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  • What You Need to Know About the US Tax System


    3/12/2014

    By Tom Hanlon

    “Taxes play such a huge role in where we are in the US today, and where we aren’t,” Doreen Griffith said at a recent lyceum.

    “Whether you plan to be a partner in a public accounting firm, or own your own business, or help a business be very successful, you need to understand how tax has an impact on you, your competition, and, most importantly, your competition around the world,” said Griffith, National Managing Partner, Tax Services at Grant Thornton.

    “Because in today’s economy, you’re not just competing against the business down the street, but against the business in China, and India, and Russia. You’re all competing for the same dollars, and taxes are a huge piece coming out of your pocket.”

    Griffith pointed out that US corporations pay a significantly higher tax rate than its 33 other OECD (Organisation for Economic Co-operation and Development) counterparts: in 2011, US corporations paid a 39 percent tax rate, while other OECD countries averaged 25 percent.

    A chief reason for that disparity is the US hasn’t budged from its tax rate since 2000, while many other countries have made significant drops. While the US rate has remained at 39.2 percent from 2000 to 2013, these countries have experienced drops in the same time period: China, 33 to 25 percent; Japan, 43.3 to 35.7 percent; Germany, 52 to 33 percent; Canada, 43.6 to 28.5 percent.

    One impact is obvious, Griffith said. “The US has a disadvantage against other OECD countries. We’re starting to lose our competitive edge.”

     

    Tax Reform Proposal

    The US hasn’t had a major overhaul to its tax code since 1986, Griffith noted. The code is complicated and voluminous, and Rep. Dave Camp, chairman of the House Ways and Means Committee, has outlined a simpler system that would allow 95 percent of filers to get the lowest tax rate (10 percent). But even this simplification, Griffith said, took 900 pages to explain.

    Highlights of the Camp proposal include:

    • Dropping from seven tax brackets to two: 10 percent and 25 percent tax rates
    • A 10 percent surtax would be added to the wealthiest earners (still keeping the highest rate at less than today’s 39 percent)
    • Corporate tax would drop from 35 to 25 percent
    • The standard deduction and child tax credits would increase
    • 40 percent of long-term capital gains and dividends would be exempt from tax, with the rest taxed as ordinary income

    “Of course,” Griffith said, “the only way to pay for those lower tax rates is to take away deductions.” Camp’s proposal, she said, called for eliminating accelerated depreciation – “You’ll get the deduction, but it will take longer” – amortized R&D deductions, and lowered advertising deductions.

    Camp also proposes to repeal LIFO (the “last in, first out” inventory accounting method that can be tax advantageous) and limit the section 199 manufacturing deduction.

    “A lot of large companies use LIFO, and repealing it would be an immediate tax pickup,” Griffith said. (Some have estimated repealing LIFO would raise about $112 billion over 10 years.)

     

    Moving Closer to a Territorial Tax System

    In addition, the Camp proposal would move the US closer to a territorial tax system, Griffith noted. The US, unlike most other countries, uses a worldwide tax system, meaning earnings by US citizens from other countries are taxed in the US.

    “When you have a worldwide system, it really discourages you from bringing money back into the US,” Griffith said, “because you pay so much tax on bringing it back.” On the other hand, she added, she’s not sure how the US could currently afford a territorial system.

    “There are pros and cons to this issue,” she said.

    A big pro to going to a territorial system is that it could spark the US economy. The way the code is currently written, US corporations are focused on manufacturing and selling overseas rather than manufacturing in the US and exporting their products.

     

    Comparing the US to Other OECD Countries

    The 10 percent disparity between the US and all other OECD countries in statutory tax rates for corporations is far bigger than the disparity in the effective tax rate. (The effective rate measures taxes paid as a proportion of economic income.) In effective rate, the US pays 27.1 percent, while other OECD countries pay 26.4 percent.

    For individual tax rates, the US rate in 2013 was 39.6 percent (compared to 41.5 percent for an OECD average). The Netherlands, Griffith pointed out, was at 52 percent – though that country also provides free healthcare and college tuition.

    It’s hard to compare countries’ systems across the board for that reason: Each country uses its tax monies differently. For example, Oxford – the oldest university in the English-speaking world, dating back nearly 1,000 years – costs about $1,000 for students from the UK.

    “What you need to understand is what your tax dollars are paying for and how the tax code impacts you and your competition,” Griffith said.

     

    Tax Reform Not Likely to Happen Soon

    While tax reform is much talked about these days – “and once something starts getting talked about in Washington, it takes on a life of its own” – Griffith believes it’s unlikely for a reform to take place before 2017.

    “There are too many elections [in 2014 and 2016] and too much animosity between the parties to be able to sit across the table and work something out before then,” she said.

    “The Camp reform is not signed into law,” she added. “But it could happen and you need to understand it, and what you’re looking at for the future so you can start planning in case it comes to fruition.”

    UIUC College of Business Department of Accountancy