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A Taxing Question
The Obama administration reportedly is considering big changes in the broken system for taxing the foreign income of US corporations.
US multinationals have piled up overseas cash holdings in excess of $1 trillion, according to some estimates. Under current law, income earned by foreign subsidiaries of US firms is supposed to be taxed at the corporate rate of 35 percent. But the law provides a huge loophole that allows companies to sidestep paying any tax on foreign profits as long as the money stays outside the US. Hence, the overseas cash stash.
Business advocates have lobbied for a so-called territorial system that would permit corporations to pay taxes only to the country where income is earned. Such territorial tax policies have been adopted by a number of industrialized countries, including Canada, France, Germany, the Netherlands, Australia, Switzerland, Japan, and Britain. The White House's bipartisan Bowles-Simpson deficit reduction panel last year endorsed territorial taxation.
“I'm a proponent of a territorial system," HBS professor Fritz Foley recently told Reuters News. He cited concern about other nations, including Japan and Britain, that already embrace it. "Having said that, any move to territorial needs to be ... thought through quite carefully," he advised.
Opponents of territorial taxation, including organized labor and some liberal Democrats, argue that the solution to the problem isn’t to exempt overseas earnings from taxation. Rather, Congress should repeal the tax law that allows corporations to defer paying taxes on their overseas income, thereby generating billions in much-needed revenue for the US Treasury. And they point to major competitors with tax policies resembling the US system, including China, Brazil, India, Korea, Chile, Greece, Ireland, Israel, and Mexico.
The Obama administration apparently is aiming to create a hybrid proposal. “The Treasury Department is considering a proposal to eliminate some but not all taxes on the overseas profits of US multinational companies, a central element of the administration's broader plans to overhaul the corporate-tax code,” the Wall Street Journal reported.
While the Journal wasn’t able to ferret out details of Treasury’s thinking, HBS senior lecturer Robert Pozen, chairman emeritus of MFS Investment Management, has his own plan that merits consideration. Here’s the heart of his proposal:
“To reform the current system,” Pozen wrote in Bloomberg Businessweek, “Congress should exempt from US taxes corporate income earned in foreign countries with an effective corporate tax rate of 20 percent or higher. Such earnings could be repatriated to the U.S., subject to payment of a 5 percent administrative charge.”
“At the same time, Congress should end the current deferral system for foreign-source income earned by US corporations in countries with effective tax rates under 20 percent. Instead, that income would be taxed every year in the US at a rate equal to the difference between 20 percent and the actual rate paid by the corporation in the tax haven.”
Pozen contends that his “modified” territorial approach would be good for business and good for the Treasury. What’s your take?
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