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Photo Credit: Time
By Wen Xin Lim

The Rationale Behind Trump’s Tax Slash

Dec. 29, 2016  |     |  0 comments


On December 14, 2016, US President-elect Donald Trump met some of US’ top tech leaders — including luminaries from Apple, Microsoft, Amazon, Facebook, Google, Oracle and Paypal — in New York for the first time to find common ground on various topics ranging from innovation, job creation, skilled immigration, and trade with China. Undeniably, the top agenda of the closed-door meeting was the repatriation of US corporations’ offshore cash.

 

The success stories of US multinational corporations have not translated into domestic employment, as many of these companies have outsourced their manufacturing to overseas to avoid taxes and reduce labor costs. Trump has repeatedly said he will rebuild the American manufacturing industry and bring jobs back to the US through tax reductions and the imposition of tariffs on imports.

 

The rationale behind Trump’s tax plan? Oxfam America reported in April 2016 that “tax dodging by multinational corporations costs the US approximately USD 111 billion each year.” The top 50 US corporations hold USS 1.4 trillion in offshore cash, which is more than three quarters of the total USD 2.1 trillion in accumulated profits held offshore by the 500 largest US companies. Apple’s offshore cash — valued at USD 181 billion — topped the list, followed by General Electric, Microsoft, Pfizer, and IBM. Massive capital outflow has depressed US economic vibrancy and dampened job vacancies in the domestic market.

 

Apple’s exploration of relocating the iPhone’s production to the US boosted the confidence of many in Trump’s camp. This attempt is not without precedent as Apple had moved the hardware production of the MacBook Pro to the US in 2013, with USD 100 million invested to kick-start production. While Apple partnered Flextronics to operate the MacBook Pro production facility in Texas, there are rumors that it might work with Foxconn, Apple’s largest manufacturer and assembler, to shift the iPhone’s assembly to US. Foxconn has also committed to investing USD 7 billion in US alongside with Softbank’s USD 100 billion investment as announced by Softbank’s Masayoshi Son in December.

 

Countries Compete to Slash Tax

 

Since 2000, many countries except for the US have been slashing their corporate tax to retain companies at home and to lure new investments (see Figure 1). The world-wide average corporate tax rate has declined from 30 percent in 2003 to 22.9 percent in 2015, and every region in the world has seen a decline over the past 12 years. Notably, UK Prime Minister Theresa May announced last month that the UK will cut its corporate tax rate from the current 20 percent to below Trump’s proposed 15 percent. The corporate tax in the US is less competitive than in other developed and developing countries, threatening the US’ position as a pro-business tax regime (see Table 1).

 

Figure 1. Corporate Tax Rate for Selected Countries (2000-2016)



Source: Global competition to cut corporate taxes heats up. (2016, November 21). The Wall Street Journal. Retrieved from http://www.wsj.com/articles/global-competition-to-cut-corporate-taxes-heats-up-1479749644

 

Table 1. Corporate Tax Rate Country List (as of December 2016)

Countries/Regions

Corporate Tax (%)

Ireland

12.5

Hong Kong SAR

16.5

Singapore

17

Switzerland

17.92

United Kingdom

20

Sweden

22

China

25

Canada

26.5

Australia

30

Japan

32.26

France

33.3

India

34.61

United States*

39

Note: US corporate income tax rate at 39.1 percent (consisting of the 35% federal rate and a combined state rate)

Source: Compiled by author using data from Trading Economics

 

Given the higher tax rate, US companies have held capital extensively in overseas tax havens over the last 30 years, causing a huge tax revenue loss to the US government. The US corporate effective tax rate (the rate actually paid on world-wide income) differs substantially from the statutory tax rate of 39 percent. By taking advantage of various legal loopholes in the Tax Code, US corporations are able to drastically reduce their effective tax rate. As of 2015, the median effective tax rate of the US top 500 companies was 29 percent, while the average effective tax rate over the past ten years was 31 percent (see Figure 2).

 

Figure 2. US Corporates’ Effective Tax Rate (as of October 15, 2015)

 

Source: Compustat, OECD and Goldman Sachs Global ECS Research. Retrieved from http://www.businessinsider.sg/us-company-effective-tax-rate-below-statutory-rate-2015-10/

 

How Effective is the Tax Cut Policy?

 

How will tax incentives reinvigorate the US economy? The Global Competitiveness Report 2016-2017 ranked US as the third most competitive economy after Switzerland and Singapore. While the US economy is driven by multiple factors including innovation, business sophistication, market size, financial market development, labor market efficiency, and higher education and training, high tax rates and tax regulations remain the two most important downsides of doing business in US, according to the World Economic Forum’s Executive Opinion Survey (see Figure 3).

 

Figure 3. Most Problematic Factors for Doing Business

 

Source: World Economic Forum, Executive Opinion Survey 2016. Retrieved from https://www.weforum.org/reports/the-global-competitiveness-report-2016-2017-1

 

From this perspective, tax reduction is likely to serve as a big incentive for the reversal of US capital outflows. This has been true for Ireland and the UK, both of which successfully attracted foreign direct investment inflows over the past few years after aggressive tax cuts.

 

Conclusion

Trump’s plan to slash the corporate tax rate to a record low to prevent corporations from channelling profits out of the US is far from a done deal. The Committee for a Responsible Federal Budget estimates that Trump’s tax cut will add about USD 4.5 trillion to the US deficit over 10 years. Critics also warn that Trump’s tax policy favors the rich — particularly the top 1 percent of income earners — and is likely to create greater income disparity. Yet, some see it as a feasible solution to revive the US economy. One of these is Steve Forbes:


“Combined with slashing the tax on profits for corporations and so-called pass-through to 15 percent, these measures would help stimulate the creation of new businesses, not to mention energizing consumers and investors. Progress is impossible without investment, and that can’t happen without capital creation.”


Nevertheless, it is important to note that the significant tax cuts will boost incentives to work, save, and invest only if interest rates remain the same. The Federal Reserve raised its benchmark interest rate last week for the first time in a year and signalled that interest rates could continue to rise next year. This could impact Trump’s expansionary policies and crowd out private investment, offsetting some of the positive incentive effects. While tighter monetary policy meant to tame the economy may diminish Trump’s expansionary efforts, Trump’s tax cut policy coupled with his proposed deficit-neutral system of infrastructure tax credits to incentivize private businesses to undertake infrastructure construction projects may have spillover effects for reviving the US economy. 

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