Center for Strategic Communication

When, Apple CEO Tim Cook appeared at a Senate committee hearing several weeks ago, he was nothing more than a high-profile example of how multinational companies are dodging taxes in America. Mr. Cook’s grilling, however, was merely a distraction from a bigger issue for Congress: fixing the corporate tax code.

Our nation’s tax policy poses a serious threat to American competitiveness. According to business leaders surveyed by the World Economic Forum, a nation’s corporate tax policy is among the “most problematic factors for doing business.” An additional OECD study revealed that “corporate taxes are found to be the most harmful for growth.”

With its global position in mind, it is imperative that the United States takes quick action to reform its tax code.

Apple CEO Tim Cook revived corporate tax discussions

Apple CEO Tim Cook revived corporate tax discussions

A recent study by the World Bank revealed just how high American business taxes are. The 35% statutory rate has long been among the highest in the world. Even including deductions, however, the effective tax rate on American companies is 27.6%, twelve percentage points above the average of all other OECD countries.

The tax code presents a complex problem for policymakers: myriad loopholes prevent the U.S. government from maximizing revenues and dampen domestic growth. The current “worldwide approach” taxes both income earned domestically and abroad (although it allows foreign tax credits to avoid double-taxation). However, corporations (not only Apple) are allowed to defer the tax on international earnings until the money is repatriated. Therefore companies, with shareholders in mind, keep their money abroad, preventing tax revenue and investment from returning to the United States. One study estimates, that American multinationals are holding more than $1.7 trillion in earnings abroad.

Other tax loopholes allow companies to transfer money and excess tax credits from high-tax countries to affiliate branches in low tax countries through “strategies” regulations and cross-crediting.

Such reform must begin, a move with bipartisan support.. The rate is substantially higher than in most other advanced countries, and puts American companies at a competitive disadvantage. Other sensible reform includes eliminating deferral, which would lead to increased repatriation and tax revenue.

But where do we go from there?

Some have called for a switching from a “worldwide” to a “territorial” tax system. A territorial approach only taxes domestic income, and is used in virtually all advanced economies other than the United States. By exempting foreign-earned income from taxation, this approach hopes to motivate firms to re-invest their earnings domestically. This could consequently lead to economic expansion and more job creation back in the United States.

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Sen. Carl Levin hopes to pass a tax reform bill before his retirement

Another advantage of the territorial approach is that it enables American firms to be more competitive in the global economy. Multinationals would no longer have to pay taxes on repatriated income. Their only tax burden, like companies from other “territorial” nations, would be in the countries in which they are operating. This would substantially level the playing field by allowing American companies to compete with a similar effective tax rate.

Senators John McCain (R-Arizona) and Carl Levin (D-Michigan) are hoping to craft a bill that may incorporate elements of a territorial tax system. With Levin set to retire in 2014, Congress hopes to achieve comprehensive corporate tax reform before then.

Despite its nearly universal use, however, uncertainty surrounding the territorial system may prevent its passage. Many economists feel the revenues abroad would not be reinvested in the United States. A 2005 tax repatriation holiday did not lead to further investment. Instead, funds returning home went to dividends and share repurchases. Such an approach could lead to further investment in tax havens. Moreover, a territorial tax system may have other adverse effects on the American economy such as lower realized wages.

Regardless, the discussion concerning the territorial tax system must continue. Mr. Cook’s appearance at the Senate made it clear that there is political advantage to making this a highly visible issue. If American competitiveness is to improve, then Congress must work together to construct a loophole-free, effective corporate tax code.