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Tax Foundation Senior Research Fellow Argues America's Real Problem Is Increasingly Out-of-Line Corporate Tax System Internationally
Washington, DC, May 5, 2009 - The following is a statement from Tax Foundation Senior Research Fellow, Robert Carroll, Ph.D., on President Barack Obama's proposal to end tax deferral of profits from American businesses earned abroad:
"The Obama Administration is proposing to raise more than $100 billion from American multinational corporations by limiting in some way the ability of U.S. companies to defer tax on profits earned abroad. The premise behind the proposal is that by raising the taxes paid on the foreign profits of U.S. companies earned abroad, the companies will somehow have more incentive to locate their operations here in the United States.
"The proposal, however, is flawed and fails to recognize that in the increasingly global economy where capital flows freely across borders, the United States can no longer expect other countries to follow its policies. The proposal will penalize the foreign operations of U.S. companies operating abroad and make it more difficult for them to compete with foreign companies.
"The manufacturing of tractors or generating facilities in places like China and India will be less likely to be done by U.S. companies. Rather, these business opportunities will more likely be won by the foreign competitors of U.S. companies with the economic rewards—jobs and profits—going abroad rather than U.S. companies.
"The real problem that the U.S. faces is that the U.S. tax system is increasingly out-of-line internationally. The U.S. now has the second highest corporate tax rate, exceeded only by Japan. Other measures of corporate tax rates show the same downward trend in corporate tax rates abroad.
"A recent study by James Hines*, examining how the economies of low-tax-rate countries have fared over the past several decades, found that countries with low tax rates grew 2.5 times faster—3.3 percent annually for low-tax-rate countries as compared to 1.4 percent for the world economy—from 1982 to 1999, a period characterized by increasing globalization.
"Other countries have also shifted to a so-called territorial tax system where only company profits generated within a country's borders are subject to tax. Japan shifted to a territorial system earlier this year and the United Kingdom announced a similar change just two weeks ago. The United States is now the only country with both a worldwide system and a corporate tax rate above 30 percent.
"Deferral—the feature of the U.S. corporate tax that is under attack by the Obama Administration—helps place the foreign business operations of U.S. multinational corporations on a more equal footing with foreign businesses operating in the same country. How does this work in practice? Consider a U.S. multinational corporation operating in a country with a territorial system:
- The income of the foreign subsidiary of the U.S. parent will be subject to the foreign country's corporate income tax. A foreign corporation operating in that same country will also be taxed on its foreign income earned in that country.
- If the U.S. multinational corporation were taxed on a worldwide basis—i.e., no deferral—the foreign profits would be subject to the U.S. corporate tax rate. The U.S. company would find itself at a disadvantage relative to its competitors because of the high 39.25 percent U.S. corporate tax rate (i.e., the combined federal-state tax rate).
- Tax deferral provides some relief from the high U.S. corporate tax rate by allowing the high U.S. tax to be deferred until the foreign profits are repatriated back to the United States.
"Deferral, in effect, helps place U.S. companies on a more equal footing by lowering the U.S. tax on income earned abroad. Without deferral, U.S. companies would be less, not more competitive."
The Tax Foundation is a nonpartisan, nonprofit organization that has monitored fiscal policy at the federal, state and local levels since 1937.
To schedule an interview, please contact Matt Moon, the Tax Foundation's Manager of Media Relations, at (202) 464-5102.
* James R. Hines, "Do Tax Havens Flourish," Tax Policy and the Economy, Vol. 19 (Cambridge, MA: MIT Press, 2005), p. 66.
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