On October 26, 2011, as part of its overall approach to comprehensive tax reform that lowers rates and broadens the base, this Committee released a discussion draft aimed at modernizing our outdated international tax rules. The draft included a structure that would allow the U.S. to move from a worldwide taxation system to a participation exemption system similar to that used by almost all of our major trading partners. In the interest of transparency, we made a specific request – we actively sought feedback from stakeholders – taxpayers, practitioners, economists, and members of the general public on how to improve the draft proposal.
Since then, we have heard from a wide range of practitioners and worldwide American companies. Nearly all have offered a universal observation – having the highest corporate rate in the developed world along with an outdated international tax system is a barrier to success that leaves our country falling further behind our foreign competitors. Academics and economists agreed, and also cautioned, that any solution to these challenges must protect against erosion of the U.S. tax base through the shifting of profits to low-tax jurisdictions.
Their concern is not without merit. Oftentimes, multinational businesses reduce their tax liability by separating the jurisdiction in which income is booked for tax purposes from the jurisdiction in which the economic activity occurs. The result of these practices is ‘erosion’ of the tax base in a jurisdiction where the activity takes place.
We’ve all heard and read about these practices, and as we will hear today, the commentary on these practices varies greatly. As policymakers engaged in the tax reform debate, it is clear that there is no perfect system for taxing corporate income.
But it is also important to bear in mind, that these activities are the consequence of bad laws, not bad companies. In my mind, the fact that the current tax code allows companies to achieve these tax results strengthens the case for comprehensive tax reform.
Whether a country has a hybrid system similar to the current U.S. worldwide system or a dividend exemption system like that of our major trading partners, it is important to develop strong base erosion rules that protect against aggressive transfer pricing, anti-migration of intangible property overseas and foreign earnings stripping.
And let me just say that it is important to remember that the most effective anti-base erosion rule is a lower corporate tax rate. But unfortunately, while a lower rate is necessary, the rate alone is not sufficient.
Mindful of the need to develop meaningful protections of the U.S. tax base, the International Tax Reform Discussion Draft included three options to mitigate U.S. base erosion.
Although the merits of each option remain open for debate, Option C (the carrot and stick proposal) received, and continues to receive, the most support from the business community. And our close work with the staff of the Joint Committee on Taxation leads us to believe it is an effective safeguard.
Under Option C, all foreign income attributable to intangibles – whether or not owned by the U.S. parent or a foreign subsidiary – would be taxed by the United States at a substantially lower rate of 15 percent (minus any credits for foreign taxes paid on the same income). This approach provides a deduction for income related to intangibles kept in the United States (the carrot) and an immediate inclusion for income related to intangibles held abroad (the stick). In other words, companies would feel less pressure to shift income to low-tax jurisdictions because that income would be taxed at the same rate –whether it is earned in the United States or Bermuda.
The result of this approach would be that moving intangibles to tax havens would have little or no appeal since the income earned from those intangibles would be taxed at the same rate regardless of location.
In fact, some companies have said that intangibles, which have already been moved to tax havens under our current system, could actually be moved back to the United States because there would not be any tax advantage to owning them abroad.
The U.S. is not the only country concerned about base erosion. We will hear testimony today from the OECD about its base erosion and profit shifting report. As noted in the report, every jurisdiction is free to set up its corporate tax system as it chooses. However, the OECD’s attention to this issue underscores that concerns about base erosion exist globally and must be considered as solutions are developed that are unique to each country’s tax system.
As I said at the outset, there is no perfect solution and all systems have problems with base erosion. Our task is to develop a system that is more in tune with the global marketplace and that will allow domestic companies to prosper while simultaneously protecting the U.S. tax base.
Comprehensive tax reform that includes a more modernized system of international taxation, coupled with a lower rate, can create the climate necessary for those companies to prosper, invest and hire here at home.