As soon as Treasury Secretary Mnuchin revealed the Trump Administration’s plan for tax reform, my phone rang. It was my older brother, Steve, wanting to know my thoughts on the proposal to lower the corporate tax rate to 15% from as high as 39%.
He remembered that in the past, I had written an article that discussed how the U.S. had the highest corporate tax rate in the developed world. However, Steve had read that U.S. corporations have a much lower average tax rate than 39%. As such, he wanted to know why the rate should be lowered if the average corporation already pays a much lower effective rate.
My brother’s observation is mathematically accurate. According to the Congressional Budget Office, the U.S. has the highest top statutory tax rate of any G20 nation. However, the average corporate tax paid (total tax paid divided by income) was only 29%. As such, Steve wondered if it really made sense to lower the rate.
It’s a good question that requires some explanation.
First, companies are owned by shareholders, not nations. Every corporation has an obligation to their shareholders to pay their legally owed taxes—but not a penny more. As such, they have an obligation to operate in the most efficient locations.
Secondly, corporations today are global in nature—meaning they sell product worldwide. The average company in the S&P 500 derives nearly half of its income outside the U.S. This means their tax structure is anything but simple or straightforward. If they sell product outside the U.S., their average tax rate will be lower than the marginal rate assessed by the U.S.
When companies sell product into a foreign country they are taxed in the jurisdiction in which the product is sold.
Many countries, such as Ireland, Canada, France and the United Kingdom, have a corporate tax rate that is less than 20%. Since the U.S. rate is nearly twice as high it can be much more profitable for U.S. based companies to sell in these nations as it helps to maximize after-tax profits.
However, the next step in global taxation is where the real confusion sets in. If a U.S.-based company sells product into England, for instance, they pay tax in England.
After they settle up with the Brits, the net profits sit in a British bank account. If they bring the money back to the U.S., they are required to pay a 35% tax on the foreign derived profits—just for moving the cash from one bank account to another. This is a process called repatriation.
Conversely, if they leave the cash sitting in a British bank, they can deploy 100% of it to expand foreign operations and hire foreign people. These foreign people then take their paychecks and spend them in their neighborhood, feed their families and expand their economy in the process.
Unfortunately, the U.S. tax rates are so high in comparison that many corporations would rather keep their foreign-earned profits outside the U.S. This means they’re not re-investing those profits in the U.S. When profits are not reinvested, factories don’t get built, people aren’t employed and profits are not recirculated in a manner that stimulates our economy. This limits pay raises, opportunities for innovation and general advancement for the average family.
Given how wide this impact is, this is not a Republican or Democrat issue—it is an American issue. This, alone, should be enough to get any elected official to revisit our uncompetitive tax structure. However, there is even more “low hanging fruit” for anyone who wants to seriously attack this issue.
U.S. corporations currently hold $2.6 trillion in foreign bank accounts.By lowering the tax rate to 15%, hopefully a significant portion of these foreign-held assets will find their way home…and in the process, serve as feedstock for innovation, employment and GDP expansion right here at home.