Jack Lew’s Misinformation on the U.S. Corporate Tax System

July 16, 2014

In a recent letter to Congress’s tax writing committees, Treasury Secretary Jacob Lew wrote that Congress should act to prevent U.S. corporations from inverting (the practice of a U.S. company merging with a foreign company and moving its headquarters to the foreign country).

In doing so, Lew writes that corporations that invert “seek to shift their profits overseas to avoid paying their fair share of taxes,” while benefiting from the United States without paying a dime. To make his case, he provides this description of the situation:

“The firms involved in these transactions still expect to benefit from their business location in the United States, with our protection of intellectual property rights, our support of research and development, our investment climate, and our infrastructure, all funded by various levels of government. But these firms are attempting to avoid paying taxes here, notwithstanding the benefits they gain from being located in the United States.”

Unfortunately, Lew provides a false and misleading depiction of the U.S. corporate tax system.

When a U.S. based corporation earns income in the United States that income is subject to the U.S. corporate income tax. When a foreign based corporation earns income in the United States, again, that income is subject to the U.S. corporate income tax.

So, any U.S. corporation that becomes a foreign corporations will still be required to pay their “fair share” for the benefits they experience when operating on U.S. soil.

Additionally, corporate taxes aren’t the only tax these corporate pay. Any corporation operating in the U.S. pays all the other taxes that deal with doing business. They pay property taxes on any land or property they own, they pay sales taxes on any good they buy, they pay payroll taxes on wages they pay to their workers, and their employees pay income tax on the income they earn.

They avoid no U.S. taxes on their domestic income. But this isn’t to say they won’t pay less in total taxes. In many cases they will pay lower taxes, due to how our tax code treats foreign earned income.

The U.S. corporate tax system subjects U.S. based corporations to what is called a worldwide system of taxation. This means that corporations must pay taxes not only on income earned in the U.S. using American infrastructure, but also on income earned anywhere else in the world.

This tax treatment is out of step with the rest of the developed world—only six of the 34 OECD countries subject their corporations to this type of treatment. But more importantly, it puts U.S. businesses at a competitive disadvantage.

Nearly every foreign corporation that competes against U.S. corporations both in the U.S. and abroad holds a competitive advantage over the U.S. Let’s take the French based corporation, L’Oreal, for example.

When L’Oreal does business in the U.S. it pays the federal tax rate of 35 percent and when it does business in the United Kingdom, it pays the U.K.’s tax rate of 21 percent.

Now, a U.S. based corporation also pays a tax rate of 35 percent on U.S. income, but on income earned in the U.K., it again pays a tax rate of 35 percent (21 percent for the U.K. and 14 percent for the United States when it repatriates that income).

This is because France, along with almost all of the developed world, has a territorial tax system. This means that income is tax in the location in which it was earned, i.e. where the country receives the benefits of the government services such as infrastructure and sound laws.

A territorial tax system is the type of international tax system the U.S. needs to be competitive in the modern world.

So, instead of misrepresenting the current U.S. tax system and demonizing businesses looking for a fair shake in the global economy, Secretary Lew should turn his attention to helping Congress find solutions to fix our tax code. A lower corporate rate and a shift to a territorial tax system would be a good start.

For more information on how our tax code taxes international income, see the video below.

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