile, while all peer countries have switched to a territorial system of taxation (taxation of income within one’s borders), the US abides by a worldwide system of taxation.
And despite bipartisan support for reform, nothing has gotten done.
“I think the reason why we haven’t done anything so far is because we have the worst, in some ways, of both worlds,” Desai explained. “We have a high statutory rate, and yet firms are able to figure out ways to not pay as much in taxes. So we have low average rates.”
The “broken system” that Desai described relies on loopholes and complexities that hurt the average business.
Tax inversions, large sums of cash abroad (an estimated $2 trillion) held by multinational companies, and corporations actively shifting incomes around the world are all symptoms of a deep systemic problem, he explained.
Desai added that tax inversions—which received increased attention after the US Treasury Department blocked Pfizer’s (PFE) proposed acquisition of Allergan (AGN) earlier this year—are just the tip of the iceberg when it comes to unfavorable policy consequences. Increasingly, US firms are being gobbled up by international conglomerates at a far faster rate than many are aware, Desai added.
Optimism in consensus view
“The good news is there’s actually consensus about the fact that we’re out of step and that we need to reduce the rates,” Desai said. “So I think what the new administration has a real opportunity to mobilize and galvanize the forces that already believe this and push through something big.”
In the HBS survey, every single corporate tax reform proposal that respondents were asked to assess received a positive net approval rating overall and across political affiliations.
Desai added that reducing the corporate tax rate, while getting rid of loopholes, will allow the changes to be made in a revenue-neutral way that benefits the overall economy.
The key next step?
Republican presidential candidate Donald Trump has focused significantly on companies moving operations overseas along with globally-focused companies.
“I think it’s really unfortunate,” Desai said. “We’ve come to demonize multinational firms who choose to do things around the world. And that’s really unfortunate, because multinational firms who prosper around the world actually are good for the American economy. We’ve kind of caught ourselves into a protectionist loop.”
Meanwhile, setting up protectionist tax measures and avoiding the realities of globalization is dangerous, he said.
“Efforts to reduce the negative effects of globalization should be focused on improving competitiveness, for instance, by upgrading the skills of workers threatened by offshoring, rather than on ill-targeted tax policies,” according to the report.
According to Desai, the key next step is to push through the concept of corporate rate cuts. This requires a lot of political capital, given that the optics suggest this just helps big business, which he said is off-base. Additionally, he said, that corporations that compete better on a global stage are better for the US.
“When we change corporate taxes that makes our workers’ wages better,” he said. “Once we change that rhetoric …then I think we can do reform in a much more positive way.”
The key proposals from the report include: 1) a rate reduction of at least 10 percentage points, 2) a switch to a territorial regime without the complexity of a minimum tax on foreign income, and 3) raising revenue by limiting the use of pass-through entities for business income and shifting to reported financial income, rather than income
The last step?
“Prepare for sacrifices,” Desai said. “We all will have to.”
Importantly, policymakers just need to do something.
“Given the disconnect between the US tax system, global realities, and competitiveness, the costs of policymaker inaction are rising with every year.”
For more on the HBS study, please see below: