Tax reform is back on the front burner, providing a key opportunity to examine rising concern over international trade issues. A new White House advisory panel on tax reform has been tasked to make recommendations by Dec. 4.
To avoid having its recommendations largely ignored, as were those of similar panels in the past, this new panel should focus on solving a current and pressing economic concern. In our view, escalating protectionism - caused partly by a U.S. tax code that hurts the competitiveness of U.S. companies - should be the tax-reform panel's top concern.
In the current environment, protectionism is increasingly popular and threatens to turn the current recession into a depression, much as the protectionist Smoot-Hawley tariff law precipitated a trade war and the Great Depression in the 1930s. Our trading partners feel similar pressures as their economies shrink and populist sentiments within their borders gain traction.
In just the past year, U.S. exports are down 8 percent; imports are down 15 percent. This net decline in our trade deficit may have added a few tenths of a percent to our gross domestic product, but the real story is that lower trading activity means fewer trade-related jobs both here and abroad. Meanwhile, opinion polls show an alarming rise in the American public's support for protectionism.
The best way to address protectionist sentiments without erecting trade barriers is to fix the U.S. tax code so U.S. firms can export more American-made goods and services. Most of our competitors have territorial tax systems that tax only income earned within their borders. They also border-adjust those taxes so those taxes are refunded for exports sent out of the country and applied to imports.
In 2005, some form of border-adjusted taxes on manufactured goods and services was the policy of 137 nations, accounting for 94 percent of trade with the United States. By contrast, the United States has direct taxes, such as the corporate income tax, precluded from refunding under World Trade Organization rules.
The net effect is a significant disadvantage for American exporters and their workers, as the goods they produce and export are hit with taxes abroad, while foreign goods coming into the country are not. The additional embedded tax burden for U.S. exporting firms is at least $100 billion annually. As a result, American companies are less competitive in the global marketplace and American workers lose job opportunities.
Critics of border-adjustable taxes point out that direct taxes - including our corporate income tax - are not readily border-adjustable, and even if they were, WTO rules prohibit border adjustments of direct taxes.
These challenges suggest a two-front attack:
(1) The United States must aggressively engage the Europeans to repeal the distinction between direct and indirect taxes. This distinction is a charade established in the 1960s and is never challenged meaningfully.
Ernest S. Christian and Gary C. Hufbauer, former Treasury Department officials, have said: "In the absence of tax adjustments at the border, the economic burden of both corporate income tax and [value added tax] falls primarily on the labor and capital that produce goods and services. In this sense, both taxes are direct taxes." The result of this charade has been an effective unilateral surrender on the part of U.S. trade officials who are supposed to represent the American exporting sector.
(2) Congress should move our corporate tax code toward a consumption-based tax by allowing full and permanent expensing of capital investments. This reform would turn our corporate income tax into the economic equivalent of a border-adjustable consumption tax.
Finally, because the United States has a trade deficit, moving to a border-adjustable regime likely would be scored as raising revenue for the Treasury. These additional revenues could be used to reduce the U.S. corporate tax rate, which is the second-highest in the world and needs to come down.
The net result of these changes would be a simpler corporate-tax system that rewards companies for investing in plant, equipment and jobs in the United States.
According to recent press reports, the Obama administration plans to "toughen" its stance on trade. During his confirmation hearing, Ron Kirk, Mr. Obama's choice to head the Office of the United States Trade Representative said that "not all Americans are winning from [trade] and ... our trading partners are not always playing by the rules." Our trading partners actually are playing by the rules - the WTO rules - which are rigged against the American tax code and U.S.-made products.
The administration should indeed get tough - not by sneaking through anti-trade policies that invite retaliation - but by demanding that the WTO end the fictitious distinction between direct and indirect taxes. Also, the new White House tax-reform panel should develop a territorial, border-adjustable corporate tax just like our trading partners have.
A pro-trade, pro-American export-tax reform is the right way to encourage foreigners to "Buy American" while making U.S. companies more competitive both here and abroad.
Cesar Conda, formerly assistant for domestic policy to Vice President Dick Cheney, is an advisory board member of the International Economy magazine. Brian Reardon was special assistant for economic policy and a staff member of the National Economic Council under former President George W. Bush.