US International Tax System is Fundamentally Unserious

May 6, 2014

On April 1st, we joked that the United States would try to raise taxes on Canada to pay down its deficit. It is unfortunate that this joke has a strong kernel of truth. The United States does try to raise taxes on other nations – largely unsuccessfully.

The United States is one of the last six remaining countries in the OECD – along with Chile, Ireland, Israel, South Korea, and Mexico – to use a “worldwide” system of corporate taxation. The other twenty-eight countries in the OECD use the much sounder territorial system.

These systems are similar on profits earned domestically. If a corporation does business in a country, it owes taxes to that country in some proportion to the profits earned. Simple enough.

They differ on profits earned abroad. A territorial tax system ends at its country’s borders. In contrast, the United States tries to levy taxes on profits earned in countries other than the United States. The tax system sees an auto assembly plant in Craiova, Romania, built using international funding, staffed by Romanian workers, building a vehicle – the Ford B-Max – that isn’t even sold in the United States – and says “Aha! This is economic activity the United States should be able to tax!”

A wiser public policy would see this as an obvious failure of jurisdiction. The United States has no real authority to decide what happens in southern Romania. In partial recognition of this limitation, the IRS waits until income is “repatriated” – brought back to the United States – in order to assess it and tax it.

One way to sidestep the repatriation tax is to wait as long as possible to return income to the United States. However, an even more foolproof way to avoid this over-assertion of authority is to put one’s headquarters in another country, one that doesn’t try to levy taxes in territories it doesn’t control.

Pfizer, an American drug maker, is currently attempting to purchase its British rival AstraZeneca, such that it can relocate its headquarters to the United Kingdom for tax reasons. If it succeeds, it will continue paying US taxes in the US, and British taxes in Britain, a perfectly reasonable-sounding arrangement that doesn’t resemble an April Fools’ joke.

Business moves like this should give us pause about the competitiveness of our tax policy. Instead, Treasury is unwisely doubling down on its ineffective attempts to tax foreign economic activity by cracking down on companies that attempt this sort of restructuring. This is not the way. Wall-building, literal or metaphorical, is not the hallmark of a free society secure in its greatness.

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