POMERLEAU: Enabling American companies to compete at home and abroad

Tax reform must reach beyond U.S. borders

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Consensus regarding the need to repair our long-broken tax code can be easily found among lawmakers of all stripes — Republican or Democrat — and pro-reform talking points are never in short supply.

Unfortunately, this debate only scratches the surface of the reforms needed to our tax code. The focus on reducing our overall rate here at home — something that is badly needed — forgets another aspect of reform that weighs just as heavily on the competitive prospects of American companies and our economy at large: the taxation of U.S. multinationals operating overseas.

It is not a stretch to call the United States’ treatment of its multinational corporations among the most onerous of any nation in the developed world. Under our “worldwide” tax structure, American companies are required to pay the standard 35 percent federal tax rate, regardless of where income is earned — at home or abroad. The cross-jurisdictional accounting confronting U. S. companies seeking to compete overseas under this structure can make your head spin.

For example, if an American company earns $100 in the United Kingdom, that income is subject to the UK’s standard 21 percent corporate tax rate — a tax bill of $21. Upon bringing that income back to the United States, an additional 14 percent ($14) tax would be levied by the U.S. government to arrive at the 35 percent U.S. rate.

In order to arrive at a total tax rate of at least 35 percent on foreign income and limit double taxation, a tax credit equal to the foreign taxes already paid is provided to U.S. corporations up to, but not beyond, the 35 percent U.S. rate. American companies can delay, or “defer” payment of this tax by reinvesting the earnings into the activities of their foreign subsidiaries.

This system is beyond unwieldy. It is decisively uncompetitive. On top of it all, the system has also reliably led to a chorus of reporters and policymakers eager to accuse American companies of avoiding their U.S. tax burdens or, worse, attempting to disqualify individual sectors from use of the vitally important foreign tax credit.

The White House’s frequent effort to modify “dual capacity” rules for American energy companies in a manner that would prevent them from taking a credit for income taxes paid overseas is a poster child for the compounding political and economic challenges that arise for American multinationals at the hand of our tax structure. These attacks come despite the fact that petroleum producers (along with coal producers) paid far more in foreign taxes than any other sector: $42.7 billion, or a 36.1 percent effective rate, according to our analysis.

Observers quick to critique American multinationals should make note of the reality of the heavy burden carried by the companies that choose to keep their headquarters in the United States despite the onerous tax code. They pay billions of dollars each year to foreign governments — $128 billion in 2010 — only to then be faced with billions more back at home on the very same income. This makes it exceedingly difficult for U.S. headquartered companies to invest their earnings in the United States, and this should serve as a red flag for any lawmaker interested in pro-growth U.S. tax changes.

The United States is one of only six industrialized nations to employ this burdensome worldwide system — and that number is shrinking steadily. In the past 15 years, 13 OECD nations (Japan, the U.K. and New Zealand most recently) have shifted to a “territorial” structure that would exempt most (or all) of foreign-earned income from additional taxation at home.

Repairing this discrepancy and ensuring that American companies aren’t placed at a competitive disadvantage to their foreign competitors should be at the forefront of the tax-reform debate.

Territorial taxation is not without its allies on Capitol Hill. The chairman of the House Ways and Means Committee, Rep. Dave Camp, Michigan Republican, prominently included a shift to this structure in his long-awaited tax-reform draft in 2013 — an encouraging if incremental step forward.

As the long campaign for a fairer and more competitive tax system continues, lawmakers should carefully examine the manner in which our government’s treatment of American companies overseas has hampered their growth and ability to invest here at home.

Kyle Pomerleau is an economist for the Tax Foundation’s Center for Federal Tax Policy.

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