While the problems with our international tax system are complex, the solution is relatively simple: U.S. corporations should pay the same tax rate, at the same time, on their domestic and foreign profits.
The ranking member of the Senate Finance Committee, Sen. Ron Wyden, made the case for this reform earlier this week in a Senate Finance Committee hearing on the international tax system by calling for an end to the deferral of taxes on foreign profits. Wyden has made ending deferral one of the central planks of his bipartisan tax reform legislation.
The root of the problem with the United States’ international tax system is multinational corporations’ ability to defer paying taxes on their foreign profits until these profits are repatriated to the United States. This creates a strong incentive for companies to shift their foreign profits and use accounting gimmicks to move U.S. profits to tax havens, where they will owe little to no tax. Without the ability to defer taxes on their offshore income, there would be no incentive to hold earnings in tax havens because companies would owe U.S. taxes on this income either way.
Exactly how much do companies avoid paying in taxes due to our system of deferral of taxes? According to the non-partisan scorekeepers at the Joint Committee on Taxation (JCT), deferral will allow U.S. companies to avoid paying some $418 billion in federal income taxes over just the next five years.
For its part, in its latest budget the Obama Administration proposed a 19 percent minimum tax on foreign profits. While this proposal is praiseworthy for ending deferral, the fact that the minimum tax rate would be lower than the tax rate on foreign profits means that it would still leave in place a system that incentivizes corporations to shift profits offshore, either on paper or by shifting real operations.
During another Senate Finance Committee hearing on simplification, Professor Mihir Desai, by no means a foe of multinational corporations, noted in his testimony that he thinks it is preferable to explicitly repeal deferral given that a minimum tax "creates numerous opportunities for planners that have resources that far eclipse the ability of the government to police them." Reinforcing this point, the JCT estimates that Obama's minimum tax would only capture about a third, $130 billion over five years, of the revenue lost due to deferral of taxes on foreign profits.
Unfortunately, much of the push for international tax reform is coming from advocates of a territorial tax system, which would actually exacerbate the problems we currently face with offshore tax shifting by exempting much of U.S. corporations’ foreign income from taxation. In other words, rather than making the U.S. more "competitive" as companies claim, a territorial system would just make it even more beneficial for U.S. companies to move jobs and profits offshore.
Looking at the big picture, tax professor and former corporate tax practitioner Stephen Shay argued before the Senate Finance Committee that the Wyden proposal to end deferral was the "first best choice" to reform the international tax system because it is the best way to address base erosion and profit shifting by multinational corporations. Senate Finance Committee members should take the recommendation of Professor Shay, Ranking Member Wyden and an increasing number of advocates to heart as they develop proposals for international tax reform going forward.