Tuesday, November 19, 2013

Senate Finance Committee international business tax reform discussion draft: Part 1

Today Senator Baucus, the chairman of the Senate Finance Committee, released a staff discussion draft on international business tax reform.  You can find a New York Times description of it here, as well as an official description of it here, not to mention a one-page staff summary here and even detailed statutory language here.

I myself have looked at all of the above except for the statutory language, which I have printed out with the hope of getting to read it during my airplane flight to Tampa tomorrow.  (I will be attending the National Tax Association's 106th Annual Meeting, at which Tracy Gordon and I are the program co-chairs.  If you can tolerate one more link, the conference program is available here.)

One key feature of the discussion draft is its imposing a one-time transition tax on U.S. companies' unrepatriated foreign source earnings.  I gather that these earnings would face a one-time 20 percent U.S. tax, which could be paid over 8 years.  This is an idea that I promoted in my article on corporate residence electivity (available here), not having previously heard anyone propose it, although I honestly don't know if I'm the source of the idea given that sometimes multiple people think of the same thing.

Not surprisingly, I consider this a generally meritorious idea, in part because its anticipation effects, if people think it might be enacted even before it actually is, push towards reducing the incentive to keep funds abroad indefinitely.  However, there is one important question to keep in mind, if it is used as a "pay-for" in a broader international or business tax reform package that also contains revenue reductions, such as from lowering the corporate rate.  Since this is a one-time tax, one wouldn't want to rely on claims of overall revenue neutrality that reflected ignored continuing revenue loss outside of a finite, such as ten-year, budget window.

A second feature of the proposal is its making U.S. companies taxable on their foreign subsidiaries' sales into the U.S. market.  Assuming that tax planners cannot game this rule too easily - a question that I obviously can't evaluate at this point - I'd view this idea as having considerable merit.  Roughly speaking, and despite major formal and substantive differences, it has some potential economic commonality with (a) making the U.S. corporate tax system destination-based rather than origin-based (as Alan Auerbach has proposed), and/or (b) using formulary apportionment, with primary or even exclusive emphasis on the sales factor (as Reuven Avi-Yonah and Kim Clausing have proposed).  In practice, this will often be income that actually was created economically in the U.S., even if the magic of tax planning causes it to be classified as foreign source income.  And in addition, there are efficiency benefits, including but not limited to reducing tax planning games, to causing U.S. tax liability, in one of these ways, to be in part a function of domestic sales.

I presume that this inclusion would be subject to the allowance of foreign tax credits with respect to the sales income.  If I am right about this (and I will correct this posting promptly if informed that I'm wrong), then there is a problem.  U.S. companies would have zero incentive to reduce foreign taxes up to the point of the foreign tax credit limit, given creditability.  OK, but isn't that already true today under the foreign tax credit?  Ah, but there's a difference.  As I discuss in my book - and I think this is an important point - deferral for unrepatriated foreign earnings, which the Discussion Draft would eliminate, is bad in almost all other ways, but it does have the virtue of making U.S. companies foreign tax cost-conscious under most of the realistic scenarios.  The foreign tax credit becomes worse, even if you don't directly change it, when you repeal deferral.  And this, to my mind, calls at a minimum for scaling back the 100 percent reimbursement percentage that the foreign tax credit generally offers when applicable.

More in subsequent posts, I hope - although subject to multiple claims on my time - first on other important features in the Discussion Draft, and then on its potential significance as a marker in the ongoing debate even if we posit that no significant Congressional tax legislation is likely to be imminent.

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