Three decades have passed since Washington last updated the U.S. tax code. Congress passed the Tax Reform Act of 1986 the same year “The Oprah Winfrey Show” debuted on television and the explosion of the Challenger space shuttle startled the nation. At the time, the average home price hovered around $89,000, incomes averaged $22,400 and a gallon of gas cost 89 cents.
That 1986 tax reform bill is widely hailed as a landmark achievement that lowered income tax rates for millions of Americans and cleaned up a tangled, outdated code. Washington needs to aim even higher this time, and there may not be another opportunity like the one they have right now.
Those reforms in 1986 made the existing tax code more efficient but failed to fix its fundamental flaws – namely, its dependence on personal income and its preference for imports.
The current U.S. tax system still penalizes American companies simply for being based here. We have the highest business tax rate in the developed world, and we apply it equally to foreign and domestic earnings.
At the same time, unlike most of our trading partners, we don’t tax imports, and we allow companies to deduct the cost of foreign purchases, creating a massive import subsidy that has undercut American businesses – and hurt their workers – for a generation.
Put simply, companies that make things in other countries and sell them here pay no corporate taxes in the U.S, but our government slaps a 35% tax bill on the overseas earnings of American companies that do business abroad. The imbalance applies to intellectual property, as well. That is not a level playing field for American businesses or their workers.
House Speaker Paul Ryan and Ways and Means Chairman Kevin Brady understand the problems with this system and, to their credit, authored a solution that would help fix this imbalance. Their blueprint would lower rates across the board and shift the burden from personal and corporate income to business transactions.
The House proposal also seeks to fix the existing imbalance between imports and exports through its border adjustment, taxing imports just like domestic consumption and ending the taxation of overseas earnings for companies based in the U.S.
The House blueprint would spur renewed investment in the U.S., creating 1.7 million new jobs and raising wages by nearly 8%, according to the nonpartisan Tax Foundation.
I have spent much of my career in other countries, from Japan to Uruguay, and the system that Ryan and Brady outline resembles those adopted by most of our foreign competitors. Their tax codes don’t punish domestic companies that do business abroad. Instead, these countries collect a greater share of their tax revenue from domestic transactions, whether the products were made locally or imported.
Since 2000, 10 of the most developed countries in the world have traded a tax system that looks like ours for one that depends more on domestic commerce than foreign income. In fact, the U.S. is one of just seven developed countries to cling to this outdated system.
Most American companies that do business abroad are familiar with these so-called “territorial” tax systems. A territorial system levels the playing field with other countries. It taxes companies in the jurisdiction where they earn the money and it is pro-growth, good for jobs and good for innovation. The current tax code discourages American companies from investing their foreign profits in the U.S. by taxing that money after another government took a chunk of the same sale.
The system is so broken that American companies often merge with foreign firms or allow themselves to be gobbled up entirely just to avoid excessive tax bills.
This preference for imports in the U.S. tax code is one of the least-examined factors driving American manufacturing and customer-service jobs to other countries. The disparity prompts companies to base their research-and-development operations in low-tax countries, such as Ireland, a rational decision under current incentives. Modernizing the tax code would remove the incentive for companies to move those jobs out of the U.S.
My company, S&P Global, does business all over the world. Most of our intellectual property is based here in the U.S., so we have to pay corporate tax in the U.S. on our foreign earnings. Ending the tax on exports would make it much easier for us to reinvest some of those earnings back in the U.S.
Admittedly, this is a major change, and major changes are always a little scary. But those fears don’t make this a bad idea. Americans have always embraced big, bold ideas that give them a better chance to compete.
The U.S. remains an outlier. Our system is old, antiquated and unfair. It is time for a change. The current system is holding our economy back at a time when we should be leading.
The clock is ticking to get this done. It is incumbent on all of us to seize this moment because we may not get the chance again for another 30 years.