Tax Reform’s Quiet Protectionism

By :: March 10th, 2014

House Ways and Means Chairman Dave Camp has offered a detailed and thoughtful set of proposals on international tax reform, as did former Senate Finance Chairman Max Baucus in November, 2013. The proposals, however, contain a new form of subtle protectionism. They quietly aim to discourage U.S.-based multinationals from making products overseas and selling them back to the U.S.

In effect, income from the sale in the United States of goods manufactured overseas by controlled foreign subsidiaries (CFCs) of U.S.-resident multinational companies would be taxed at a higher U.S. rate than other income from the same factory.

Here’s how it would work: Camp—like Baucus-- would mostly or fully eliminate the taxation of dividends that these foreign subs pay to their parent company (Baucus would remove the dividend tax entirely on these repatriated earnings, while Camp would allow firms to deduct 95 percent of dividends.)

To limit firms’ incentive to shift reported profits to low-tax countries, both would impose minimum taxes on new forms of income accrued within foreign subs. Camp would exempt most active profits of foreign subs, but would apply a minimum tax of 15 percent (10 percentage points below his proposed corporate rate of 25 percent), to profits attributable to their intangible assets. These are the profits that are easiest to shift to tax havens because it is so hard to establish their correct value. Baucus would have gone even further by including either 80 percent of active income in low-tax countries or 60 percent of all active income of a foreign subsidiary (Baucus proposed two different options for corporate reform, dubbed Y and Z).

Camp would create a simple formula to compute intangible profits. He would assume firms earn a 10 percent rate of return on physical investments such as plant and equipment and attribute any excess returns to intangible assets such as patents or brand name reputation.

The net result is that the United States, like our major trading partners, would continue to tax most foreign-source income of U.S. firms at a lower effective rate than their domestic income. We’d also follow most of our major trading partners by mostly or fully eliminating the tax on overseas income that is returned to the United States while increasing taxation of accrued foreign-source income.

But here is the kicker: Camp would deny preferential U.S. tax rates for intangible profits of foreign subs for goods imported into the United States. Instead, they’d be taxed at the full domestic rate of 25 percent. Baucus would similarly deny the preferential treatment he provides to active income of foreign subs from sales to the United States by including all of these profits in current income.

The following table compares the U.S. tax rates on foreign subsidiary income under current law,Baucus’s option Z assuming a 30 percent corporate rate, and Camp’s plan with its 25 percent rate.

U.S. corporate   income tax rate Current Law Baucus Option Z Camp
Income of U.S.   domestic corporations 35%, 31.9% with   domestic production deduction 30%, 27.1% with   domestic production deduction 25%
Active income of foreign   subsidiaries of U.S. corporations from foreign sales 0% as accrued; 35%   when repatriated 18% as accrued 15% as accrued for   intangible income from low-tax countries; 0 for other active income with   1.25% repatriation tax
Active income of foreign   subsidiaries of U.S. corporations from U.S. sales 0% as accrued; 35%   when repatriated 30% as accrued 25% as accrued for   intangible income from low-tax countries; 0 for other active income with a   1.25% repatriation tax

 

Under current law, most income accrued within foreign subs is tax-free until it is returned to the U.S. and firms escape most of this tax by retaining and reinvesting these profits over seas. The lock-in of funds overseas does impose some costs on firms, estimated at slightly over 5 percent of foreign profits by economists Harry Grubert and Rosanne Altshuler. Still, this is much lower than the net tax they would pay by repatriating the profits.

Camp and Baucus remove most of this repatriation tax, thus eliminating a firm’s incentive to retain profits overseas. They’d tax foreign subsidiary income when it is earned to help prevent base erosion and income shifting. And they’d apply a higher tax rate to income of foreign subs from sales to the United States than to income of foreign subs from sales overseas.

What does a discriminatory tax imposed on income from imports from U.S. firms look like in the real world? Suppose Ford and Volkswagen produce automobiles in both the United States and Germany for sale to the United States and Europe. The U.S. would impose the same corporate tax rate on income earned from either firm’s U.S. plants no matter where the cars are sold. VW would pay no U.S. tax on income from its German plant, no matter where those cars are sold. But the story would be different for cars Ford produced in its German factory. Ford would pay a higher U.S. rate on income from the cars it sold into the U.S. than on sales anywhere else in the world.

This is what would happen under the Baucus plan because its tax is aimed at active income. Camp’s effective tariff would be more limited because it would apply only to intangible profits in low-tax countries. But U.S. firms that shift their profits from the use of intangibles to low-tax countries would still face a higher tax on sales to the United States than on sales overseas.

