- The Washington Times - Friday, July 26, 2002

It is hard to feel sorry for corporations, but not all of their wounds are self-inflicted. The Internal Revenue Code, for instance, makes it very difficult for American-based companies to compete in the global marketplace. The U.S. corporate income tax rate is the fourth-highest in the developed world, and it will soon be the second-highest if Belgium and Italy implement planned tax rate reductions.

But the punitive corporate tax rate is just part of the problem.

The IRS also taxes U.S. companies on income they earn in other nations. This "worldwide" tax system makes American firms much less competitive, particularly since most nations rely on "territorial" taxation the common-sense notion of taxing only income earned inside national borders.

Consider, for instance, what happens when a U.S. firm competes against a Dutch firm for business in Ireland. If the Dutch firm earns money in Ireland, it pays only the Irish corporate tax of 10 percent-16 percent (the Irish corporate tax rate will be a uniform 12½ percent beginning next year). But a U.S.-based company must pay both the Irish tax and the 35 percent U.S. corporate income tax on any Irish income. This double taxation can be reduced, at least partially, by the use of foreign tax credits. But even in a best-case scenario, the U.S. company has a tax burden about 3 times as high as the Dutch company.

The Netherlands' territorial system creates a big advantage for Dutch companies.

Worldwide taxation, by contrast, is a millstone around the neck of U.S. companies. Indeed, the desire to escape the IRS' global tax reach is the primary reason some American companies have decided to recharter in low-tax jurisdictions like Bermuda and the Cayman Islands (a process sometimes referred to as inversion). Simply stated, they want to compete on a level playing field with their foreign competitors.

This is why the legislation recently proposed by Bill Thomas, California Republican and chairman of the House tax-writing committee, is a significant step in the right direction. Unlike the anti-inversion bill proposed by Sens. Max Baucus, Montana Democrat, and Charles Grassley, Iowa Republican popularly know as the "Dred Scott Tax Bill" since it assumes corporations belong to the IRS and are not allowed to escape bad tax law Mr. Thomas actually reduces some of the problems in the tax code.

The Thomas legislation, for instance, reduces the burden of worldwide tax by making it easier for companies to defer the tax until foreign-earned income is sent back to the United States. Another important provision allows companies to better protect themselves against double-taxation by reforming so-called interest expense allocation rules. The Thomas proposal also improves foreign tax credit rules so it will be easier for companies to avoid double-taxation.

These provisions as well as many others are designed to help American companies compete. And while the Thomas legislation does not reduce the corporate tax rate, it does take a small but important step toward territorial taxation. This is good news for workers, shareholders, and consumers.

Now for the bad news. The Thomas bill may be good, but it has some warts.

The proposal levies a tax increase on foreign companies that create jobs in America and invest in the U.S. economy. This hardly seems like a wise step, particularly at a time when the United States should be trying to attract overseas capital to boost weak financial markets. It also is making it hard for Mr. Thomas to round up votes since foreign companies are major employers in many congressional districts.

Another problem is that Mr. Thomas has included in the bill a three-year moratorium on corporate inversions. While far less offensive than the Senate proposal, any restriction on taxpayer mobility is bad news because it undermines the liberalizing process of tax competition. The rivalry between states is powerful evidence that governments are more likely to be fiscally responsible when they know taxpayers can flee to jurisdictions with better laws. The same fiscal discipline should exist at the international level.

Indeed, one of the reasons the corporate tax code is so bad is that politicians mistakenly thought companies were geese with a never-ending supply of golden eggs. Now that some of the geese are flying away, some lawmakers want to blame the victim. Mr. Thomas presumably understands that an inversion moratorium is bad policy, but he must think the provision is politically needed. But expediency is never a good reason for misguided tax law. The legislation would be much stronger if the inversion moratorium disappeared.

The Thomas proposal is the first step on the road to much-needed reform of our international tax rules particularly if the chairman is able to address the two problems discussed above. The legislation will help U.S. companies compete in the global economy, and the initiative complies with international trade commitments. Supporters of tax reform and tax competition should seize this opportunity.

Daniel J. Mitchell is the McKenna senior fellow in political economy at the Heritage Foundation.

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