December 1, 2013


Which Corporate Taxation for America? (Laura Tyson, Eric Drabkin, Ken Serwin, 11/30/13, Project Syndicate)

The current US system is based on a worldwide principle: the foreign earnings of US companies are subject to US corporate tax, with the amount owed offset by a tax credit for taxes paid in foreign jurisdictions. Most other developed countries, by contrast, have adopted "territorial" systems that largely exempt their MNCs' foreign earnings from home-country taxation.

MNCs headquartered in countries that employ a worldwide tax system are at a disadvantage when they compete in third-country markets with MNCs headquartered in territorial systems. Whereas US MNCs must pay the high US corporate tax rate on profits earned by their affiliates in low-tax foreign locations, MNCs headquartered in territorial systems pay only the local tax rate on such profits.

For example, when a US firm and a firm headquartered in a territorial system compete in a country where the local tax rate is 17%, the foreign firm owes 17% of its profits in taxes to the local country, while the US firm owes 35% of its profits in taxes - 17% to the local country plus 18% to the US. That difference translates into a sizeable cost advantage that allows the foreign firm to charge lower prices and capture market share from its US counterpart.

Current US law attempts to offset this competitive disadvantage through deferral: US MNCs are allowed to defer - potentially indefinitely - payment of US corporate tax on their foreign earnings until the earnings are repatriated to their US parent firms. Not surprisingly, most US MNCs take advantage of the deferral option for at least some of their foreign earnings.

As a means of bringing back this estimated $1.7 trillion in foreign earnings, the Senate Finance Committee's draft proposals suggest the elimination of deferral. However, faced with the threat to their competitiveness that this would pose, many US MNCs would shift their headquarters to countries with lower corporate tax rates and territorial systems.

Tax consumption, not earnings.

Posted by at December 1, 2013 2:27 PM

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