Business tax & beyond outlook 2009.

• Author: McClellan, Ed
• Position: TAX

Major challenges face the United States income tax system over the next several years. These have already attracted the attention of congressional tax writers and have become issues in the presidential campaign. Changes to come in 2009 and beyond could impact taxes for both businesses and individuals.

While tax relief for individuals may drive tax reform, Congress also may consider business tax reforms to promote U.S. investment and employment. There is growing concern among policymakers that the current corporate tax system limits the competitiveness of U.S. business.

The U.S. corporate tax rate is much higher than the rates of most of its trading partners. The combined top federal, state and local statutory U.S. corporate income tax rate is 39.3 percent--the federal rate of 35 percent plus an average state and local tax rate of 4.3 percent. This is the second highest (after Japan) among the 30 member countries of the Organization for Economic Cooperation and Development (OECD) and 10.7 percentage points greater than the OECD average.

For many U.S. companies, another key issue for maintaining competitiveness abroad is the ability to defer U.S. tax on active foreign earnings until this income is brought home. Approximately one-third of OECD countries provide such "deferral" rules. The remaining two-thirds have "territorial" tax systems, under which active foreign earnings are not taxed at all by the home country.

Some U.S. policymakers have criticized deferral, claiming that it provides a tax incentive for U.S. companies to locate production and jobs overseas. On the contrary, limiting deferral and thus imposing higher tax burdens on foreign operations would hinder the ability of U.S. companies to grow and compete in foreign markets that serve 95 percent of the world's consumers and, in turn, would significantly diminish future U.S. economic growth.

Projected federal budget deficits will create pressure for tax reform to be "revenue neutral," meaning that tax cuts must be offset by tax increases. For example, the Tax Reform Act of 1986, which may serve as a model for tax reform, reduced individual and business tax rates on a revenue-neutral basis by broadening the tax base and eliminating certain individual and business tax preferences.

However, one consequence of the 1986 Tax Reform Act was a shift in tax burdens from individuals to business. As a result, even if tax reform is revenue neutral overall, business taxes could increase to pay...