Alan Cole at the Tax Foundation highlights yet another way in which the corporate tax code works against American interests. He cites a recent report from the Australia Institute which argued that a large chunk of their corporate income tax cuts will be eat up by the IRS. This is because the U.S. employs a “worldwide” tax code, which taxes companies and individuals on income earned overseas.
Even tax collectors and politicians understand that completely piling U.S. taxes on top of foreign taxes would be excessive, so they provide a credit for any taxes paid to the local jurisdiction and only collect the difference up to the typically higher U.S. rate. As Cole explains, this has the odd effect of leaving the U.S. tax base at the mercy of foreign politicians:
The essential question for U.S. policymakers is this: is it in the U.S.’s best interests to have the U.S. Treasury treat U.S. revenues and Australian revenues as equal priorities?
Our worldwide system doesn’t just impact the competitiveness of our multinationals; it allows other countries to define our tax base. Australia, when it changes its tax rate, defines our federal revenues, which is dubious policy from our perspective. It would be better to stop having the IRS concerned with what goes on abroad; this would best be done through a territorial or dividend exemption system. Under such a system, we would no longer concern ourselves with the tax regimes of foreigners.
The incentives created by the worldwide system are extremely perverse. Nations that attract a lot of U.S. companies are being encouraged to raise their taxes to collect what otherwise might go to the U.S. treasury (deferral allows companies to avoid U.S. taxes so long as they keep profits overseas, which while necessary to blunt the impact of the worldwide system creates its own set of problems). This undermines tax competition and promotes policies more destructive to the global economy.
As Cole suggests, ending the worldwide system and taking the globally standard territorial approach would go a long way toward solving our corporate tax problem.
