A bold fix for US international taxation of corporations

Both the Biden administration, through its just announced “The Made in America Tax Plan,”  and several senators, including Senate Finance Committee Chair Ron Wyden (D-OR), Sherrod Brown (D-OH) and Mark Warner (D-VA), are trying to revamp the complicated, and to some extent, flawed changes made to the U.S. international tax system  in 2017 by the so-called Tax Cuts and Jobs Act.

The target of this effort should be to encourage corporations to keep and create new good paying jobs in the United States, to avoid tax barriers to repatriation of offshore profits and to prevent U.S. taxation from making U.S. companies noncompetitive with their foreign rivals. 

While the international tax changes made by the act may have addressed the latter two goals, it has failed at the first and presumably the most important objective, which Senator Wyden stated during a March Senate Finance Committee Hearing “is a need to make sure the best research and manufacturing is done in America.” 

To that end, I propose the U.S. should repeal the global intangible low taxed income provision altogether coupled with the removal of the participation exemption, both enacted as part of the Tax Cuts and Jobs Act. Under the participation exemption, most dividends made from foreign subsidiaries to the U.S. parent company are entitled to a 100 percent dividends received deduction, thus permanently avoiding U.S. taxation. 

These two features of the act should be replaced with a worldwide tax system, wherein profits of foreign subsidiaries of U.S. corporations are taxed to the corporate parent when they are earned, but coupled with both a U.S. corporate tax rate a few points lower than that for domestic profits as well as the reenactment of a credit for foreign income taxes paid by a foreign subsidiary. Thus, for example, if the normal U.S. corporate tax rate was increased from the current 21 percent rate to 28 percent (which the Biden administration is proposing) foreign earnings might be subject to a rate of about 22 percent.

The Biden administration has recommended modifying the global intangible low taxed income provision by increasing the tax rate U.S. corporations pay for certain amounts earned by their controlled foreign corporations. It also recommends modifying it to eliminate a taxpayer favorable reduction of what is deemed taxable to the U.S. multinational corporations under the provision. 

Furthermore, the plan contains a country-by-country element to calculations to attempt to better capture profits in tax haven jurisdictions. There seems to be a fixation on rectifying the global intangible low taxed income provision rather than fundamentally revamping the Tax Cuts and Jobs Act methodology for addressing international taxation which includes doing away with the participation exemption. 

When the global intangible low taxed income provision was originally enacted, it was supposed to prevent U.S. companies from migrating profits and jobs overseas. It has failed in this regard.  During the March Senate Finance Committee Kimberly Clausing, the Treasury Department’s deputy assistant secretary, Tax Analysis, testified that the international tax system post-Tax Cuts and Jobs Act “definitely rewards offshoring” of jobs and profits. According to a recent report by the Staff of the Joint Committee on Taxation (JCX 16-21), the Tax Cut and Jobs Act reduced the average U.S. tax rate paid by the largest U.S. corporations by more than half. 

While the Biden administration initiative would, if enacted, likely make the global intangible low taxed income provision somewhat more effective, renovating the provision is not the approach that should be undertaken. This is akin to trying to plug a leaking dyke when the architectural plans for the structure were improper.

The proposal I am making admittedly doesn’t fully achieve all three targets in full. It would, however, prevent the lock-out effect existing before the Tax Cuts and Jobs Act that fostered a system wherein U.S. companies kept low taxed earnings of their foreign subsidiaries offshore. At the same time, this plan will keep U.S. companies somewhat competitive with their foreign rivals, with respect to tax, although not as good as what they enjoy today. 

Foreign companies organized in countries with a territorial system exempting home countries from taxation of foreign subsidiary earnings will still be somewhat advantaged. Most importantly, adoption of this reform to our tax system will result in a sharply reduced incentive to shift operations outside the U.S.  

Philip G. Cohen is a professor of Taxation, Pace University’s Lubin School of Business & a retired vice president-Tax & General Tax Counsel at Unilever United States, Inc. The views expressed herein don’t necessarily represent any organization to which he is or was associated with.