Corporate Taxes

Joining the race to the bottom

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President Donald Trump went to the motorsport capital of the US, Indianapolis, to join the race to cut corporate taxes. Source: Reuters.

US President Donald Trump wants to give a whole new meaning to leading from behind with his plans to cut the corporate tax rate in the United States from the highest among industrial countries to one of the lowest. In doing so, he inflames an already heated competition with developed economies in Europe and elsewhere that are engaged in a mercantilist effort to beggar their neighbors with ever-lower taxes on companies.

Eight industrial countries cut their corporate tax rate last year by an average 2.7 percentage points, the Organization for Economic Cooperation and Development (OECD) reported last month in its annual survey of tax policy. “An increase in corporate tax rate competition,” OECD secretary general José Angel Gurría wrote in introducing the report, “raises challenging questions for governments seeking to strike the right balance between maintaining a competitive tax system and ensuring they continue to raise the revenues necessary to fund vital public services, social programs and infrastructure.”

This is precisely the dilemma the new German government will face once Chancellor Angela Merkel cobbles together a common platform between her Christian Democrats and their likely partners, the Free Democrats (FDP) and the Greens. In particular, the business-friendly FDP wants to cut taxes on individual and corporate incomes alike and has laid claim to the post of finance minister in order to carry out that campaign pledge.

“Germany will not be able to escape from it. We will have to go down in our tax rates.”

Clemens Fuest, president, Ifo Institute for Economic Research

“Germany will not be able to escape from it,” Clemens Fuest, head of the influential Ifo economic research institute, warned last week. “We will have to go down in our tax rates.”

The tax reform proposed by the Trump administration, one of the most ambitious in years, foresees among other things a cut in the nominal corporate tax rate from 35 percent now to just 20 percent. US Treasury Secretary Steven Mnuchin said as he presented the plan that this rate is not negotiable. Mr. Trump originally wanted the rate to go down to 15 percent. Germany’s current corporate tax rate is 29.8 percent, significantly lower than the current US rate but much higher than the new rate.

“When the US gets active, the suction effect on investments is much greater,” Mr. Fuest said in his remarks to the German daily Die Welt. Even though Britain, France and Sweden all have plans to cut corporate taxes, it is the US move that tips the scale. He suggested Germany lower its corporate rate to 25 percent.

Marcel Fratzscher, head of the DIW research group, echoed these remarks. “The tax reform will expose German exporters in particular to greater competitive pressure,” he told Die Welt, “as it will improve the competitiveness of US companies.”

Just how strong this mercantilist trend is amidst the cutthroat competition between countries for jobs and investment emerged this week as the European commissioner for competition, Margrethe Vestager, ordered Luxembourg to collect another €250 million in taxes from Amazon, which she said had paid too little. Ms. Vestager also said she was going to take Ireland before the European Court of Justice for failure to claw back €13 billion in illegal subsidies granted to Apple as she ordered last year.

In making the announcements, Ms. Vestager urged the European Union to agree on a common measure for corporate taxation in order to avoid this kind of tax avoidance. A proposal from the commission along these lines has met, not surprisingly, with strong resistance from Luxembourg and Ireland, as well as the Netherlands.

These countries are fueling “a dangerous tax race to the bottom with their special conditions,” said Sven Giegold, financial policy expert for the Greens in the European Parliament. “Amazon and Apple aren’t isolated cases, we have a systematic problem with tax avoidance.” Coming at it from a different direction, the Greens may be just as difficult a coalition partner for Ms. Merkel as the FDP with regard to corporate taxation.

Mr. Trump’s tax proposal is controversial and there is no guarantee it will actually be passed by the US Congress in its current form. However, the focus of the debate in the United States is on reductions in the personal income tax, because the proposed cuts favor the wealthy disproportionately and will exacerbate the already serious trend toward income inequality.

As a result, even the sophisticated analysts at the Brookings Institution tend to lump “tax breaks for wealthy Americans and for corporations” together as if they were the same thing – undeserved windfalls for plutocrats. “This tax reform plan is a petri dish for increasing inequality,” Brookings research fellow Camille Busette wrote in an analysis this week. She cited figures that the cuts in personal income tax would lower the rate for the bottom 99 percent of taxpayers by only 0.4 to 1.7 percentage points while reducing the burden on the top 1 percent by 5.7 points.

However, this has nothing to do with the corporate tax rate, which both Republicans and Democrats have agreed for years is in urgent need of reform. Touting his skill as a negotiator, Mr. Trump boasted during the presidential campaign last year that he would get leaders from the two parties together in a room for half an hour and hammer out a reduction in corporate taxes. In the meantime, of course, Mr. Trump has learned the hard way that’s not how things go in Washington.

But it remains a key part of Mr. Trump’s effort to bring jobs back to the United States. The latest tax reform proposal also includes a one-time amnesty rate for repatriating the $2 trillion-plus in profits US firms are holding abroad because of the high corporate tax rate at home.

In any case, the headline corporate tax rate is misleading. While the nominal rate in the United States may be 39 percent when state and local taxes are added in, the actual rate paid by companies after taking advantage of numerous loopholes is only 18.6 percent, according to calculations by the US Congressional Budget Office. Germany’s effective corporate tax rate, the agency says, is only 15.5 percent. By eliminating the loopholes in favor a lower nominal rate, the US plan would level the playing field for companies and perhaps even increase actual tax revenue.

Darrell Delamaide is a writer and editor for Handelsblatt Global based in Washington, DC. To contact the author: d.delamaide@extern.handelsblatt.com.

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