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Reforming the corporate tax system - four things that matter.

The following op-ed piece has been submitted to newspapers around the United States.

Tax reform is a lot like the weather--everyone talks about it but no one seems to do anything about. Incoming New Treasury Secretary Henry Paulson should change that by focusing forthright on the gaping need for corporate tax reform. To be sure, Congress should not ignore the need to revise the tax rules governing individuals, but modernizing America's business tax system is critical to promoting growth, creating jobs, and narrowing the budget deficit. In deciding how best to reshape the rules, Secretary Paulson and Congress must recognize four things.

First, America's Tax System Must Be Competitive. Every day we make choices based on cost: If gasoline is selling for 10 cents less a gallon on the left-hand side of the street than on the right, very few of us turn right to fill up the car. Similarly with taxes: They are a cost that a business rightly considers as it locates new plants, creates distribution networks, and hires workers. To be sure, taxes are not the only or most important cost to be considered, but they do matter.

A primary reason that taxes matter is that U.S. business does not operate in a closed system. Some economists bemoan tax competition as "a race to the bottom," but the competition is real, persistent, and effective. Our foreign trading partners are not shy in vying for new plants, research facilities, and distribution centers, by lowering rates, paying grants, or granting special tax incentives. The U.S. system must change in order to remain competitive.

Second, Tax Rates Matter. A critical aspect of tax competition is the tax rate. Regrettably, while the Bush Administration has moved to reduce individual tax rates, the corporate rate has remained unchanged since the 1990s. Whereas the United States once had one of the lowest corporate tax rates in the industrial world, it now comes in near the top of the list.

In contrast, lowering tax rates has become the rule of the day in Europe. For example, in 1999 Ireland passed legislation that over time reduced its overall corporate rate to 12.5 percent (slightly more than one third the U.S. rate), which has helped spur strong economic growth. The Celtic Tiger is not a myth--it's a reality, and the results (including jobs, economic development, and tax revenues) have prompted Ireland's neighbors to follow suit, with Germany and Spain being the most recent countries to announce significant reductions and The Netherlands signaling the intention to follow suit.

Significantly, lower rates do not mean lower revenues. Economist Martin Sullivan of the independent publication Tax Notes has confirmed that tax rate reductions in European countries have led to increased tax revenues. Moreover, a recent study of more than 70 countries by the American Enterprise Institute strongly links lower corporate rates with higher wages. Corporate tax reductions should do the same here.

Third, the Tax Base Matters, Too. The amount of revenues raised by a tax system is the product of the tax rate and the tax base. While there will never be unanimity over which should take precedence, a growing consensus favors lower rates and a broader tax base to reduce complexity, ease tax administration, and minimize the government's role in picking "winners" and "losers."

Where it gets tricky, of course, is balancing the need to raise revenue to fund the government while encouraging or discouraging certain behavior. For example, the Nation has long placed a premium on education and, as a result, Congress has numerous incentives to advance that goal. Similarly, the strategic importance of having research conducted in the United States prompted the enactment of a research tax credit that, at the margin, has kept research in the country.

Fourth, Complexity Matters. A primary advantage of lowering taxes through a rate reduction is that such a system is much easier to construct and, hence, simpler for taxpayers to understand and follow. Simple is good, because complexity represents a daunting, hidden tax on American business. The Tax Foundation estimated that in 2005 it cost taxpayers more than $265 billion to comply with federal income tax laws, with business's share being a staggering 55 percent.

A simpler system will also be easier for the Internal Revenue Service to enforce. Currently, the IRS spends too much time trying to plug so-called loopholes, often creating unintended consequences and inviting mischief by financial professionals and other creative souls. By making low rates the cornerstone of the new, simpler system, Congress can make it easier for companies to comply and obviate onerous compliance measures that impede routine transactions and force businesses to absorb the heavy proxy tax of record-keeping.

For too long, corporate tax reform has been put aside as Congress and the Administration focused on other aspects of the tax system. It is time to embrace corporate tax reform and to do something about it to promote growth, create jobs, and reduce the trade and budget deficits. An important step forward will be acknowledging that these four things matter.

By Michael P. Boyle, TEI International President
COPYRIGHT 2006 Tax Executives Institute, Inc.
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Author:Boyle, Michael P.
Publication:Tax Executive
Date:May 1, 2006
Words:849
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