26 Apr 2017

A Better Way to Tax U.S. Businesses


President Trump today outlined his plans for corporate and personal tax reform. HBS professor Mihir Desai has his own ideas, as first explained in a Harvard Business Review article published in the July/August 2012 issue and excerpted below:

Of all the policy changes that could improve the competitive position of the United States and the living standards of Americans, revamping the corporate tax code is perhaps the most obvious and least painful. High corporate taxes divert capital away from the U.S. corporate sector and toward noncorporate uses and other countries. They therefore limit investments that would raise the productivity of American workers and would increase real wages. This is the cruel logic of a corporate tax in a global economy—that its burden falls most heavily on workers.

What principles should guide a reform of the corporate tax that would advance American interests? First, the structure of the tax must reflect developments in the world economy—notably, declining tax rates in other nations, the mobility of innovative and headquarters activities, and the rising importance of non-U.S. markets. Second, corporate tax reform will probably need to be instituted separately from fundamental tax reform and must be roughly revenue-neutral, given fiscal and political realities. Third, any reform must relegitimize corporations as responsible citizens and the corporate tax as a meaningful policy instrument.

The proposal elaborated on in this article follows those three principles. It calls for a significant reduction in the corporate tax rate, a new tax policy toward innovation, and an end to taxes on active foreign income—changes that would give global corporations better incentives to locate and invest in the United States. It proposes a tax on the growing noncorporate business sector, to reduce distortions in firms’ business structures and bring in revenues that offset corporate rate reductions. It also recommends aligning the definition of taxable income with what corporations report to capital markets, which could help broaden the corporate tax base, further fund rate reductions, and restore the public’s trust in business.

These changes won’t be truly effective, however, unless managers change their behavior. The complexity of the current system and the proliferation of tax avoidance techniques have made the corporate tax optional for many global corporations. Tax has been transformed from a compliance function into a profit center that provides the pennies needed to reach earnings per share targets. More broadly, globalization has led countless corporations to view countries’ infrastructures as interchangeable, and national identities and responsibilities as passé. Rather than shirking their tax obligations, business leaders should treat them as seriously as their other social responsibilities.

Read the full article on Harvard Business Review

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