As Senator Wyden replaces Senator Baucus as Chairman of the Senate Finance Committee, the Committee has an opportunity to revise Baucus' recent proposals to reform the current U.S. system for taxing foreign profits of U.S. multinational corporations. Under the current system, U.S. corporations are subject to a 35% U.S. tax on their foreign profits only if repatriated to the U.S.; but that tax is indefinitely deferred if these profits are kept overseas. As a result, close to $2 trillion in U.S. corporate profits have piled up abroad—which are not deployed to build U.S. facilities, pay U.S. dividends, or make U.S. acquisitions.
The recent Baucus proposal has three main parts:
- A 20% tax (over the next 8 years) on pre-2014 foreign profits held abroad by U.S. corporations;
- A reduction in the general U.S. corporate tax rate from 35% to "below 30%"; and
- An annual tax on future foreign profits of U.S. corporations, at either 60% or 80% of the U.S. statutory rate on domestic corporate income.
While the Baucus proposal is built on useful principles, its suggested rates are too high. The implicit premise of the first part seems correct: pre-2014 foreign profits held abroad should be taxed at a lower rate than the current 35% U.S. statutory rate—almost the highest in the world. These pre-2014 profits were kept abroad by U.S. executives in reasonable reliance on current law.
Nevertheless, a 20% rate is still too high for pre-2014 profits. Countries like France charge 5% for their corporations to bring home their foreign profits. David Camp, Chairman of the House Ways and Committee, has also suggested a tax on pre-2014 foreign profits, though in the 5% to 6% range.
Second, Baucus tries to reduce the U.S. corporate tax rate on domestic profits below 30% in order to make the U.S. more competitive with most industrialized countries. Although this is a worthy goal, he does not identify enough revenue raisers to finance such a rate reduction on a revenue neutral basis—without increasing the federal debt.
A companion Senate bill proposes limits on accelerated depreciation, changes in tax accounting and repeal of tax preferences for specific industries. Other proposals would limit tax credits for research or interest deductions for corporations. Yet each of these proposals to raise tax revenues will meet fierce political opposition, so it is unclear whether the corporate tax rate on domestic profits can be brought below 30% on a revenue neutral basis.
The third proposal would replace the current system for tax deferral on foreign profits with the useful concept of a global competitiveness tax—paid by U.S. corporations either to foreign nations or the U.S. Suppose the global competitiveness rate for corporate taxes actually paid is 17%. If a U.S. corporation's profits in the Cayman Islands were taxed at 2%, it would immediately owe the US 15% in taxes on such profits. On the other hand, if those foreign profits were earned in the UK and taxed there at 17% or higher, the U.S. corporation could bring these profits back to the U.S. without paying any U.S. taxes.
A global competitiveness tax makes sense because it allows U.S. corporations to freely repatriate their foreign profits from nations with reasonable corporate tax rates, such as Germany or the UK. At the same time, a global competitiveness tax discourages U.S. corporations from cleverly transferring foreign profits to tax havens with minimal corporate taxes.
But the viability of a global competitiveness tax depends on the rate selected. Baucus suggests two alternative rates—60% or 80% of the U.S. tax rate on domestic corporate profits. Although these percentages may be negotiable starters, the design of these alternatives is flawed. The future U.S. tax rate on domestic corporate profits is too unpredictable to serve as the benchmark for the U.S. tax rate on foreign corporate earnings.
Instead, Congress should directly set the global competitiveness tax rate on U.S. foreign corporate profits around 17%. Why? Because this is the effective marginal tax rate, on average, paid by corporations in other advanced industrial nations, according to the OECD. In such nations, U.S. corporations would be able to compete on a roughly level playing field with foreign firms if both were paying taxes in the 17% range.
In short, the new leadership of the Senate Finance Committee should build on the principles in the Baucus proposal, but with lower rates on foreign corporate profits. Although the global competitiveness tax is not perfect, it is much better than the current system—and much simpler than other reform proposals that distinguish among different types of foreign income.
In order to enact the global competitiveness tax in 2014, Congress would have to wait on "comprehensive" tax reform. That broad program would require many powerful interest groups to give up their cherished tax preferences. By contrast, Congress can revise the current U.S. system for taxing foreign profits because it benefits almost no Americans (other than lawyers). This system raises little revenue for the U.S. Treasury, forces multinational corporations to take loans to pay U.S. dividends and discourages these corporations from building plants or research labs in the U.S.