Corporate Sqeeze


Corporate Sqeeze

Aug 19th, 2003 2 min read

It's time to turn high-tax lemons into low-tax lemonade.

It would be easy to resent the World Trade Organization right now. Here we are, trying to get our economy to grow, and the WTO comes along and says the European Union gets to impose a $4 billion annual tax hike on American companies.

This is because of a WTO ruling that claims U.S. tax law gives dvomestic companies an impermissible "subsidy" because our taxes on export-related income are "too low." The EU now has the right to impose more than $4 billion in taxes on our exports unless we repeal this alleged "subsidy."

That puts Congress in a difficult position. If lawmakers repeal the "impermissible" sections of our tax law, American companies will see their taxes go up. If lawmakers leave the law unchanged, the European Union will hit American exporters with the $4 billion in taxes. It sounds like a no-win situation.

But it doesn't have to be. Lawmakers should realize that the WTO has handed them a golden opportunity to reform certain parts of our tax law that make it hard for U.S. companies to compete abroad. In effect, we can turn high-tax lemons into low-tax lemonade.

Here's the problem: Under current law, companies based in America aren't allowed to compete on a level playing field with their foreign-based competitors. In part, this is because our corporate tax rate of 35 percent exceeds the rate found in most other nations. And if you take state corporate taxes into account, the United States may have the highest corporate tax rate in the developed world.

But it gets worse. The United States also taxes companies on income earned in other nations, even though that income already has been taxed where it was earned. Most other nations, by contrast, tax companies only on income earned inside their borders, a common-sense approach known as "territorial taxation."

America's high corporate tax rate and "worldwide" system of taxation are a bad combination. For example, an American-based company operating in Ireland is at a competitive disadvantage since its profits are subject to the 35 percent U.S. corporate income tax, as well as Ireland's 12.5 percent corporate tax. A Dutch firm, by contrast, only pays Ireland's low corporate tax rate of 12.5 percent. The U.S.-based company supposedly gets a credit for taxes paid to Ireland, so the tax rates aren't cumulative. But even if the tax credit operates perfectly, the U.S. company's tax burden is about three times larger than the one the Dutch company faces.

This system puts U.S. companies in a terrible position. Indeed, this is why some have chosen to "re-charter" in jurisdictions such as Bermuda and the Cayman Islands that have better tax law. Re-chartering allows them to keep their jobs and headquarters in the United States, but because, technically, they're no longer based in America, they don't have to pay a second layer of tax on overseas income.

Re-chartering may be the best response to a bad situation, but wouldn't it be nice to fix our tax laws so that U.S. companies don't have to go through so much trouble to get the same tax treatment as their foreign competitors? That's what would happen under a bill introduced by the chairman of the tax-writing committee in the House of Representatives, Rep. William Thomas. In his view, we need to improve the competitiveness of U.S. tax law - not treat companies as cash cows for greedy government.

But some politicians want to go in the wrong direction. They would rather punish companies that "re-charter" by denying them the right to bid on government contracts. But this blame-the-victim approach ignores the harmful effect of U.S. tax laws and would penalize companies that try to protect their workers and shareholders.

Fiscal protectionism isn't the answer. Bad tax law caused the problem, and good tax reform is the solution. Congress should use the WTO decision as a long-overdue excuse to fix our tax code so that American companies - and their workers - are better equipped to compete in the global economy. 

Daniel J. Mitchell is the McKenna Fellow in political economy at The Heritage Foundation.