US Congress is fast approaching a consensus on a comprehensive tax reform. Though certain details still remain to be decided, it looks like US companies can expect to see their tax bills go down considerably. The reform will also lead to radical changes in how corporations are taxed in the United States. From now on, the US tax authorities will no longer tax the worldwide income of US companies; instead, following the concept of territoriality, only profits generated in the United States will be subject to tax. The Centre for European Economic Research (ZEW) in Mannheim together with the University of Mannheim have conducted a comprehensive study analysing the effects of this reform on international tax competition.
According to the findings, the reform will lead to a significant decrease in the effective tax burden (including US state taxes) on companies operating in the US from 36.5 per cent currently to 22.7 per cent. This is caused not only by the considerable cut in the federal statutory tax rate from 35 per cent to just 20 per cent, but also by the planned immediate write-offs for certain capital assets. Following the reform, the effective tax burden on firms in the US will be lower than in Germany (28.2 per cent) and close to the EU average (20.9 per cent).
This tax cut along with the decision to stop taxing worldwide income and move towards territoriality instead will also alter the incentives for international investment, with the US becoming an even more attractive investment location for European companies after the reform is implemented. However, US companies investing in Europe will also face a lower tax burden since, according to territoriality, there is no longer an obligation to pay US taxes on top of the taxes paid to host countries on profits generated in Europe. EU countries with low tax rates such as Ireland will particularly benefit, while countries like Germany with a comparatively high tax rate will become less attractive to investors.
“Competition between EU Members for US investment is going to intensify”
“This tax reform in the US isn’t just going to stoke tax competition between the United States and Europe; competition between EU Member States for US investment is also going to intensify and Germany is going to lose out,” says ZEW Research Associate and leader of the study Professor Christoph Spengel, describing the findings of the study. The consequences of the reform for direct investment flows between Europe and the US could be considerable. According to the findings of the study, we can expect to see German companies increase their investment in the US by around a quarter after the reform.
In terms of current EU efforts to combat tax avoidance, the results of the study are somewhat sobering. “EU anti-avoidance legislation cannot protect against loss of revenue due to this tax reform in the US. On the contrary, the legislation could further reduce investment in Europe because the risk of double taxation is increasing,” says Spengel. According to Spengel and the conclusion of the study, the new German government would be well advised to develop a strategy for increasing Germany’s competitiveness when it comes to taxation.
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