Since the end of World War II, the U.S. has gradually reduced its trade barriers, lowering tariffs that impose discriminatory taxes on goods produced overseas and sold here. But Camp (and Baucus before him) includes provisions that move in the opposite direction for goods and services produced overseas by U.S.-resident multinational corporations. The proposals discourage U.S. corporations from producing overseas for the U.S. market, but apply no similar tax penalty to imports from foreign-owned corporations.

8Comments

  1. Tax Roundup, 3/10/14: Sioux City $afety Edition. And: rogue dentistry! « Roth & Company, P.C  ::  10:16 am on March 10th, 2014:

    […] Todor, Tax Reform’s Quiet Protectionism (TaxVox): “In effect, income from the sale in the United States of goods manufactured […]

  2. Eugene Patrick Devany  ::  10:41 am on March 10th, 2014:

    The corporate tax problems arise because the U.S. is the only developed country without a VAT. Consider no payroll taxes, 8% on income and 4% VAT. The problem of taxing deferred foreign profits is solved because foreign profits will be repatriated with an 8% tax rate.

  3. Ralph H  ::  12:31 pm on March 10th, 2014:

    Eugene, I must admit originally I thought you were possibly a nutcase, but after looking at your site and proposal I think it may work and actually solve many problems we have as a country. Only beef I see is that either the $500k should be raised, particularly because many older people with conservative investment tendencies can lose money if they buy CDs or government bonds. The other difficulty is for people like me who own private businesses.

    With the above concerns, I applaud your efforts and would encourage others to look at your proposal — TPC might even analyze it. probably no way Congress or the president will go for it as no way to reward their favorites. Certainly we would collect way more tax from Mr Buffett and Gates! But they would have less assets to “give away” (untaxed, I might note).

  4. Michael Bindner  ::  3:12 am on March 11th, 2014:

    These multinational firms already collect (and arguably pay) income taxes earned overseas by US citizens. Indeed, it might be cheaper for them to drop both the current regime and the regime proposed and simply go with a Value Added Tax on all imported goods – whether they be made by US subsidiaries or a firm owned by the state (like British Airways). Such a regime would include an end to the taxability of most foreign income earned abroad, save for an income surtax on the top 20% of earning families (and a very modest tax at that).

  5. new providence offshore  ::  1:08 pm on March 11th, 2014:

    The Capital gains tax is zero for offshore foreign bankers in tax havens like the Cayman Islands and Bermuda.

    Foreign banks in tax havens have an unfair advantage over the
    American taxpayer, and it isn’t just and it isn’t fair.

    I’ve filed a FBAR since 1995 – with signature authority over Financial account of an offshore company. No IRS problems yet!

    I live offshore in the Bahamas since 1990

    If you plan Carefully, and file 8621 for a (“few”) pedigreed QEFs, you can reduce your tax Liability on short term and long term capital gains (just like the offshore Foreign banks in tax havens do and have done for over 40 years) and other SubPart F type income (section 954(a) to a low rate of .5%. Of course the Offshore foreign banks still pay NOTHING (0%) under the unusual US Tax Code on the capital gains receive on US investment, but 1/2 of 1% (with 2 pedigreed QEFs) Tax on capital gains is no so bad.

    http://tomazz1.wordpress.com/2014/03/08/tax-planning-for-pfics-and-cfcs-and-fatca/

    Foreign banks in tax havens use deceit, subterfuge, camouflage, concealment to hide US taxpayer accounts, who often trade in so called “Street name” and file a
    W-8BEN with the banker.

    Now, under FATCA, foreign bankers will be reporting American securities accounts in obstruction to the host country’s own bank secrecy and confidentiality laws.

    Very unjust to American tax planners and US investors. Congress does nothing to level the playing field generally speaking. See link above. It may be one of the few avenues left for the American taxpayer.

    “Avoidance of taxes is not a criminal offense. Any attempt to reduce alleviate taxes by legitimate means is permissible. The distinction between evasion and avoidance is fine yet definite. One who avoids tax does not conceal or misrepresent. He shapes events to reduce or eliminate tax liability and upon the happening of the events makes a complete disclosure.

    Evasion on the other hand involves deceit subterfuge camouflage concealment some attempt to color or obscure events or making things seem other than what they are.” — Internal Revenue Service

  6. 2014 CALIFORNIA SALES TAX TABLE  ::  5:17 am on March 13th, 2014:

    […] TaxVox » Blog Archive » Tax Reform's Quiet Protectionism […]

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