Tax Analysts Blog

Of Trends and Mega Trends

Posted on Jan 22, 2013

Many tax reform advocates point to the United Kingdom as a source of inspiration. We often hear that Congress should emulate our British cousins when it comes to taxing corporate income. This argument is worth exploring.

Several developments stand out when we scrutinize recent U.K. tax reforms: (1) the adoption of a territorial system; (2) CFC rules that don't offer much bite; (3) lack of interest allocation rules; (4) enactment of a patent box; and (5) a steadily declining statutory rate. By way of background, the previous U.K. corporate rate was 28%. It’s already been reduced to 24%, and is scheduled to drop to 21% by 2014. While those rates sound low, the patent box will reduce the rate to only 10% for qualifying income when it becomes effective later this year.

And the Brits are not alone. Declining corporate tax rates are a clear international trend. Scanning the headlines in Worldwide Tax Daily it seems most other governments are behaving similarly, except the United States. Our statutory rate remains stubbornly high at 35% — the highest in the world. We understand that statutory rates bear little resemblance to the effective rates firms actually pay. Nevertheless, we must ask why so many countries are willing to ease the corporate tax burden. What is driving this trend?

In the case of the British, the explanation is simple. Parliament panicked when a handful of British firms chose to relocate to low-tax countries. They feared an exodus might follow. The swift reaction was the series of pro-business reforms outlined above. Each measure was enacted for the sake of "global competitiveness.” In substance, these tax breaks aren't so different from indirect trade subsidies. Yes there was a revenue cost, but such is the nature of a subsidy.

I have nothing against a competitive tax environment that is conducive to economic growth and job creation. But if we are serious about identifying the dominant tax policy trend of our era, we need to take a step back and see the forest for the trees. There are trends, and then there are mega trends.

The mega trend of our age is not just exempting foreign profits or slashing corporate rates. It's bigger than that. The over-arching theme is diminished reliance on taxing capital income coupled with increased reliance on other, less mobile revenue sources. Usually that boils down to a broad-based consumption tax (although it could just as easily be a carbon tax). Everywhere one looks we see governments dialing down the corporate tax and ramping up VAT. These are not independent phenomenon; the latter finances (and thus enables) the former.

Sure, the U.K. went territorial. They simultaneously increased their VAT to 20% to make up the revenue loss. Yes, the Dutch have a wonderful participation exemption. They just raised their VAT to 21% to pay the bills. Japan now offers a lovely territorial regime. They just doubled their VAT to keep from going broke. And of course there's Ireland, the darling of tax planners across the globe with it's ultra-competitive 12.5% corporate tax rate (roughly one-third of the U.S. rate). The Irish VAT is 23%. At the end of the day, revenue needs to come from somewhere.

Currently more than 150 nations have a VAT. Every single one of them has a lower corporate rate than the United States. Coincidence? We think not. The point is worth mentioning because some proponents of tax reform are quick to lavish praise on territoriality, patent boxes, and rate reductions without mentioning the equally compelling need for an alternate revenue source. No fair cherry-picking ones' global trends.

Finally, no analysis of these issues would be complete without mentioning that VAT is regressive. So while it's possible for budget committees to substitute a dollar of VAT revenue for a dollar of revenue from taxing corporate income, we must note that entirely different groups of people bear the economic burden of these taxes. But that's another kettle of fish.

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