Tax Reform and International Competitiveness
How important is corporate tax reform for a country’s global competitiveness? The U.S. Congress passed the Tax Cuts and Jobs Act in December 2017. Has the new tax law improved U.S. competitiveness? Swiss voters rejected a reform proposal in early 2017. Has it affected Switzerland?
In an interconnected world with ever-shifting goal posts, constant efforts are required to stay ahead of the curve, or even just to keep up. Many observers in Switzerland and the United States place their hopes for their country’s increased global competitiveness in corporate tax reform.
The U.S. Congress passed the Tax Cuts and Jobs Act (TCJA) in December 2017. As the Tax Foundation states, the TCJA “represents a dramatic overhaul of the U.S. tax code.” What are some of the main business aspects of this dramatic overhaul?
Moved 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.”)
Lowered the corporate-income tax rate from 39.1 percent to 21 percent. This reduction is especially significant, as the United States had, at 39.1 percent, one of the highest corporate-income taxes in the world (some maintain that it was the highest in the free world; some disagreement exists on the subject). The worldwide average is 22.5 percent, with Europe at only 18.8 percent.
Established 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. Increased 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.
Reduced taxes on new investment. The marginal effective tax rate (METR), at 34.8 percent, was one of the highest in the world. (The average developed-country METR is 19.2 percent.)
Enacted“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.
What Has Been the Economic Effect of These Changes? In short, the TCJA has been working as intended: American firms repatriated $217 billion from foreign affiliates.
Not surprisingly, such a major shift has had a worldwide effect, with global foreign direct investment (FDI) falling by 41 percent during the first half of 2018. As American companies pulled money from their foreign investments, FDI flows to China rose by 6 percent, making China the no. 1 destination for foreign investments.
Flows to Europe fell by a whopping 93 percent, mainly due to the reduction of flows to Ireland (the European base for many U.S. multinational companies) and Switzerland.
An October 2018 report by the United Nations Trade and Development Agency states that U.S. “[r]epatriations of accumulated foreign earnings were not the only explanation for the [41 percent] drop in global investment flows. Inflows to the United States also fell sharply… Uncertainty about the implementation details of the [TCJA] reforms, combined with uncertainty about trade relations and about more stringent investment screening procedures could all be contributing factors.”
Britain, however, jumped to the no. 2 spot for inflows, and the United States is the no. 3 destination for FDI.
Money invested into new start-ups rose by 42 percent overall.
Benefits for Americans. Just a month after passage of the new tax law, nearly 300 U.S. 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.”
Predictions and Numbers. As a result of the changes to U.S. tax policy, the International Monetary Fund (IMF) expected 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 July 2018, the U.S. economy was already roaring at a 4.1 percent growth rate.
Some economists worry about economic stability, expect a slowdown in 2019, and believe, as does the IMF, that starting in 2022, expiring tax provisions and larger fiscal deficits will slow down growth even more. Time will tell.
While Switzerland lost $77 billion in inflows in the first half of 2018, a boon is that U.S. affiliates of Swiss companies benefit from the same reduced 21 percent corporate tax rate as U.S. companies.
Another consequence is that, since American multinational companies are now investing more at home, their foreign tax payments are reduced. With subsidiaries of U.S. giants, such as Johnson & Johnson and Procter & Gamble, as well as those of many U.S. financial companies located in Switzerland, at least 5 percent of U.S. corporate profits are registered in the Alpine county.
Martin Naville, CEO of the Swiss-American Chamber of Commerce, does not expect huge losses for Switzerland, however. He believes that so far, the majority of U.S. companies in Switzerland have not repatriated earnings to the U.S., as they are waiting to see what happens with Swiss tax reform.
Swiss Tax Reform.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 are gearing up for another attempt at tax reform.
The U.S. has now dramatically lowered its corporate tax rate. Whether the Swiss will do the same is still uncertain. It remains to be seen whether, or how much, the United States and Switzerland benefit, or lose an edge, over the long term.
Tax Reform Made Me Do It! National Bureau of Economic Research, co-authored by Michelle Hanlon (YL 2010)
Investment Trends Monitor, UNCTAD
Reform of the U.S. Tax Regime—The Swiss Perspective, Prager Dreifuss
A Quick Guide to the GOP Tax Plan, Bloomberg
Macroeconomic Analysis of the Tax Cuts and Jobs Act as Passed by the Senate, Urban Institute
The Macroeconomic Impact of the Swiss Corporate Tax Reform III, BAK Basel Economics
Corporate Tax Reform 2017—Switzerland’s Changing Tax Landscape, International Tax Review
How the TCJA can affect U.S. taxpayers who live in Switzerland, Dominic Nazareno, Prime Tax