Growing Consensus on Corporate Tax Reform? Not So Much

By :: February 28th, 2012

At first glance, it looked like President Obama and congressional Republicans were miraculously headed in the same direction on corporate tax reform.

Reform plans by Obama and GOP leaders such as House Ways & Means Committee Dave Camp (R-MI) seemed simpatico. Both sides embraced lower rates. Both endorsed ending business tax subsidies, through neither had much to say about which ones.  But on one fundamental issue the gap between Obama and the GOP remains wide.

How would they tax foreign earnings of U.S.-based multinationals? Both sides agree that the current system is the worst of all worlds: It is immensely complicated, wildly distorts economic decisions, and collects little revenue.

But when it comes to the solution, Obama and the Republicans seem headed down different roads. Obama wants to force U.S. companies to pay more tax on their overseas profits. Many Republicans would exempt offshore earnings from U.S. tax liability.

To understand where reformers are headed, think about today’s system. Under our current worldwide structure, foreign subsidiaries of U.S.-based firms must pay U.S. tax no matter where they earn their income. To prevent profits from being taxed twice, those firms get a credit against their U.S. tax for the levies they pay to other countries.  

Those foreign tax rates are nearly always lower than in the U.S. But because U.S. rates are relatively high, companies game the system to avoid domestic levies on their overseas income, and even to reduce U.S. tax on domestic income.

Under a practice known as deferral, U.S. firms don’t pay U.S. tax until they bring their profits home. This allows them to reinvest earnings in foreign subsidiaries and, in effect, never pay those high U.S. rates.

Firms also use sophisticated accounting gimmicks to shuffle income to low-rate countries while shifting deductible expenses back home, where they can offset domestic profits and lower their overall U.S. tax liability. Sometimes, they actually move their production—and their jobs—overseas to avoid U.S. tax (though that’s rarely the most common reason).

All of this allows many multinational firms to pay effective tax rates well below the 35 percent statutory rate that is getting all the attention. Often they pay less less than they might under a territorial system.

What to do?

Obama would impose a minimum tax on multinationals—effectively forcing them to pay immediate tax on foreign income even if they never return the money to the U.S. But Obama’s plan would be incredibly complicated and may drive more companies to move overseas, since the minimum tax would 0nly apply to U.S.-based firms.

Some Republicans would shift the U.S. to a territorial system and effectively abandon efforts to tax active overseas income of U.S. multinationals. All companies—foreign or domestic-- would pay tax on U.S. profits. But domestic firms would owe no U.S. tax on overseas income, either when their foreign subsidiaries earn it or when they pay it as dividends to their U.S. parent.

This would move the U.S. closer to the territorial systems used by most of the world. But such a shift might encourage some domestic companies to move more of their operations---and shift both jobs and more reported income-- to low tax countries. Preventing such an exodus would require a complicated new set of rules.

Is there some middle ground between the Obama view and the GOP position? Maybe.  Perhaps there is a way to increase taxes on foreign profits as they are earned but lower the additional tax companies pay once profits are returned to the U.S. This could raise U.S. taxes on income earned in tax havens but reduce the penalty for bringing foreign earnings home.    

But this is complicated, vexing stuff. And it will require honest cooperation among serious tax mavens, not the sort of political one-upmanship that infects most everything else in Washington.

10Comments

  1. Michael Bindner  ::  6:49 pm on February 28th, 2012:

    The Senior Senator from New York wants a repartriation holiday as well. I suspect that Obama won’t get his way on this one – although he may be able to hold out for including this in comprehensive tax reform that raises dividend and capital gains rates to the 28% level, while limiting deductions and dropping the top tax rate to 28%. If you throw in enough sweetners, the GOP will be willing to deal. Hopefully, they will also simplify tax benefits for families as part of this and increase them as well. Without compromise, all plans are pretty much academic.

  2. Michael Bindner  ::  6:54 pm on February 28th, 2012:

    Countries with territorial systems also use a VAT. We should not adopt one without considering the other.

  3. Ralph H  ::  9:59 am on February 29th, 2012:

    How about a VAT and no corporate income tax? That way we tax what’s consumed here regardless of its origin and our companies are made more competitive.

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  6. Jack Strandquist  ::  4:06 pm on April 8th, 2012:

    1. Reduce the IRS to 50 accountants. Each one has only one job to do: submit a bill each year to his/her state, and collect the tax owed by that state. The state tax bill would be based on median income of individuals and businesses, gross state product, mean property value, etc. (not my main point here). This single tax bill submitted to each state would be the ONLY tax the federal government could legally collect, period.

    2. Each state would gather the revenue required to pay the federal tax bill by using methods (income tax, sales tax, property tax, etc.) already in place; they would simply dial up the percentage, which would not require an IRS-sized beauracracy to do. To prevent well-healed interests from taking advantage of the poor, there should be a minimum income level for individuals AND businesses below which ZERO tax would be owed, and no filing required. Yes, wealthy individuals and well-established companies would pay a greater share in order to relieve poorer families and fledgling new businesses of their tax burden. Sounds good to me, even though I would certainly be in the tax-paying category. I’m quite willing to pay more to make this work for the country.

    3. Eliminate all tax exemptions that encourage people to go into debt, such as the home mortgage exemption. If you can’t afford a mortgage payment without the exemption, save enough of a down payment until you can get a mortgage with a payment you can afford. Until then, rent a home. Who says we all have a right to “own” a home that we’ll eventually lose to foreclosure?

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  10. Perks, Oversea Jobs and Increased Taxes for Middle Class & Seniors | New NY 23rd  ::  7:53 am on July 2nd, 2014:

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