Fixing America's Corporate Tax System

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Fixing America

As we've pointed out in previous issues, the U.S. economy has been transitioning from the Installation Phase of the Digital Revolution into its Deployment Phase. This transition is anything but smooth because the institutions that supported the Mass Production era have to be transformed to make way for the 21st century Digital Revolution.

Research by Michael Porter, co-chair of Harvard Business School's U.S. Competitiveness Project, revealed that one of the institutions undermining American competitiveness is the nation's tax system. The survey is based on responses by thousands of Harvard Business School alumni who were asked to compare the competitiveness of the U.S. economy to those of other countries. It concluded that the tax code is America's greatest economic weakness.

That's not surprising, because the U.S. corporate tax rate, at 35 percent, is one of the highest in the world. According to the Tax Foundation, the U.S. tax code is rated 32nd out of 34 advanced economies in terms of business friendliness. According to the World Economic Forum's recently released Global Competitiveness Report 2014-2015, the issue most frequently cited as a barrier to U.S. competitiveness is the country's tax rate.1 On this measure, the U.S. ranks 102nd among the world's economies.

The problem isn't just the high tax rate; an even greater problem is that tax policy gives U.S. corporations powerful incentives to keep their profits overseas instead of investing that money in the U.S. That's because the U.S. uses a system known as "worldwide taxation," while all but a few of the world's other countries use "territorial taxation."

Here's the difference:

  • Under the "territorial" tax system, any company doing business in a country pays taxes to that country, regardless of where they are headquartered. If a U.S. company makes profits in France, it pays taxes to France. The U.S. also uses this system to collect taxes from foreign companies that do business in America.
  • Under the "worldwide" tax system, a U.S. company that makes profits overseas must pay taxes to the U.S. So an American company that makes profits in France has to pay taxes to the U.S., as well as to France, when it "repatriates" the money by bringing it to the U.S. The company receives a credit for the amount of tax it paid to France and pays the difference to the U...

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