Lessons from the EU: Slash the US corporate tax

The United States has the third-highest corporate profit tax in the world. If the average state tax is added to the federal tax of 35 percent, the U.S. corporate profit tax rate is actually 39 percent. The revenues from corporate taxes in the United States are steadily 2.5 percent of GDP.

In the 28 countries of the European Union, the revenues from corporate profit taxes are also 2.5 percent of GDP, but the European average profit tax rate is only 22.5 percent of corporate profits. Revenues from corporate profit taxes have always been small.

{mosads}In 1981, European profit tax rates, at 48 percent, were almost as high as in the United States (50 percent). Since then, European corporate taxes have fallen like stones, while their revenues have risen from an average of 2 percent of GDP to the current 2.5 percent of GDP. Most of all tax revenues have surged where corporate tax rates are particularly low — Malta, Cyprus, and Luxembourg, where they range from 4.5-6.7 percent of GDP.

Evidently, companies move to European countries with low taxes. These revenues fluctuate somewhat with the business cycle. Their absolute peak of 3.5 percent of GDP came in the boom year of 2007.

The reason for the sharp declines in average European corporate profit taxes, from 48 percent in 1981 to 22.5 percent at present, is an invigorating tax competition, which has been driven by the new East European members. In 1981, the highest EU profit tax rate was 61.5 percent (Finland) and the lowest was 33 percent (Spain). Today, the highest European corporate tax rates are 33 percent (France and Belgium), while Bulgaria has the lowest corporate tax rate of 10 percent.

As in so many other cases, the reformers in Eastern Europe have shown the way. They have cut their standard tax rate for corporate profits to 10-22 percent, while abolishing almost all loopholes, thus simplifying taxation. These governments have repeatedly lowered corporate tax rates to attract foreign and domestic investment.

They argue that poorer countries with worse infrastructure and institutions need to have lower taxes to be able to compete. The irony is that they did not lose revenues that the international financial institutions warned them of. In 2000, the successful conservative Estonian government drew the ultimate conclusion and abolished corporate profit taxes as harmful to enterprise, keeping it only for dividends.

One and two decades ago, French and German leaders regularly accused East European countries of “tax dumping,” another term for lowering one’s tax to lure business. Now, these laggards have joined the race. One of French President Emmanuel Macron’s key promises is to cut the corporate profit tax sharply. Countries with traditionally high taxes, such as Sweden and Denmark, have slashed their profit tax rates to 22 percent.

Not only do lower corporate profit tax rates yield slightly higher revenues, it is probably far more important that lower tax rates can eliminate many bureaucratic costs and distortions. Former U.S. Treasury Secretary Paul O’Neill (2001 to 2002) used to argue that the corporate profit taxes cost companies about as much in preparation and planning as the state received, rendering it completely inefficient.

The U.S. has the most complex and costly corporate tax system in the world. The only reason for this state of affairs is due to an inability to adopt legislation that all other advanced countries have promulgated.

Needless to say, the United States also offers far more loopholes than any other country. Famous large U.S. companies get away without paying any profit taxes, while small firms are encumbered, making the corporate tax capricious, arbitrary and counterproductive.

There does not appear to be any agreement among analysts on the actual size of the average effective tax rate, but it is low and revenues equal those in the European Union. It is difficult to imagine a worse tax system short of sheer arbitrariness.

Some tax cuts have been radical while others have been gradual, but it does not matter much. The East Europeans tended to carry out the most radical cuts, whose great advantage is that they facilitate the abolition of loopholes and simplify tax administration.

The United States is a complete outlier among developed countries, insisting on a nominal corporate profit tax rate that is nearly twice the EU average, while collecting about as large a share of GDP in such revenues. Therefore, the United States does not need to introduce any other tax, such as the much-maligned border adjustment tax, in order to finance this vital tax reform.

Rather than pursue dubious simulations, the Congressional Budget Office should study the experiences of other developed countries that have slashed their corporate taxes. The simple conclusion is that it makes no sense to have a high corporate profit tax. It is high time for the United States to become as rational as Europe about corporate profit taxes.

Anders Åslund is a senior fellow at the Atlantic Council, where he specializes in economic policy of Eastern European nations. He is the co-author, with Simeon Djankov, of “Europe’s Growth Challenge” (OUP 2017).

The views expressed by contributors are their own and not the views of The Hill.