A simple fix for the divisive U.S. corporate tax debate

July 8, 2013

No one is satisfied with the U.S. corporate tax system. From one perspective the main problem is that at a time when corporate profits are extraordinarily high relative to GDP, tax collections are very low relative to GDP. And many very successful companies pay little or nothing in taxes at a time when the budget deficit is a major concern and when hundreds of thousands of defense workers are being furloughed and lotteries are being held to determine which children Head Start can no longer afford to help. From another perspective, the main problem is that the United States has a higher corporate tax rate than any other major country and, unlike other countries, it imposes severe taxes on income earned outside its borders. Many argue that this unfairly burdens companies engaged in international competition, discourages the repatriation of profits earned abroad, and–because of the patterns of investment that result–benefits foreign workers at the expense of their counterparts.

These two perspectives on corporate taxes seem to point in opposite directions with respect to reform. The former perspective points towards the desirability of raising revenues by closing loopholes, whereas the latter perspective seems to call for a reduction in corporate tax burdens. Little wonder, then, that corporate tax reform debates are so divisive. Many can get behind the idea of “broadening the base and lowering the rate,” but consensus tends to collapse when the issue becomes the means to broaden the base. Indeed a principal objective of many business-oriented reformers seems to be narrowing the corporate tax base by reducing the taxation of foreign earnings through movement to a territorial system.

Where then should the debate go? Despite the tension between the critical perspectives on corporate tax reform, the current debate has landed us in so perverse a place that win-win reform is easy to achieve. The center of the issue is the taxation of global companies. Under current law U.S. companies are taxed on their foreign profits (with a credit for taxes paid to other governments) only when they repatriate these profits to the United States. Right now U.S. companies are holding nearly $2 trillion in cash abroad.  The companies argue, with some validity, that current rules burden them by making it expensive to bring money home without raising much revenue for the government because it has no claim against foreign profits that are not repatriated. They hope for and call for relief arguing that it will help them bring money home at a minimum for the benefit of their shareholders and possibly to increase investment.

The debate continues. The companies make their point while others rail against the idea that companies who have used what could politely be called aggressive accounting practices to locate income in low-tax jurisdictions should be given further relief. In the meantime, what is a corporate treasurer to do? With the possibility of some kind of relief looming, there is every reason to delay repatriating earnings to the United States even if the company has no good use for the cash abroad. And so the debate encourages exactly what everyone can agree should be avoided — corporate cash kept abroad to the detriment of companies and to no benefit for the American fisc.

A homely example makes the problem clear. Imagine a library where many books have been borrowed and are long overdue. There is a case for an amnesty to bring the books back and move on. There is a case for saying that rules are rules and fines must be paid. But the worst strategy is to keep indicating that an amnesty may come soon without ever introducing it. Yet something very similar is where we are in our corporate tax debate.

A clear and unambiguous commitment that there will be no rate reduction or repatriation relief for the next decade would be an improvement over the current situation because companies would know that they were going to have to pay taxes on their foreign profits if they wished to make them available to shareholders and would no longer have an incentive to delay.

But this would not be the best outcome. As a very general rule, any time tax rules are experienced by taxpayers as a substantial burden without generating substantial revenue for the government, improvement is possible. Having taxpayers be burdened less and pay more can make them better off and help the fisc. That is what should be done with corporate taxes. The U.S. should eliminate the distinction between repatriated and unrepatriated foreign corporate profits for U.S. companies and tax all foreign income (after allowance for taxes paid to other governments) at a fixed rate well below the current U.S. corporate rate — perhaps in the 15 percent range. A similar tax should be imposed on past accumulated profits held abroad.

Such a proposal could easily be designed to raise revenue relative to the current baseline, encourage the repatriation of funds to the United States, and reduce the competitive disadvantage faced by U.S. multinationals operating abroad. It is about as close to a free lunch as tax reformers will ever get.

PHOTO: A woman walks out of the Internal Revenue Service building in New York in this May 13, 2013 photo. REUTERS/Shannon Stapleton


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How about the worlds politicians actually acknowledging globalization? The world corporations have already done so. They see national borders as hindrances or leverage depending on the situation. We need to establish real global political entities that have real authority. Set a single standard tax rate for all international trade. Simple. Yes, it will be hard to get them all to agree. But just because it is hard to do doesn’t mean we should do nothing.

Posted by tmc | Report as abusive

How about the worlds politicians actually acknowledging globalization? The world corporations have already done so. They see national borders as hindrances or leverage depending on the situation. We need to establish real global political entities that have real authority. Set a single standard tax rate for all international trade. Simple. Yes, it will be hard to get them all to agree. But just because it is hard to do doesn’t mean we should do nothing.

Posted by tmc | Report as abusive

“No one is satisfied with the U.S. corporate tax system.” Clearly you never heard of Apple Computers.

Posted by BidnisMan | Report as abusive

Surprising how Summers completely ignores all the special tax rules that benefit just specific sectors: 1038 exchanges for real estate investment, depletion allowance for the oil industry, K1 limited partnership income, REITs, and of course the notorious preferential tax rate for private equity.

