The Need for Corporate Tax Reform

It’s no secret that the U.S. corporate tax rate is one of the highest in the world. However, a recent report released by the Cato Institute measured exactly how the U.S. compares with 90 other nations on corporate taxes. The results of the study are unsettling – the authors found that the U.S. marginal effective tax rate of 35.6% is nearly double the average rate among the 90 countries examined.

To be clear, the U.S. maintains the highest statutory corporate income tax rate in the world at 35 percent, with an average combined federal-state rate of 40 percent. This, however, is not the full story. The study takes into account interest expenses and deductions for capital depreciation. By taking these factors into account, it is revealed that the U.S. has a marginal effective tax rate (METR) of 35.6 percent, while the average rate for the 90 countries examined is 18.2 percent.

Our neighbors to the north can provide a positive example of corporate tax reform. According to the report, Canada currently maintains an effective corporate rate of 19.9 percent. Since 2000, Canada reduced its statutory rate from 29.12 percent to 15 percent and also scaled back special tax preferences. The result has been a more competitive and neutral corporate tax system with virtually no loss in government revenues.

To make the U.S. rate more competitive, the answer is not only to reduce the corporate tax rate, but also to eliminate preferential, industry-specific tax treatment and loopholes. Historically, empirical evidence has demonstrated that with a broadening of the tax base, a lowering of rates, and elimination of preferences, high rate countries will not experience significant revenue losses. In fact, the result often is a Laffer-curve effect, where a cut in tax rates leads to increased revenues. Most notably, though, a rate reduction will attract foreign investment while enhancing domestic investment.

The study also emphasizes that corporate income taxes are the most distortionary, and therefore, the most harmful.  Our foreign competitors have recognized this, and sought to mitigate the damaging effects of the tax. For example, Swedish Prime Minister Fredrik Reinfeldt recently remarked that corporate taxes are “the most damaging tax of all.” Most OECD countries have recognized this fact in recent years, and have taken actions to make corporate tax policy more competitive. The U.S., however, has been one of the only OECD countries not to reduce its corporate tax rate in recent years. In fact, of the 30 OECD countries, 27 have cut their corporate tax rates since 2000, while the U.S. has not.

An important message from the study is that reform should not be limited to the federal level, but should also take place at the state level. In order to enhance economic growth and competitiveness, state policymakers need to reduce or eliminate corporate income taxes, a move that is supported by the empirical evidence presented in ALEC’s annual Rich States, Poor States report. With pro-growth tax reform, the U.S. will incentivize businesses to remain or relocate to the U.S., creating jobs and increasing economic growth.