Treasury Secretary Hank Paulson will hold a one day conference on July 26th to focus attention on the US tax treatment of business income and how it might be improved. The conference will include a larger meeting in the Treasury Cash Room open to the press followed by at least two “break out” sessions for conference participants.

Why focus on corporate tax policy now? The Wall Street Journal, Bloomberg Markets, and other publications have recently observed how the United States’ corporate tax rate is now the highest among our major trading partners. While our corporate tax has stagnated, other countries have been cutting rates. The Wall Street Journal writes:

There’s a trend here. At least 25 developed nations have adopted Reaganite corporate income tax rate cuts since 2001. The U.S. is conspicuously not one of them. Vietnam has recently announced it is cutting its corporate rate to 25% from 28%. Singapore has approved a corporate tax cut to 18% from 20% to compete with low-tax Hong Kong’s rate of 17.5%, and Northern Ireland is making a bid to slash its corporate tax rate to 12.5% to keep pace with the same low rate in the prosperous Republic of Ireland. Even in France, of all places, new President Nicolas Sarkozy has proposed reducing the corporate tax rate to 25% from 34.4%.

What do politicians in these countries understand that the U.S. Congress doesn’t? Perhaps they’ve read “International Competitiveness for Dummies.” In each of the countries that have cut corporate tax rates this year, the motivation has been the same — to boost the nation’s attractiveness as a location for international investment. Germany’s overall rate will fall to 29.8% by 2008 from 38.7%. Remarkably, at the start of this decade Germany’s corporate tax rate was 52%.

Aside from high rates, other aspects of our corporate tax code are also blamed for hamstringing American corporations’ ability to compete, including our policy of taxing US citizens on their income worldwide, rather than just within our borders.

Flow-through businesses like S corporations and partnerships will also be addressed at the conference. Speakers and panelists will be asked to address the impact of the tax code on business formation and structure and what impact the overall tax burden has on entrepreneurial activity. Anytime tax writers get together to discuss the divergent tax treatment of C and S corporations, S-Corp members should pay attention.

The different tax treatment of C versus S corporations and partnerships parallels recent policy discussions of the treatment of hedge fund earnings. When different types of income are taxed at different rates, activity tends to flow into the activity that faces the lower tax. As CBO Director Peter Orzag observed at Wednesday’s Finance Committee hearing on hedge fund taxation:

Much of the complexity associated with the taxation of carried interest arises because of the differential between the capital gains tax rate and the ordinary income tax rate, which creates an incentive to shift income into a form classified as capital gains. Further widening of the differential between the taxation of ordinary income and of capital gains would create even stronger incentives to shift income into the tax-preferred capital form.

Those of us who know Peter can guess how he’d close the gap — raise the tax rate on capital gains and dividends. But that would increase the double tax on corporate income, exaggerate the tax gap between C and S corporations, and put additional pressure on the S corporation community to defend its current tax treatment.

There is another way to close a tax rate gap — cut them for the disadvantaged party. As the Treasury tax conference will highlight, the rest of the world is cutting tax rates and making their corporate citizens more competitive. Will the United States follow?