DUDE, YOU SKIPPED A STEP:

"PROFIT SHIFTING" IS THE biggest lawful tax avoidance strategy in the United States and the world. Tax professor Kimberly Clausing of Reed College estimates that 31 percent of corporate tax revenue was lost due to profit shifting in 2012. In other words, the IRS collected $242 billion in corporate tax revenue that year, but should have collected another $111 billion if profit shifting to foreign jurisdictions did not exist. The problem rapidly accelerated from 2004 to 2012, and continues to increase dramatically. In 2016, it is possible that more than 40 percent of potential corporate tax revenue will be lost.

Some reformers on the Democratic side may be missing the mark when focusing on tax loopholes, tax breaks, and statutory rates while preserving the taxation of U.S. corporations' worldwide income. Most developed countries tax income generated in their country; this is called a "territorial" income tax system. While the worldwide taxation system we have may, at first, seem like a good idea to progressives who want U.S. multinationals to be taxed properly, our system is having the opposite effect, and it can't be corrected through tinkering.

Professor Clausing of Reed College puts it this way:

As a result, the U.S. "worldwide" system of taxation is substantially more generous to foreign income than many alternative systems of taxation.

Unlike most trading partners, the U.S. system purports to tax the worldwide income of multinational companies at the statutory rate of 35 percent, granting a tax credit for taxes paid to other countries. Yet, because U.S. taxation is not triggered unless income is repatriated, multinationals can avoid residual tax by indefinitely holding income abroad. ... As a result, the U.S. "worldwide" system of taxation is substantially more generous to foreign income than many alternative systems of taxation.

Republicans want lower statutory corporate tax rates (and some want to eliminate the corporate tax entirely). They also advocate "territorial taxation," which taxes only that corporate income generated in the United States. They rightly point out that most developed countries have territorial taxation and that we apply a territorial, not worldwide, tax on foreign companies doing business here. This is indeed unfair to U.S. companies. But the Republican goals are unworkable without addressing the problem of profit shifting to tax havens.

Representative Sander Levin of Michigan is the ranking Democratic member of the tax-writing Ways and Means Committee. In a 2011 speech, Levin said of the GOP's push for a territorial system:

We need to move beyond the current easy rhetoric about a move to a territorial system because it does have the potential to encourage American corporations to shift more of their income, and possibly jobs, overseas. If we are going to consider a territorial system, we will need to strengthen our transfer pricing rules, address the allocation of expenses, and consider provisions to deal with tax havens.

Put simply, if Congress were to adopt a territorial system to tax only U.S.-originated revenue without addressing profit shifting, corporations would continue to artificially book income in tax havens. Tax revenue would continue to plummet. There is a remedy that fixes profit shifting, adopts a territorial tax, and solidifies tax revenue, by adapting a variation of the corporate tax system already used at the state level.

This approach is called "sales factor apportionment" (SFA). Here's how it works. SFA would apportion U.S. corporate tax on worldwide company income based upon the ratio of U.S. sales to worldwide sales. Despite the complex name, the principle is very simple. SFA disregards all internal corporate transfer pricing between subsidiaries, so a "sale" to a true customer outside the company is all that matters. In other words, the internal profit shifting in our RGC example becomes not only useless but stupid, as it lacks a business rationale. SFA also achieves the Republicans' territoriality goal in a way that is good for the country while achieving the Democrats' goal of eliminating tax avoidance and maintaining tax revenue. In fact, the U.S. states adopted this system long ago, to avoid artificial income shifting from high-tax to low-tax states. So it is hardly an alien concept, because U.S. companies already comply with it.

The U.S. corporate tax rate is indeed high among developed economies, but is so ineffective that it collects less revenue as a percent of GDP than foreign countries with lower tax rates. SFA ends the charade.

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