Existing US Tax Code Hurts American Firms

The United States has lost thousands of companies due to its anti-competitive tax system, says report
October 3, 2017 Updated: October 4, 2017

Due in part to the existing tax code, the United States has lost about 4,700 companies and $510 billion in business assets in the last 12 years, according to a study released by advisory firm Ernst & Young (EY) on Sept. 19. The country has the highest corporate income tax rate among developed nations and applies a worldwide tax system.

The United States adopted the lowest corporate tax rate among the world’s advanced nations in 1986, when President Ronald Reagan signed tax reform into law. Since then, however, many countries followed suit and slashed corporate taxes aggressively.

“Other countries saw our success and copied our playbook. Our foreign competitors adopted tax rates much lower and much more competitive than our own,” Trump said at the National Association of Manufacturers on Sept. 29.

According to the tax reform plan announced by the Trump administration on Sept 27, the top corporate tax rate will be cut from 35 percent to 20 percent. This is below the 22.5 percent average worldwide corporate tax rate. The 20 percent rate will restore the nation’s competitive edge and level the playing field for U.S. companies, according to Trump.

The outdated features of the current U.S. tax system present a fundamental challenge for American companies and put them at a disadvantage in the global mergers and acquisitions (M&A) market, according to the EY report.

The United States collects a high corporate income tax on all worldwide profits of multinational firms. This impedes American companies’ ability to outbid their foreign competitors in M&A deals.

E&Y examined the effects of various statutory corporate tax rates on 97,500 global cross-border M&A transactions across 68 countries between 2004 and 2016. American companies were the target in 31 percent and the acquirer in 16 percent of M&A transactions by value, according to the report. As a result, the United States had a net deficit of $510 billion in the global M&A market.

The report estimates that with a 20 percent corporate income tax rate, U.S. companies could have been a net acquirer, even under the current worldwide tax system that taxes foreign earnings when they are repatriated.

Instead of losing $510 billion in assets over the last 12 years, U.S. companies would have bought $1,205 billion in cross-border assets—a net shift of $1,715 billion from other countries to the United States—and the country would have kept 4,700 companies, concluded the report.

The adoption of a territorial system, in which profits earned abroad by American companies are not taxed in the United States, together with a lower tax rate, would likely further boost cross-border acquisitions by U.S. companies, stated the report.

M&A deals allow businesses to access new markets, new distribution channels, and new technologies. It also strengthens the contribution of an American company to the U.S. economy.

“As the typical U.S. multinational company expands its foreign operations, it is estimated that for every 100 jobs added abroad, an additional 124 jobs are created by the U.S. parent domestically,” stated the report.

The current tax code also hinders foreign direct investment (FDI) in the United States, which is a significant contributor to a country’s economy. EY estimates that inward FDI would have been 14 percent, or $195 billion, higher if the U.S. corporate tax rate had been 20 percent between 2004 and 2016.

“Corporate income tax rates affect not only the competitiveness of global U.S. companies, but also the ownership and management of global capital,” stated the report.

“If the significant disadvantages in the U.S. corporate income tax system persist, they could have long-lasting effects on U.S. productivity, wages, living standards, and economic growth.”

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