Moving to a Territorial System and Reforming the Corporate Tax
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Description
As the Volcker task force evaluates base-broadening ideas, some important and meritorious reforms are unfortunately off the table. One example would be (after the housing market workout has eased) replacing the home mortgage interest deduction with a smaller, capped subsidy for homeownership that is unrelated to homeowner debt and takes the form of a refundable credit. Surely we've learned from the financial crisis that encouraging excessive homeownership (giving people undiversified asset portfolios), financed by excessive leverage, is undesirable. On the business side, it's unfortunate that the Obama administration led off with international tax proposals whose long-term feasibility is undermined by the difficulty of sustaining residence-based taxation of corporate entities. Investors can all too easily avoid those taxes by investing through non-U.S. entities, suggesting that in the long run, the United States may need to follow the worldwide trend toward territorial taxation of active business income. Tax reformers should keep in mind, however, that under the current international tax rules, U.S. multinationals have invested more than $10 trillion abroad, perhaps including as much as $1 trillion of what they designate for accounting purposes as permanently reinvested earnings. There is no reason those investments should reap a windfall transition gain from a shift to exemption. The most straightforward way to avoid the windfall would be to impose a one-time tax (the payment of which might be deferrable with interest) on the accumulated earnings and profits of U.S. companies' foreign subsidiaries. If that is politically or administratively unfeasible, a more complicated fallback, based on William Andrews's similarly motivated effort to limit windfalls from the adoption of corporate integration, might involve limiting dividend exemption to a normal return on posteffective-date new equity. Shifting to a territorial system should also be accompanied by improving the source rules so that companies cannot as easily shift income outside the United States. Several important studies have recently explored how that might be done. Key details should include relying on objective factors such as worldwide sales ratios—whether or not the method used is called formulary apportionment—and applying the system as uniformly as possible to multinational groups headed by U.S. companies on the one hand and foreign companies on the other. That would make corporate residence as irrelevant for tax purposes as it is economically. However, because this proposal would amount to raising the tax burden on business investment in the United States, rather than simply preventing the use of tax planning to recharacterize income generated here as foreign source, it should be accompanied by lowering the U.S. corporate tax rate.
Source Publication
Toward Tax Reform: Recommendations for President Obama’s Tax Force
Publication Date
2009
Recommended Citation
Shaviro, Daniel N., "Moving to a Territorial System and Reforming the Corporate Tax" (2009). Faculty Chapters. 1754.
https://gretchen.law.nyu.edu/fac-chapt/1754