Plus the only the mega-mega companies can take advantage of off-shore revenue booking and the myriad ways taxes are avoided. Not the case for small firms (less than 100 employees) who are actually the job creators for the US economy for the past 30 years.

Huge powerful lobbies like the Chamber of Commerce are only concerned about the mega corporation enjoying the lowest effective tax rates in modern history. Summers should know. He is part of the problem. Just look at his tenure in Clinton’s cabinet.

Posted by Acetracy | Report as abusive

The main issue is not the taxes, laws, loopholes, etc., but the fact that corporations have no citizenship and no allegiance to anything, but the bottom line (a.k.a. profit)… which is why Western capitalism shoots itself in the foot by growing monsters like pseudo-capitalist actual-communist China that may very well devour the former in the end.
So, the real question to me is how to save capitalism from itself and if it’s not too late already?..

Posted by UauS | Report as abusive

“Right now U.S. companies are holding nearly $2 trillion in cash abroad.”

No, they don’t. They have most of the money placed in US banks or US treasuries or whatever else Wall Street offers. But they are holding it in the US in the name of a foreign entity. So all that “cash abroad” is already back in the US. It is only the tax law that do not recognize this fact.

Posted by Gaute | Report as abusive

The tax laws are just fine if your a corporation and since corporations control the politicians it will only get better for them. Our elected officials know who is really in charge and as much as they like to pander to the masses to get elected, they dare not offend the owners of the country. That’s why you get all that false concern from the politicians. It’s really an acting job that they have. They act like they care about the “people” and the “country”, but it’s just a ploy. It won’t change either, since the electorate is convinced that the economy is important to them, and assumes the stock markets signify the true economy. If the stock markets tank the current adminstration will get the blame and the political actors will shift. Neither party would do anything different though, since they are both in this same trap. So, since the american people are likely to defend the corporations because they are convinced it benefits them directly we cannot have any change to the current approaches that see the middleclass shrinking and the wealthy obtaining ever increasing amounts of money. Most amazing of all is the simplistic ideologies with which both the parties ensnare the common masses. One party says cut taxes for the wealthy and the other says spend on social welfare. Neither being sophisticated enough to take reality into account, but yet apparently easy enough for the average serf to understand and believe in.

Posted by brotherkenny4 | Report as abusive

A simpler solution is to establish a minimum flat “loyalty tax” on corporate unadjusted gross income worldwide, deduct foreign taxes, then require corporations to pay that, AMT or regular income tax, whichever is greater. Then everyone pays something, including the poor, who would be relieved by an increase in refundable credits equal to their loyalty tax. This makes foreign profits and repatriation irrelevant, and everyone pays something, both natural and fictional “persons.”

Posted by JamesSutton | Report as abusive

As is usual the solution are laws that are already on the books, just not enforced against public companies. Treat them like small family owned businesses and rape them. Equal protection under the law is the best disinfectant, kind of like legal sunshine Mr. Brandeis.

Posted by JP007 | Report as abusive

Correction to my prior comment. That would not work since governments are perpetual motion machines powered by cronies, kickbacks and corruption. Never mind.

Posted by JP007 | Report as abusive

Summers should know. He is part of the problem. Just look at his tenure in Clinton’s cabinet.

Why not look at his current part of the problem? There are in reality only a small number of individuals that agree on the stories they feed to the public. Not whether to change anything or not, just the storyline.

Posted by RetCombatVet | Report as abusive

Prof. Summers, as usual, offers a lucid explanation of a cloudy situation.
Let’s pursue his library fine analogy a little further. A library book held for, say, 20 years has been a useless combination of ink and paper for most of that time. It has sat on somebody’s shelf gathering dust, its paper browning under the onslaught of our acid-laden air, or been forgotten under a pile of old clothes in an attic or cellar, adding precious little to the world’s ever-diminishing supply of knowledge, wisdom or amusement. If the book is ever returned, with the usual accompanying newspaper feature whimsies, the homongous fine of $14,000.00 or so is forgiven. The book,with its foxed pages and crumbling binding, is rarely returned to the library shelves, being, instead, pulped, in essence flushed away.
An alternative scenario: the returned book is sent to someplace where there are few books, and where the printed word is still honored. There, readers, hungry for any book, will benefit from it.
In the same way, why can’t offshore profits be used locally as some sort of Financial Peace Corps avatar — with the corporation receiving kudos and credit (and perhaps credits against taxes as well)? It might partially substitute for US overseas loans to Third-World countries as well.

Posted by MossyMorse1118 | Report as abusive

This is an interesting article. I did not know that married couples pay different taxes. I am studying law so I really wanted to learn more about ways the IRS takes money from people who do not pay their taxes. I decided to look up IRS wage garnishment and I found some interesting stuff. It seems like wages are a power tool used by the IRS.

Posted by webimax2013 | Report as abusive