Imagine two companies that sell the same product across the globe and directly compete against one another. Further imagine that both companies earn the same gross profit. However, the first company is located on the U.S. side of the U.S.-Canadian border; the second company is located on the Canadian side. Thanks to the corporate tax system in the U.S., this is all the advantage the Canadian company requires.
The average federal and state tax rate on U.S. corporations is around 40 percent – and those taxes are paid on income not just earned in the U.S., but also on income earned in any country across the globe. In Canada, the comparable tax rate is around 26 percent.[i] Additionally, Canada, like the rest of the OECD countries, only imposes its corporate tax rate on income earned in Canada (a territorial tax system).
The consequences are not immaterial. Even if both companies are currently earning the same gross profit, the U.S. company will likely face a much higher tax burden on its earned income. The U.S. company’s after-tax profits will be, consequently, smaller than the Canadian company’s after-tax profits.
This tax advantage improves the competitive position of the Canadian company vis-à-vis its American competitor. The Canadian company could use this advantage to provide its shareholders with a higher dividend than its American counterpart. Perhaps the company will create a more efficient production process by investing in its workers or by investing in new and better equipment. Or, perhaps the company will lower its prices in an attempt to take market share away from its U.S. competitor.
Regardless of which action the Canadian competitor takes, the U.S. tax system has created a competitive advantage for the Canadian company. This scenario is very real for far too many U.S. companies. Whether the competitors are from Canada, Ireland, or South Korea, the U.S. corporate tax system is making it more difficult for U.S. companies to compete against their international rivals.
These disadvantages are exemplified by the merger of Burger King and Tim Hortons, which included locating the headquarters for the combined company in Canada, in part, to lower the new company’s tax burden. The consequences from these adverse tax incentives are less job growth in the U.S., slower U.S. income growth, and a less vibrant U.S. economy.
Removing the pall of this competitive disadvantage should be a top priority for U.S. policymakers. Toward this end, Representative Devin Nunes (R-CA) has proposed The American Business Competitiveness Act (ABC Act).
The ABC Act simplifies the current complex federal corporate income tax system. Under the ABC Act, investments would be 100 percent written off in the year in which they are made, significantly improving the incentive for firms to invest in new equipment. The ABC Act also reduces the current top income tax rate from 35 percent on taxable income over $18.3 million to a flat 25 percent tax rate.
The U.S. is also the only major economy that taxes global profits of domestic companies – all other major countries only apply the corporate income tax to profits earned domestically. The ABC Act rectifies this disadvantage as well.
These changes make the U.S. corporate income tax rate significantly more competitive as compared to the tax system in the other major OECD economies.
As is true for most political compromises, the ABC Act is not ideal; including provisions such as the 5 percent transition tax on un-patriated foreign earnings and the elimination of the interest deduction. However, the net result from the ABC Act would be a significant improvement in the incentives for U.S. based corporations to grow and expand.
According to an analysis by the Tax Foundation, if the ABC Act were implemented, 1.2 million jobs would be created, the U.S. economy would be 6.8 percent larger, wages would be 5.7 percent higher, and total investment would be 20 percent larger.[ii]
It makes no sense for the U.S. government to implement policies that creates an automatic advantage for international companies over U.S.-based companies. Corporate tax reform that lowers the corporate tax rate and transitions the U.S. to a territory-based tax system is necessary in order to eliminate the self-imposed competitive disadvantages that currently burden U.S. companies compared to their international competitors.
The ABC Act, if passed, would have a transformative impact on our economy. The Act implements sensible reforms that eliminates our self-imposed growth obstacles and incents greater economic investment and growth in the U.S.