• The Option of a Lower United States Corporate Tax Rate with a Worldwide System

    By Mark Keightley


    The views expressed herein are those of the author and are not presented as those of the Congressional Research Service or the Library of Congress.

    Many consider the current United State international corporate tax system in need of reform. The U.S. has the highest statutory rate in the world, which corporations argue affects their ability to compete against their foreign rivals1. The U.S. also taxes its multinational businesses on their worldwide income, but allows them to defer paying taxes on foreign-earned income until it is brought home. A relatively high statutory tax rate, combined with deferral, encourages firms to move profits to low- and no-tax countries, needlessly wasting resources and depriving the Treasury of revenue. It’s less clear what effect the current system has on corporate decisions about where to invest in physical capital and hire workers because the U.S effective tax rate is comparable to the OECD average when appropriate adjustments are made2.

    It would appear from recent tax reform debates that the most popular way to reform the system is to lower the corporate tax rate and move to a territorial-based system. It is not clear what rate would prevail, but somewhere in the ballpark of 25% seems realistic. To deal with the approximately $2.5 trillion of U.S. corporate earnings that are stockpiled abroad, transitioning to the new system would likely include a one-time deemed repatriation with a relatively low tax rate applied to those earnings3. Going forward, foreign earnings would then be taxed under the new territorial system which would mean they would not be subject to U.S. tax. This would create incentives for corporations to shift valuable assets (e.g., intellectual property) and profits out of the U.S. and into low- and no-tax countries. Policymakers have realized this and have indicated that strong anti-base erosion provisions would be needed. History has demonstrated, however, that drafting these rules would be no easy task, and would add a great deal of complexity to the code. There is also no guarantee that the rules would work as corporate tax planners would likely search for ways around or through them.

    To address the base erosion problem and avoid drafting complex rules, a minimum tax could be tacked onto the new territorial system. For example, if a corporation reports income in a country with a rate above, say 15%, then the territorial system is applied and no tax is owed to the United States. If, however, a corporation reports income in a country with a tax rate less than 15%, then the firm would owe the U.S. the difference between the reporting country’s tax rate and the 15% rate. Thus, U.S. corporations would still have access to foreign tax credits. While a minimum tax may be easier than designing a complex set of rules to prevent profit shifting, it comes with its own problems. Would the minimum tax be worldwide-based or country-by-country? If it is worldwide-based, then a company with real operations in a high-tax country could divert a significant amount of earnings to a tax haven and owe very little U.S. tax. A country-by-country minimum tax could prevent this, but would likely be strongly opposed by participants. Careful consideration would also have to be given about which country’s system would be used to compute tax rates for purposes of the minimum tax, and what tax rate measure would be used since statutory and effective tax rates are bound to be different. In the end, the need for a minimum tax may imply that there is something structurally wrong with the underlying framework that needs patching.

    There is alternative to the territorial-based approach that may be structurally sturdier, and that also allows for a reduction in corporate taxes and addresses profit shifting: a move to an (almost) pure worldwide tax system. This may also be the easiest and most economically efficient option too, although it has been given much less consideration outside of academics. The move would involve two changes - the repeal of deferral, and the lowering of the statutory tax rate. Since U.S. corporations complain that the tax rate under the current system is too high, they should be receptive to a rate around 20% (or less) under the new system since that would put the U.S. on the lower end of the tax distribution among developed countries4. Corporations could not argue that such a system does not allow them to compete in foreign markets since they would be facing similar, and in many markets, lower rates than their rivals. Additionally, foreign tax credits would still be available under this new system, so there would be no double taxation on repatriated profits.

    There are several potential benefits to this approach. First, corporations would make business decisions based on real economic factors instead of tax differentials. From an economic perspective, this would increase efficiency as resources would be directed to their most productive use. Second, tax revenues would likely increase as there would be no incentive or ability to stash earnings in tax havens since that income would be taxed regardless of if it is brought home. Also, depending on how the $2.5 trillion in untaxed overseas earnings were handled, for example via a deemed repatriation similar to the one included with recent territorial proposals, there could be a significant one-time surge in revenues that could be used for any number of domestic programs. Third, the argument that the U.S. tax system inhibits the ability of corporations to compete abroad losses credibility because U.S. companies would face tax rates similar to that of their rivals. Finally, and related to the last point, with its low tax rate the U.S. would be an attractive place for foreign investment which could provide an added to those at home.

    As with implementing any tax system, the devil is in the details. A worldwide system that is chipped away at with special exceptions would return us to where we started. Careful thought would also be needed regarding foreign tax credit rules so that the U.S. did not end up subsidizing other countries’ treasuries. In the end, a true worldwide system may not be politically palatable, and perhaps a territorial system with strong anti-base erosion provisions is the second-best solution. Still, with corporations arguing for a tax rate cut and some policy makers raising concerns over the debt, it may be worthwhile considering a worldwide system as a possible option to meet everyone’s objectives.

    1. Using competition as a criteria for evaluating international tax policy may be problematic for a number of reasons. For more information, see Competition And International Tax Policy.
    2. The three most important adjustments (1) properly accounting for differences in tax provisions that drive the effective rate below the statutory rate, (2) separating equipment from structures, and (3) computing the average OECD tax rate as a “weighted” average to account for the size of the economies that comprise the OECD.
    3. It is important to note that a significant fraction, perhaps 50% or more, of these untaxed earnings are in the form of productive capital assets (machines, factories, etc.), and not cash. For a discussion about this distinction, see An Important Detail About The Amount Of Untaxed U.S. Corporate Income Held Abroad.
    4. The exact rate would depend on whether revenue neutrality was a goal. See How The United States Can Attain Revenue Neutral Tax Reform for a discussion about some of the issues revenue neutrality presents.
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  • The information provided in this article is for general information purposes only. The information is not intended to be comprehensive or to include advice on which you may rely. You should always consult a suitably qualified professional on any specific matter.

Mark Keightley

Mark Keightley is an economist with the Congressional Research Service (CRS) in Washington DC. His research areas include corporate and business taxation, housing taxation, financial securities taxation, and macroeconomics. He serves as an adjunct professor in the School of Policy, Government, and International Affairs at George Mason University where he teaches graduate-level courses in macroeconomics, microeconomics, and investment. Mark was previously an associate at the Congressional Budget Office, a visiting scholar at the Federal Reserve Bank of Saint Louis, and an adjunct professor in the economics department of The George Washington University. He earned a BS in economics from the College of Charleston, and an MS and PhD in economics from Florida State University.

* The views expressed herein are those of the author and are not presented as those of the Congressional Research Service or the Library of Congress.

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