US tax cuts will likely intensify global tax competition

By Zhang Monan Source:Global Times Published: 2017/12/25 20:53:40

Illustration: Peter C. Espina/GT


US President Donald Trump signed into law a $1.5-trillion tax reform package on Friday, which is the largest overhaul of the nation's tax code since 1986. Trump has promoted the tax plan as a "once-in-a-generation opportunity" that will bring "revolutionary change." However, the spillover effect and the chain reaction caused by the competitive tax reform should not be overlooked.

The impacts that the US tax overhaul will bring to the US economy, Sino-US economic relations and the global economy deserve our attention. From the perspective of the policy position, the tax reform is the core measure for the Trump administration to reshape US competitiveness and leadership under the "America First" strategy. For a long time, the high tax burden and the complex tax system in the US have become important constraints affecting the competitiveness of US companies and the domestic business environment. Through tax reform, as well as other policies like trade protection and immigration restrictions, the Trump administration is looking to lower business costs and enhance the nation's comparative advantage, so as to guide global industry and capital to flow back to the US.

It is important to note that the current US tax system is no longer suitable for the development of the global taxation system. The US is a major capital-exporting country, but due to its relatively high corporate tax rate and the worldwide taxation principle, many US companies have set up subsidiaries overseas so as to keep foreign earnings abroad to avoid paying tax in the US. Such export of assets and profits has led to the outflow of employment opportunities, thus inhibiting US economic development.

According to an estimate by Congress's Joint Committee on Taxation, US companies had up to $2.6 trillion in untaxed earnings overseas as of the end of 2016, equivalent to about 14 percent of US GDP during the same year. The new tax plan shifts to a territorial system, exempting foreign profits from tax, which will prevent US companies from paying too much attention to classifying profits as being earned overseas. Moreover, cutting the corporate rate from 35 percent to 21 percent may also give US companies a big incentive to repatriate their profits rather than stashing money overseas.

It is expected that the tax overhaul may narrow the gap in comparative advantage between China and the US in terms of cost. According to the World Investment Report 2017 issued by the United Nations Conference on Trade and Development, China's stock of foreign direct investment reached $1.3 trillion, which, based on my calculations, included around $130 billion in stock of US investment. Most of the US investment has already been transformed into fixed-asset investment. The tax reform may encourage some US companies to remit their cash earnings to the US, while at the same time, the narrowed gap in manufacturing costs may also push some manufacturers to return to the US.

However, it should be noted that as China's economic development and transformation have enhanced its household consumption and innovation capabilities, some market-oriented or high-tech US companies are still interested in expanding direct investment in China, which will see little impact from the tax reform. With the Chinese economy shifting to an innovation-driven growth model amid rising labor costs, its labor-intensive manufacturing industry will gradually move overseas, while its attractiveness to foreign investment in market-oriented or innovation-oriented areas will improve. As such, the tax reform in the US will not change the general trend of China's structural change in absorbing foreign investment, with US investment in China still maintaining growth in consumption and services, as well as research and development.

From an international perspective, reasonable tax competition has a positive effect by helping reduce the corporate tax burden, promoting host countries to absorb foreign capital and technology, enhancing technical innovation and expanding the tax base. However, excessive competition in taxation may trigger a global chain reaction, bringing competitive pressure to bear on other countries. At present, the UK, France and Australia reportedly have similar plans to cut corporate rates. In this sense, the new tax plan in the US will probably lead a new wave of global tax cuts, intensifying global taxation competition.

On the other side, there are also concerns that the US tax reform may violate the "tax fairness" principle. In order to prevent US multinational companies from using transactions to pay large sums of money to overseas related parties to reduce their US tax base, the overhaul introduces new taxes to fix the problem. But for Chinese companies that have trade, service and intellectual property transactions with their related parties in the US, the new tax may result in the additional tax burden on money they obtain from their related parties in US, which is obviously contrary to the international tax fairness principle.

The author is a research fellow at the China Center for International Economic Exchanges.

Posted in: INSIDER'S EYE

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