How to fix the corporate tax system

With Europe in disarray after Brexit, US lawmakers should fix the nation’s broken system for taxing foreign profits of US corporations.

In theory, foreign profits of US corporations are subject to a US tax of 35 percent. But in practice, these profits are not taxed at all by the United States — unless they are brought back to the states. Because of this rule, US multinationals have kept abroad over $2.5 trillion of their foreign profits.

This huge sum could be a growth engine for the American economy. The money could be used to build factories, modernize infrastructure, or pay dividends in the United States. Instead, it is deposited in bank accounts or invested in foreign countries.

We clearly need to reform this system, but responses in the past have not had much success.

Most Republicans argue for a territorial tax system in which foreign profits would be taxed only where they are earned. But this unfortunately won’t work. US multinationals have become very adept at shifting their earnings to tax havens, such as Bermuda, and other low-tax jurisdictions, such as Singapore.

Thus, if Congress adopted a true territorial system for taxing foreign profits of US multinationals, these companies could easily move more facilities and jobs out of the United States to low tax jurisdictions. Then they could use their foreign profits to distribute higher dividends without paying any US corporate taxes on these profits. In short, the adoption of a territorial tax system would be disastrous for our economy.

On the other hand, Congress should not simply keep the 35 percent rate on foreign profits of US corporations, while stopping them from deferring US taxes on these profits. That combination would prevent US multinationals from competing on a level playing field with their foreign counterparts. When the average corporate tax rate is 24 percent for the association of industrialized countries, the United States is left scrambling.

So what should be done?

In the short term, US corporations should be encouraged to repatriate past foreign profits by taxing them at a relatively low rate, such as 10 percent — if and only if a substantial portion was invested in federal or state infrastructure bonds. This condition would help implement a proposal put forth by Democratic presidential candidate Hillary Clinton. It would boost government spending on US infrastructure in order to promote economic growth and increase American employment.

US firms cannot compete with companies in other countries unless we reduce our corporate tax rate. With a more competitive rate, somewhere around 25 percent, we could eliminate the ability of US corporations to defer US taxes on their foreign profits.

However, we cannot afford to reduce the corporate tax rate without raising tax revenues from other sources. Without revenue neutrality, we would be just increasing our national debt.

There are several sensible proposals to limit existing preferences in the US tax code and generate substantial revenue. For example, to reduce the code’s bias for debt and against equity, Congress could allow large companies to deduct only 65 percent of the interest they pay on their bonds and loans. More broadly, Clinton’s proposal would cap various deductions that are utilized extensively by high income taxpayers. Such proposals could help achieve revenue neutrality while creating a more level playing field for the average family and small business.

Although politics may inevitably get in the way of comprehensive reform, both parties should agree that corporate tax reform is long overdue. They should find a way to reduce the US corporate tax rate and bring back foreign profits to the United States, while helping rebuild our infrastructure and create jobs — all without ballooning our national debt.

Editor’s note: This piece originally appeared in the Boston Globe.