International Tax Reform

Prepared for SIEPR-TPC Tax Reform Conference

Rosanne AltshulerJanuary 18, 2013

The Current System

35%

The Current System

Lowland

15%

35%

The Current System

35%

15%

A U.S. corporation sets up an affiliate In Lowland…

The Current System

… earns $100and pays $15 in tax

to Lowland

35%

15%

Worldwide taxation with credit

Owes $35 to U.S. ─ $15 credit for taxes

paid to Lowland= $20 residual tax to U.S.

35%

15%

$100

Worldwide taxation with credit

earns $100 in Highland and pays$55 in taxes

35%

55%

Worldwide taxation with credit

$10035%

55%

Owe $35 to U.S. ─ $35 credit for taxes paid to Highland

= $0 residual tax and $20 of “excess credits”

Worldwide taxation with credit

15%

Earns $100

Earns $100

35%

55%

Worldwide taxation with credit

15%35%

55%Use $20 of “excess credits” from Highland to offset

$20 owed on income from Lowland= $0 residual tax

$100

$100

When is Tax on Foreign Earnings Paid?

Owe $20 residual tax to U.S. on earnings in Lowland ONLY when the $100

is repatriated

$10035%

15%

The current worldwide credit and deferral system creates many avenues for sophisticated tax planning

It’s complicated…

Transfer of intellectualproperty Royalties

License

Royalties

Sub license

RoyaltiesSublicense

Overseasbuyers

Even Dilbert does Google’s Double Irish with a Dutch Sandwich

Discontent with the current system has focused policy makers and analysts on possible reforms…

How do Territorial Systems work?

$10035%

15%

No tax owed to U.S. on the active income earned in Lowland

Territorial taxation through dividend exemption (royalty payments made to parent would be taxed)

List of OECD countries

Australia, Austria, Belgium, Canada, Chile, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Israel, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Slovenia, Slovak Republic, Spain, Sweden, Switzerland, Turkey, United Kingdom, United States

Territorial Tax Systems

Australia, Austria, Belgium, Canada, Chile, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Israel, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Slovenia, Slovak Republic, Spain, Sweden, Switzerland, Turkey, United Kingdom, United States

Worldwide Tax Systems

Australia, Austria, Belgium, Canada, Chile, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Israel, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Slovenia, Slovak Republic, Spain, Sweden, Switzerland, Turkey, United Kingdom, United States

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

20

25

30

35

40

45

50

Top Combined Statutory Corporate Tax Rates since 1986

United States

OECD average excluding U.S.

Combines central and sub-government taxes. Source: OECD tax database.

Problems with current system

• Income shifting and its effects on investment location decisions and revenue

• Lockout effect of repatriation tax and associated costs of avoidance

• Complexity• May put U.S. multinationals at a competitive

disadvantage• Raises little revenue

(Some) Possible Reforms

• Fundamental reforms– Worldwide taxation with repeal of deferral– Dividend exemption • Grubert and Altshuler (2012): combine dividend

exemption with a minimum tax of 15%

– Formulary apportionment

(Some) Possible Reforms

• Incremental reforms– Lower the statutory rate– Repeal check the box– Administration budget proposals and other

reforms of current law

Evaluating the Reforms

• Key considerations– Repatriation tax?– Income shifting incentives?– Tax revenue? – Simplicity?– Location incentives for tangible and intangible capital?– Expatriation incentives?– Transition rules?

Effective Tax Rate Simulations*

• Home country (U.S.) with tax rate of 30%• Low tax country (5% tax rate), high tax country

(25% tax rate), tax haven (0% tax rate)• A discrete high tech investment in low tax

country based on U.S. R&D• A routine investment in high tax location• Income shifting possible but is not costless

*From Grubert and Altshuler, 2012, “Fixing the System: An Analysis of Alternative Proposals for the Reform of International Tax”

Effective Tax Rate Simulations*Investment in

low tax country

(5% tax rate)

Investment in high tax country

(25% tax rate)Current law with 30% rate -23.6% 13.0%Current law, 30% rate, repeal of deferral 30.0% 30.0%Current law, 30% rate, repeal of check the box

-18.2% 24.2%

Dividend exemption -29.5% 10.7%Dividend exemption with minimum tax of 15%

5.6% 12.1%

*From Grubert and Altshuler, 2012, “Fixing the System: An Analysis of Alternative Proposals for the Reform of International Tax”. Assumes check the box remains in place unless noted.

Conclusions

• Look for reforms that make improvements to the current system across many dimensions including lockout effect, income shifting, competitiveness, and complexity

• Goals may not be in conflict– A minimum tax combined with dividend

exemption may have advantages over repeal of deferral and dividend exemption alone, and reduce their shortcomings