April 19, 2005

April 19, 2005 | Commentary on Taxes

Let There Be Light… Taxation

There's a worldwide race to the bottom going on. And if the United States doesn't get moving again, we might even lose it.

Now, normally, you'd want to lose such a race. In this case, though, the race is to cut corporate taxes, so losing would leave us with higher taxes than other countries, and thus a worse climate for businesses. And we can't afford that.

Of course, the U.S. started this race in the 1980s, when we first slashed taxes during the Reagan administration. That helped fuel an era of economic growth that's continued, almost unbroken, right up to today.

But in recent years, we've given up the lead. Other countries -- even some in the high-tax European Union -- are trimming taxes further and faster. And it's no coincidence that those countries with the biggest tax reductions are enjoying rapid economic growth.

Consider Ireland. It slashed corporate tax rates from 50 percent in the 1980s to 12.5 percent today. Not surprisingly, that made Ireland a leading European destination for international investment, creating jobs and generating growth. Amazon.com, Hewlett-Packard, Kellogg and Lucent are just a few of the American companies that have recently opened facilities in Ireland. In a short time, Ireland's low taxes have allowed it to transform itself from an economic basket case to the economic tiger of Europe.

It's also important to note that while cutting taxes encourages economic growth, boosting taxes tends to slow it down. It's still true that "if you want less of something, tax it more."

For example, while some countries were cutting corporate tax burdens, Japan and Germany were increasing them. Germany's total rate reached 56 percent in 1999, and Japan's national rate is estimated at 40.9 percent today. It's no surprise that the German and Japanese economies stalled under those high taxes. Each country has been mired in stagnation for years.

Now, however, even Germany has seen the light. After years of railing against countries with lower tax rates, Chancellor Gerhard Schroeder plans to get with the program. The German government is slashing the federal corporate tax rate from 25 percent to 19 percent (although when you factor state taxes in, the average tax burden still will be a high 32 percent). It's a start, and future cuts are likely to follow.

After all, the pressure to cut taxes is still growing, and Germany is surrounded. Poland recently joined the European Union, making it a direct competitor of Germany's. And Poland's corporate rate is also plunging, down to 19 percent last year from 27 percent the year before. It's not surprising that Poland is now home to several plants, including six run by American auto-parts maker Delphi.

On Germany's other frontier sits the Netherlands, which this year dropped its corporate tax rate by three percentage points, and plans to cut them another point by 2007. Plus, Finance Secretary Joop Wijn recently toured the U.S. to declare, "I am going even lower."

The Dutch government had little choice but to cut rates, because it was losing business to lower-taxation countries. "There is a sense of urgency that [the tax climate] has to improve, that we are in competition with countries like Ireland and do lose direct investment from the U.S. to countries like Ireland," says Dutch tax attorney Fred de Hoos. That competition is good for business, and good for employees too, because as businesses expand, they add workers.

Of course, all this should be worrying to American companies. If they seem to be racing to open facilities in other countries, it's at least partly because taxes are creeping up here at home. Since 1986, our tax laws have been complicated with any number of shelters and deductions. And when we add in state and local taxes, the corporate burden here is estimated at more than 39 percent.

All the evidence shows that in the long run we can't afford this. As former Democratic Sen. John Breaux recently put it, "We are living in a global economy and if our corporations are competing against societies that don't tax their corporations as much, we have to consider that."

Corporations don't pay taxes -- people do. Declining corporate tax rates are good for people, but will be bad for countries that don't cut taxes. Those countries will find themselves struggling to keep pace in the global economy.

It's time for American lawmakers to start cutting corporate taxes once again, to ensure we emerge the winners of this critical international race.

Ed Feulner is president of the Heritage Foundation.

About the Author

Edwin J. Feulner, Ph.D. Founder, Chairman of the Asian Studies Center, and Chung Ju-yung Fellow
Founder's Office