The U.S. is home to some of the world’s most successful multinational business enterprises, which generate large profits outside of the country. These profits could, in theory, be reinvested in the U.S., or disbursed in the form of dividends to U.S. shareholders. Yet as Robert Pozen explains, these firms are only obligated to pay U.S. corporate income taxes on profits earned by their foreign subsidiaries if they bring them back into the country. And so U.S. corporations have roughly $2 trillion in accumulated foreign earnings locked up in foreign affiliates:
Treasury receives very little tax revenues from foreign profits of U.S. corporations , although the U.S. statutory rate of 35% on corporate profits is one of the highest in the world. Like almost every other country, the U.S. provides a credit against U.S. taxes for any foreign taxes paid on foreign income. For example, if a U.S. corporation pays taxes of 33% of its Japanese profits, it can bring these profits back to the U.S. by paying only a 2% tax rate (the U.S. rate of 35% minus a tax credit of 33%). On the other hand, if a U.S. corporation pays an 18% tax rate on its Spanish profits, it will rarely be willing to pay another 17% U.S. tax ( the U.S. rate of 35% minus a tax credit of 18% ) to bring these Spanish profits back to the U.S.
One solution to the (non)repatriation problem is to move to a territorial tax system, in which profits are only taxed in the jurisdictions in which they are earned. Pozen warns that this might lead U.S. firms to minimize their tax burden through clever lawyering. Rather than switch to a pure territorial tax system, he calls for a “global competitiveness tax.” U.S. firms would be subject to a 17 percent tax on all foreign profits every year, yet they’d also be granted a credit for foreign taxes. So if Corporation X has to pay 17 percent or more in taxes in the foreign jurisdiction in which it has earned its profits, it won’t have to pay additional U.S. taxes to repatriate these profits. If Corporation X pays less than 17 percent in a foreign jurisdiction, it will have to pay the difference. But Corporation X will also be free to repatriate these profits without paying additional U.S. corporate taxes after doing so.
In an ideal world, we’d simply lower the U.S. corporate income tax rate to address the problem Pozen identifies, or move to a business consumption tax. But Pozen reminds us that the obstacles to such a sweeping overhaul are considerable. Reducing the corporate income tax rate would either involve a substantial revenue loss or the closing of “loopholes” that have tenacious defenders. For example, Pozen has made a convincing case for limiting the corporate interest deduction on debt and using the resulting revenue to lower the statutory rate, but highly leveraged firms have, for obvious reasons, attacked the idea. And while we’re waiting for a large corporate income tax overhaul, U.S. firms are finding it extremely expensive to bring foreign profits back home, to the detriment of U.S. workers and investors. Indeed, Pozen suggests that his global competitiveness tax might raise enough revenue to actually finance a reduction in the U.S. corporate income tax rate. That is, his proposal might make corporate tax reform easier to achieve.