The Patriot Post® · U.S. Lagging Behind in the Race on Tax Policy

The Tax Foundation released its International Tax Competitive Index this week. The index rates 34 members of the Organisation for Economic Co-operation and Development (OECD) on the degree to which they promote free market economies through tax policies. Unfortunately, the U.S. made a poor showing, ranking 32 out of 34 nations, just above Portugal and France. Even our tax policy leads from behind.

The index measures “the extent to which a country’s tax system adheres to two important principles of tax policy: competitiveness and neutrality.” Competitiveness is defined as limiting the taxation of businesses and investment. Neutrality refers to “a tax code that seeks to raise the most revenue with the fewest economic distortions. This means that it doesn’t favor consumption over saving, as happens with capital gains and dividends taxes, estate taxes, and high progressive income taxes. This also means no targeted tax breaks for businesses for specific business activities.”

To business, profits are simply revenue minus costs, but government and business rarely agree, even on simple terms. Companies in most countries aren’t allowed to deduct the entire cost of doing business, and thus taxable income is artificially pumped up. And because the after-tax rate of return is unnaturally reduced, the incentive for either managers or investors to invest also decreases.

The Tax Foundation believes, “A neutral tax code would define business income the way that businesses see it: revenue minus costs.”

Researchers looked at three factors affecting corporate taxes – the corporate marginal tax rate, the cost recovery system and tax code complexity.

Cost recovery involves how quickly a business can deduct capital investments from its taxes, a crucial factor for a pro-growth tax code. Currently, depreciation differs for different office supplies and equipment. In an ideal world, the business could deduct the cost of all such capital costs in that same year. As reasonable as that sounds, it’s more realistic to look at other changes, for example, shortening depreciation periods.

The U.S. has the world’s highest corporate tax rate, which must eventually be reduced by a significant amount if we wish to remain competitive. But, as with the other “features” of our tax system, we can begin more modestly and still achieve significant improvement. “We don’t need to get into the top ten” near Estonia, New Zealand and Switzerland, argues Forbes’ Ryan Ellis. “We just need to get into the high teens or early twenties, and we’ll be in very good shape.” Hungary (18), Mexico (19), Germany (20) and the UK (21) are all major competitors of ours. By at least aiming there, we could begin rebuilding our edge.

One reform that would improve the code greatly is to reduce the tax rate on international business from its current 40% (including state taxes) to 25%, the average of developed nations. Because states tax this income too, the federal tax should actually drop to about 20% or less. Even Barack Obama admitted the corporate rate has to come down, though his goal is ultimately to raise taxes through eliminating some deductions.

Another idea is to change from a worldwide system of taxation – in which U.S. companies pay taxes overseas on their profits and then a second time to the IRS – to a territorial system. In this case companies taxed overseas are exempt from further taxation at home. That might not fly with money-hungry Beltway politicos, but even reducing the current taxation level companies face in the U.S. would be a good second-best.

Ironically, former Soviet slave state Estonia currently has the most competitive tax code in the OECD. Four features make it the best: First, a 21% tax on corporate income applied only to distributed profits; second, a flat 21% tax on individual income and no tax on personal dividend income; third, its property tax applies only to the value of land; and last, its territorial tax system exempts virtually 100% of foreign profit earned by domestic corporations from domestic taxation.

Those who’ve escaped slavery know true freedom, and we would do well to follow their example. Given the anemic Obama “recovery,” hindered by his own Socialist policies, a move toward more free market tax policy would be welcome.