The Treasure has released a paper “US Corporate Tax Reform: Implications for the rest of the world” which examines the likely impacts of the US reforms on the US and on the rest of the world, placing the US changes in the context of the global trend toward lower corporate taxes.
The paper says that the economic impact of the Republicans’ tax plan will depend on how time and compromise shape the package that is ultimately legislated. Key in this regard is the size of the cut, how it is funded and whether investors believe it is a permanent reduction.
On 27 September 2017, the United States (US) Administration and Republican Congressional leadership released a framework for US tax reform, including a reduction in the federal corporate tax rate from 35 to 20 per cent.
The key elements of tax framework with respect to corporate tax are:
- a reduction in the federal corporate income tax rate from 35 to 20 per cent;
- immediate expensing of depreciable assets (except structures) for at least 5 years;
- limitations on interest deductions;
- the removal of the domestic production deduction;
- an exemption for dividends paid by foreign subsidies to US companies (where the US company owns 10 per cent or more of the foreign company); and
- a one-time tax on overseas profits.
These proposals were reflected in the draft of the Tax Cuts and Jobs Act released by the House Ways and Means Committee on 2 November 2017.
This paper examines the likely impact of this reform on the US and rest of the world, placing the US changes in the context of the global trend toward lower corporate taxes.
In theory, a corporate tax rate cut stimulates investment by making more investment opportunities sufficiently profitable to attract financing. The extent to which this is the case in practice will depend on how the tax cut is funded and whether investors consider the tax cut to be permanent. If the corporate tax rate cut results in an overall reduction in tax on US investments and investors believe that the tax cut is permanent, we are likely to see an increase in the level of US investment. If investors believe that the tax cut is temporary, the effect on US investment may be minimal. Ultimately, the economic impact of the plan on the US will depend on how time and compromise shape the final package.
If a US corporate tax cut does result in an investment boom, goods, labour and funds will be required. In a scenario in which the investment boom is largely funded domestically from US savings, negative impacts on the rest of the world are likely to be short-lived and modest.
Realistically, however, a US investment boom is likely to be only partially funded domestically and would draw funds and goods from the rest of the world. In this scenario, the rest of the world would experience a decline in capital stock resulting from the flow of capital into the US. The magnitude of the resulting welfare loss in those countries will depend on the size of the US corporate tax cut; how it is funded; the elasticity of the US labour supply response and the US saving response. For Australia, the size of the negative impact will also depend on how other countries respond.
While the size of the US economy means changes to the US tax system have particular significance, it is important to consider these reforms as part of an ongoing trend. As capital markets have become increasingly global and business location increasingly mobile, governments have sought to drive economic growth in their jurisdictions by lowering corporate tax rates. The US reforms have the potential to accelerate tax competition between jurisdictions, making Australia’s current corporate tax rate increasingly uncompetitive internationally.
While the Administration and Republican Congressional leadership have indicated that they will ‘set aside’ the idea contained in the House Republicans’ 2016 plan to move to a destination-based cash flow tax (DBCFT), this paper also provides a discussion of the theoretical underpinnings of the proposal.