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Tax Code Requires a Revamp

May 24, 2012

High corporate rate prevents flow of capital, say panelists at Management Conference session

The US tax system is fundamentally broken and needs an overhaul, three corporate tax experts agreed at a breakout session during the 60th Annual Chicago Booth Management Conference, held May 11 at Gleacher Center.

That's bad enough for starters, but the news gets worse. There is little interest or political motivation in Washington DC to take on such a mammoth task as rationalizing the tax code, the speakers said.

"We would take the tax system of any other country over the tax system we have," said David Lewis, chief tax executive at Eli Lilly & Co. in Indianapolis. "It is broken, not achieving its objective, and—more importantly—it is seriously preventing growth in the US economy."

Merle Erickson, professor of accounting, who moderated the session on US corporate tax policy, opened by highlighting the staggering fiscal pressures that soon will confront the country if the current rate of deficit spending is not reined in. The panelists' discussion began with their unanimous belief that the need for increased revenue can be met only if the tax code becomes fairer, more balanced, easier to administer, and less punitive toward cross-border economic activity.

Jeff Maydew, a partner at Baker & McKenzie LLC in Chicago, said that as a matter of international comparison, the complexity and inscrutability of the US tax system is in a separate league; only India and Brazil are as bad.

The United States has the distinction of levying the highest corporate income tax rate in the world, bringing with it serious consequences for capital formation, corporate mergers, international competitiveness, research and development, and job creation. In 1981, the US rate was roughly comparable to that of its trading partners in the Organisation for Economic Co-operation and Development (OECD). Since 1988, the average OECD corporate income tax rate (not including that in the United States) dropped 19 percent, while the US federal rate increased 1 percent, according to Maydew.

The US tax system was put in place 50 years ago, during the Kennedy administration, said Rod Donnelly, a partner with Morgan Lewis in Palo Alto, California. Compromises in Congress introduced a multitude of complications that have not been properly updated since. "The corporate tax rate is too high, it prevents the free flow of capital, and it inhibits US international corporations competing with their foreign counterparts," Donnelly said.

The panelists spent a large part of the presentation explaining the issue of repatriation of foreign-earned profits by US-based multinationals. These companies have accumulated an estimated $1.2 trillion in offshore earnings that have not been brought into the country because the companies face an effective tax rate of 35 percent, Donnelly said. They won't repatriate those earnings until the tax law is changed or Congress declares another one-time tax holiday, as it did in 2004.

Bypassing the issues of fairness, equity, and political preference that have dogged this issue as it pertains to individual taxpayers and small business, the panelists described in technical terms how the current situation distorts business decision making in the United States and abroad. It's especially harmful to spending on research and development, which can easily be sent offshore, with deleterious consequences for future US employment, they said.

The economy's inability to create enough new jobs may be due in no small part to the perverse incentives in the tax system, the group suggested. Maydew said he sees "tremendous disincentives to having any intellectual property sitting in the US."

For Eli Lilly to remain an independent company, Lewis said, it has to be able to compete with Novartis, based in Switzerland, and he worries that Novartis will enjoy a tax advantage in the future. "This is a very serious issue for our country. If you take away our ability to arrange our affairs in a tax-efficient manner, we will be unable to compete with companies in countries with efficient tax systems." —Duncan Moore