International tax gives me a migraine, but President Obama’s new effort to tax overseas income has the wonkosphere buzzing, so I can’t resist adding to the cacophony.
First, some of what Obama is proposing will be very useful. Some may be counterproductive. But whatever it is, it is not tax reform. I wish Obama would stop degrading the concept of reform by using the phrase to describe what is mostly a tax increase on multinational businesses. Tax reform implies a coherent structure for raising revenue. This is a complex package of international tax changes, but I don't see the all-important internal logic that makes it reform.
Second, Obama is conflating two issues: tax abuse and legitimate efforts by multinationals to reduce their tax liability. To the degree he is trying to crack down on real abuse, bravo. Washington has been yapping about this for years, but never pulled it off. Maybe Obama will. It is about time.
But a company’s decision to defer paying U.S. tax on foreign income by leaving profits overseas is not abuse. It is a perfectly sensible response to a U.S. system of taxing multinationals that is out of synch with most of the world.
It is all very complicated, but boiled down to its essence, the tax regime works like this: You open a plant in Ireland and pay the top Irish rate of 12.5 percent on your profits. If you bring your earnings home, you must pay the U.S. rate of 35 percent, which you then offset with a U.S. credit for those Irish taxes you already paid.
If you are like many CFOs, however, you never bring the money home. Instead, you reinvest those profits back into your Irish business or, perhaps, build a new plant in Thailand and avoid that 35 percent U.S. tax. The problem is not that companies won’t repatriate the money back to the U.S. It is that most countries tax only local profits while we persist in trying to tax worldwide income, offset by those complex credits. That’s the part where my head starts to throb.
Obama could try to fix this by proposing to get the U.S. corporate tax system in harness with everyone else. For instance, he could lower the rate and impose a Value-Added Tax, which almost every other country in the world already has. He could exempt foreign dividends from domestic tax, which is the way most countries do it. Or, he could at least combine a requirement that companies pay U.S. tax on foreign income right away with a significant cut in the corporate rate. That would make U.S. rates more competitive with the rest of the world, and make it less likely companies will continue to stash their profits overseas.
A couple of years ago, House Ways & Means Committee Chairman Charles Rangel (D-N.Y.) tried to combine limits on deferral, foreign tax credit reforms, and a big corporate rate cut. Rangel’s idea went nowhere, but it was a serious effort at reform. I'm not saying Obama needs to be locked into a revenue-neutral corporate tax package. He could scrap billions of dollars in business tax subsidies to help reduce the deficit. But somehow bringing the U.S. corporate rate more in line with the rest of the world seems unavoidable.
One final point: Obama says his crackdown will generate $210 billion over 10 years. Problem is, cadres of smart tax lawyers probably are already working out ways around these changes. If they find enough of them, the package will produce much less than the Administration hopes.
