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Policy Brief 11-2

Corporate Tax Reform for a New Century

by Gary Clyde Hufbauer, Peterson Institute for International Economics
and Woan Foong Wong, Peterson Institute for International Economics

April 2011

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The US budget outlook has the makings of a fiscal disaster, but it is the beginning of economic challenges, not the end. Among other challenges, a tax system that discourages business and erodes American competitiveness ranks high. The United States lags well behind other advanced countries, not to mention China, in reforming its corporate tax regime. Instead, over past decades, the United States has sought to make up through a high statutory tax rate, especially on multinational corporations (MNCs), what has been lost though a host of exemptions, deductions, and credits. The combination of a high corporate tax rate and its worldwide reach makes the United States—despite all its positive attributes—one of the least favored locations from the standpoint of business taxation. Unlike all other major economies, which limit corporate taxation to income earned within the national boundaries (territorial taxation), the United States hobbles its MNCs by taxing their worldwide income.

Hufbauer and Wong caution that solutions to the looming fiscal crisis could make a bad corporate tax system even worse. To forestall this outcome, they advocate four measures: (1) meaningful caps on the growth of entitlement spending (Medicare, Medicaid and Social Security); (2) a national consumption tax to narrow the federal budget deficit to around 2.2 percent of GDP and to arrest the rise of public debt at about 88 percent of GDP; (3) a deep cut in the statutory corporate tax rate to 20 percent or lower, coupled with the elimination of exemptions, deductions and credits so as to broaden the tax base; and (4) the explicit adoption of a territorial system for taxing business income.

The authors recognize that a national consumption tax is deeply unpopular with many Americans. However, the United States remains the only OECD country (and one of the very few countries in the world) that has not implemented a national consumption tax to fund its ambitious social programs and military commitments. Unless these programs and commitments can be downsized to a degree seldom seen in history, circumstances may compel the United States to choose between a competitive economy and a national consumption tax.


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