x Abu Dhabi, UAEWednesday 26 July 2017

US politicians at odds over globalisation's effect on corporate taxes

Globalisation is creating two misleading impressions about corporate taxes in the United States.

Globalisation is creating two misleading impressions about corporate taxes in the United States.

First, corporate-tax revenue is keeping up with recent historical averages as a share of GDP. However, that's only because globalisation has raised the corporate-profit share of GDP, while reducing the share of labour compensation.

Second, both Democrats and Republicans in Congress are committed to corporate-tax reform in response to globalisation. Yet they are unlikely to accomplish much, because each party's desired reforms are nearly the opposite of the other's.

Consider the state of corporate taxes. In the final quarter of fiscal year 2012, corporate income taxes amounted to 1.7 per cent of GDP — exactly their quarterly average over the past three decades. A closer look, though, reveals that this pattern reflects two contrasting trends.

The effective tax rate — the share of corporate profits actually paid in taxes — averaged 19 per cent over the past three decades. That is much lower than the top corporate statutory rate, currently 35 per cent, because of various deductions and exclusions.

Over the past few years, this effective tax rate has plummeted. In the final quarter of fiscal year 2012, it was only 13 per cent. That's not necessarily a problem if it is temporary.

Yet there is a more permanent reason for the decline that has to do with globalisation: an increasing share of profits is now earned abroad and taxed more lightly than domestic profits, as Edward Kleinbard of the University of Southern California has underscored. Relative to domestic profits, foreign profits have been rising for several decades, and that trend is likely to continue.

Globalisation is thus reducing the effective corporate-tax rate as the share of profits earned abroad increases. At the same time, however, by raising the corporate-profit share, it is also increasing corporate-tax revenue as a percentage of GDP.

Over the past three decades, profits averaged 9 per cent of gross domestic income. In the final quarter of fiscal year 2012, though, they amounted to 12 per cent. That increase amounts to an extra US$450 billion (Dh1.65 trillion) a year.

Globalisation is also the main reason why corporate-tax reform is harder than most people think. Under the current complicated system, as a recent congressional budget office (CBO) report explains, US multinationals are partially taxed on the profits they earn abroad.

Republicans and the Business Roundtable, an association of chief executives of leading US companies, generally favour moving away from this system and towards a territorial one, in which companies would be taxed only on the profits they earn within the US.

The Obama administration, in contrast, is concerned about companies shifting profits and jobs overseas, an activity that a territorial system would encourage.

As the CBO report highlights, other countries with so-called territorial systems typically have anti-abuse provisions to keep companies from shifting profits to tax havens.

Globalisation is putting increasing pressure on the corporate-tax system. But with diametrically opposed visions on how to adapt the system, the likelihood that reform will happen is very small.

Peter Orszag is a vice chairman of corporate and investment banking at Citigroup and a former director of the office of management and budget in the Obama administration

* Bloomberg News