How to tax the income of multinational corporations was an unlikely headline topic at the recent G-8 summit in Ireland. It will be a key agenda item at the upcoming G-20 summit in Russia as well.
Given these companies' significance to national and global economic performance, world leaders' focus on the arcane intricacies of corporate taxation is easy to understand -- perhaps nowhere more so than in the United States.
As the U.S. embarks on the difficult path of corporate tax reform, it should heed the United Kingdom's example. Even as it champions multilateral cooperation to ensure that multinationals pay their "fair" share, the British government has slashed its corporate rate, exempted the active foreign income of British multinational corporations from the national corporate tax, and enacted a "patent box" that stipulates a 10 percent tax rate on qualified patent income.
As a result of years of cuts in corporate tax rates by other countries, the U.S. now has the highest rate among the advanced economies. Reducing the top U.S. federal rate, currently at 35 percent, to a more competitive level -- the Organization for Economic Cooperation and Development average is around 25 percent -- would encourage investment and job creation in the U.S. by both domestic and foreign multinational corporations.
Paying for a rate cut by eliminating various corporate credits and deductions would simplify the code and trim the cost of compliance. It would also enhance efficiency by curbing tax-based distortions in companies' investment decisions (what and where) and their choices concerning how to finance investments and which organizational forms to adopt.
In addition to reducing its corporate tax rate, the U.S. needs to reform the way it taxes its multinational corporations' foreign earnings. All other G-8 countries (and most OECD countries) boost their multinationals' competitiveness by taxing only their domestic income, exempting most of their foreign earnings from domestic taxation (an approach known as a territorial system). The U.S., by contrast, taxes its multinational corporations' worldwide income, with taxes paid elsewhere credited against their U.S. tax liability to avoid double taxation.
As part of corporate tax reform that includes a revenue-neutral rate cut, Congress is currently considering a hybrid territorial reform and evaluating several measures to counter tax-base erosion and income shifting, including those used by other advanced countries.
The U.S. last reformed its business tax code in 1986, when it had one of the lowest corporate tax rates in the world and the competitive dynamics of the global economy were very different. It is time for another comprehensive corporate tax reform, one that reduces the tax rate, broadens the tax base and adopts a hybrid territorial approach with effective base-erosion safeguards.
Laura Tyson is a professor at the Haas School of Business at the University of California, Berkeley. She is currently serving as an outside economic adviser to the Alliance for Competitive Taxation, a coalition of 42 American companies.