Preparing for the 2015 Corporate Tax Battle
As President Obama and the Congress prepare for the first of many tax and spending battles in the coming months, the White House made its opening offer on corporate tax reform, which was contained in the presentation of its budget in early February.1 Under the White House proposal, the federal corporate tax rate on profits earned in the United States would be cut from 35 percent to 28 percent, while eliminating "dozens of inefficient tax expenditures." In theory this package of domestic tax reforms is revenue neutral.
Not so for the White House proposal on taxing foreign earnings. Under present law, US corporations are liable for US taxes on all foreign profits earned by their controlled foreign subsidiaries, less taxes already paid to foreign governments on those profits. Since the US statutory rate of 35 percent is higher than almost all other countries, the residual US tax burden is significant.
However, no US tax liability arises until a US corporation repatriates earnings from abroad (an approach known as "deferral"). This creates an artificial incentive for US multinationals to reinvest foreign profits in their foreign subsidiaries indefinitely—while they wait for Congress to join the global norm and enact a territorial system that simply does not tax foreign earnings.
Under the White House proposal, US firms would face a one-time 14 percent "toll charge" on these accumulated foreign earnings, which now amount to about $2 trillion. After allowing for foreign taxes paid, the White House estimates that over $200 billion in tax revenue would be raised. The money would fund Obama's Surface Transportation Reauthorization proposal, designed to invest nearly $500 billion in US infrastructure over the next six years.
In addition, the White House would impose US tax at a 19 percent rate on all future profits earned aboard, allowing a credit (as under current law) for foreign taxes paid.
The White House package is a mixture of good and bad ideas. In the plus column, the package ends the "lock-out" incentive for US firms to reinvest profits abroad, it reduces the exceedingly high US statutory corporate tax rate, and it spurs infrastructure projects.
In the minus column, the US statutory rate would remain high relative to the average for countries in the Organization for Economic Cooperation and Development (OECD), particularly when subfederal corporate income taxes are factored in.2 The United States would persist as one of the few remaining countries that has not adopted a territorial corporate tax system and instead still seek to collect revenue from profits earned abroad.
The fundamental reality, overlooked by the White House, is that investment abroad is associated with the creation of US exports and jobs in the United States.3 Our research has repeatedly shown that foreign investment does not take place at the expense of US investment; it complements US investment. However, a one-time "toll charge" on accumulated earnings from the past would not act as a disincentive to future investment and the associated beneficial effects for the US economy, unlike a continuing 19 percent tax on future foreign earnings. Put simply, the 19 percent tax on future foreign earnings is a very bad idea. Moreover, while the White House package would spur much-needed infrastructure projects, the United States would benefit immensely from bolder action, as we outlined in a previous post.
Observers labeled the White House proposal "dead on arrival" in the Republican-controlled Congress. Key leaders John Boehner and Paul Ryan were both critical. However, Republicans might view some pieces of the proposal as a starting point for compromise. Obama's 28 percent corporate tax rate could be trimmed to Paul Ryan's 25 percent proposal. A more modest "toll charge" on accumulated foreign earnings—say 10 percent rather than 14 percent—coupled with a territorial system on future foreign profits should be acceptable to both the White House and the Congress. And fortunately, there is broad agreement that infrastructure is a nationally priority.
2. The US combined statutory corporate income tax rate is 39.1 percent, the highest in the OECD. If this rate fell by 7 points, only Japan, France, and Belgium would have higher overall rates.
3. Gary Clyde Hufbauer, Theodore H. Moran, and Lindsay Oldenski, 2013, Outward Foreign Direct Investment and US Exports, Jobs, and R&D: Implications for US Policy.