Corporate Tax Reform and International Competitiveness

Many observers in Switzerland and the United States place their hopes for their country’s increased global competitiveness in corporate tax reform. Swiss voters rejected a reform proposal in early 2017; the U.S. Congress passed the Tax Cuts and Jobs Act in December of the same year.

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A Tale of Two Countries: How will corporate tax reform affect the United States and Switzerland?  

By Karina Rollins

While Switzerland and the United States regularly rank as the world’s most competitive economies, economists and politicians know that is no reason to take the eye off the ball. In an ever-globalizing world with ever-shifting goal posts, constant efforts are required to stay ahead of the curve. One of those efforts is tax reform.

United States

Can a tax cut help corporations become more internationally competitive? High corporate taxes have famously been hampering American companies when competing around the world. Before the Tax Cuts and Jobs Act passed in December 2017,

Canada, which lowered its corporate-income taxes from 43 percent to 27 percent in 2000, achieved a much more competitive tax structure. Canada also broadened the corporate tax base, and eliminated a capital tax on nonfinancial companies as well as most sales taxes on capital purchases. As the Tax Foundation states, the “reform led to more investment and better growth in both GDP and national income without a significant loss in corporate income tax revenue as businesses found it more attractive to keep profits in Canada.”

Changes to business taxes under the 2017 Tax Cuts and Jobs Act:

  • Moves the United States from a worldwide to a territorial system of business taxation. (Why does this matter? Many analysts argue that The U.S. Tax System Unfairly Burdens U.S. Business.”)
  • Lowers the corporate-income tax rate from 39.1 percent to 21 percent.
  • Establishes a 20 percent deduction of qualified business income from certain pass-through businesses.
  • Allows full and immediate expensing of short-lived capital investments for five years. Increases the section 179 expensing cap from $500,000 to $1 million.
  • Limits the deductibility of net interest expense to 30 percent of earnings before interest, taxes, depreciation, and amortization (EBITDA) for four years, and 30 percent of earnings before interest and taxes (EBIT) thereafter.
  • Eliminates net operating loss carrybacks and limits carryforwards to 80 percent of taxable income.
  • Eliminates the domestic-production-activities deduction (section 199) and modifies other provisions, such as the orphan drug credit and the rehabilitation credit.
  • Enacts “deemed repatriation” (under which foreign profits are deemed to have been brought to the U.S., and are taxed immediately) of currently deferred foreign profits, at a rate of 15.5 percent for cash and cash-equivalent profits and 8 percent for reinvested foreign earnings.

As the Tax Foundation states, the Tax Cuts and Jobs Act “represents a dramatic overhaul of the U.S. tax code.” The results of the foundation’s modeling “indicate that the plan would be pro-growth, boosting long-run GDP 1.7 percent and increasing the domestic capital stock by 4.8 percent. Wages, long stagnant, would increase 1.5 percent while the reform would produce 339,000 jobs.” Should the Tax Foundation’s model turn out to be accurate, it seems that this tax reform would indeed boost America’s international competitiveness.

Romina Boccia (YL 2016) of The Heritage Foundation co-authored an article on how the Tax Cuts and Jobs act will “revitalize the U.S. economy.” Matt Welch (YL 2011) of Reason magazine, maintains that the Republican tax legislation “is almost certain to generate even more debt.” Dan Mitchell (YL 2003), formerly of the Cato Institute, argues that lower corporate taxes boost wages and increase competitiveness. Patrick Gleason (YL 2015) and Grover Norquist (YL 1993) of Americans for Tax Reform lament that, while the tax reform ended double taxation of U.S. companies’ overseas profits, “one of the biggest missed opportunities in the new law is that it fails to stop double taxing” of Americans living abroad.

At the 2018 World Economic Forum, the consensus among business executives was that, due to the new tax cuts, “foreign businesses want to pump money into the United States again.” As Bank of America CEO Brian Moynihan put it at Davos: “Think about large global companies: They can go anywhere. They think the U.S. is the place to talk about investing in the next 12 to 18 months.”

Just a month after passage of the new tax law, at least 287 companies had raised salaries, issued bonuses, and increased 401(k) matching contributions—benefitting around 3 million American workers—which these companies attributed to the tax reform. Americans for Tax Reform maintains a running tally in its “List of Tax Reform Good News.”

As a result of the changes to U.S. tax policy, the International Monetary Fund (IMF) expects the U.S. economy to grow by 2.7 percent in 2018—representing a revision from the IMF’s earlier prediction of 2.3 percent. In 2019, the IMF expects growth to slow down to 2.5 percent—a significant revision of the previous prediction of 1.9 percent. The IMF does maintain that, starting in 2022, expiring tax provisions and larger fiscal deficits will slow down growth even more. Time will reveal the accuracy of the forecasts.

The Effect of Federal Tax Reform on State Tax Codes and Budgets. All states align their tax codes to some degree to the federal tax code, so the federal reform will affect individual state revenues and budgets. Since the base-broadening provisions of the federal tax law often flow through to the states, while the corresponding rate reductions do not, many states can expect an increase in state tax revenue without taking any action at all. The Tax Foundation argues that “[s]tates anticipating additional revenue should view this as an opportunity to make their tax codes more competitive.”

Switzerland

In early 2017, Swiss voters rejected their government’s plan for corporate tax reform, a decision many observers believe may damage Switzerland’s appeal as a location for multinational companies.The majority of Swiss voters felt that the reform proposals—eliminating specially tailored tax breaks for multinationals in exchange for tax cuts for all multinationals’ income from patents and for R&D—would benefit companies at the expense of ordinary taxpayers.

The basis of the reform proposal was, in the face of international pressure, to fall in line with OECD rules on competition and taxation. Multinational companies are vital to the Swiss economy:Around 6,500 such companies—including Google, Unilever, IBM, and Medtronic —have operations in Switzerland, paying around $5 billion a year in taxes, and employing 150,000 people. These companies account for half of all R&D spending in Switzerland. About half the corporate tax revenue that the Swiss federal government receives comes from multinationals; for cantons and municipalities, it is 20 percent.

The Swiss government and businesses believed the reform would have been important in keeping Switzerland an attractive location for companies. While acknowledging reform opponents’ claims of likely revenue losses for the federal, cantonal, and municipal governments, supporters of the reform said that it was the “least bad option” for several reasons—one being the fact that other countries, especially the United States, could lower their corporate tax rates, which would hurt Switzerland’s international competitiveness.

The U.S. has now dramatically lowered its corporate tax rate. It remains to be seen whether, or how much, the United States and Switzerland benefit, or lose an edge, respectively.

Or, perhaps Switzerland might pass a tax reform package after all—in September 2017, the Swiss government launched a consultation on a new package of corporate tax reforms.

Additional reading:

2017 International Tax Competitiveness Index, Tax Foundation

A Quick Guide to the GOP Tax Plan, Bloomberg

Analysis of the Tax Cuts and Jobs Act, Tax Policy Center

Analysis of the 2017 Tax Cuts and Jobs Act, The Heritage Foundation

Macroeconomic Analysis of the Tax Cuts and Jobs Act as Passed by the Senate, Urban Institute

The Most Persuasive Argument for Slashing the Corporate Tax Rate, Dan Mitchell (YL 2003)

The Macroeconomic Impact of the Swiss Corporate Tax Reform III, BAK Basel Economics

2012 Annual Global Tax Competitiveness Ranking–a Good News Canadian Story, University of Calgary School of Public Policy