This paper argues that the erosion of the U.S. corporate income tax base is a large policy problem. Profit shifting by U.S. multinational corporations is reducing U.S. government tax revenues by more than $100 billion each year, and other countries are facing similar concerns. Yet given the starting point of the current U.S. corporate tax system, potential reformers face a dilemma. Reforms that would protect the U.S. corporate tax base may not find support in the multinational business community, which is more concerned with perceived competitiveness problems. But reforms that address competitiveness worries—such as the “toothless territorial” system that many in the multinational business community favor—would make the tax base erosion problem far worse.
This paper demonstrates that the perceived competitiveness problems are exaggerated. By all common metrics, U.S. multinational firms are doing quite well. They are not tax-disadvantaged relative to firms based in other peer countries. But the United States, like other non-tax-haven countries, has a large and growing corporate tax base erosion problem that has been fueled by both tax competition pressures and the increased tax avoidance activities of multinational firms, resulting in dramatic increases in income booked in very low-tax countries.
I offer several modest reforms that would improve our system of taxing multinational firms, including incremental steps that would stem tax base erosion, reduce the lockout of overseas U.S. corporate profits, and end the flight of U.S. corporations to overseas tax havens via corporate inversions. I also offer two more fundamental policy options: a worldwide consolidation of corporate returns for tax purposes, and a formulary approach similar to the way in which U.S. corporations determine what share of their national income is taxed across U.S. states. Such reforms would create a more effective and efficient U.S. corporate tax system that better serves the needs of the U.S. economy.
Almost all observers of the U.S. corporate tax system agree that the system is broken and in desperate need of reform. The United States has one of the highest statutory corporate tax rates among peer nations, yet we raise comparatively little corporate tax revenue as a share of our gross domestic product, or GDP. Specifically:
- Profit shifting by U.S. multinational corporations is reducing U.S. government tax revenues by more than $100 billion each year.
- About 98 percent of this revenue loss results from profit shifting to countries with corporate tax rates that are less that 15 percent, and 82 percent of the revenue loss results from profit shifting to just seven tax-haven countries.
- The scale of the revenue loss due to profit shifting has increased five-fold over the previous decade, due to increased profit shifting by multinational firms as well as global tax competition pressures.
Reformers face a policy dilemma between proposals that the multinational business community might favor on competitiveness grounds and corporate tax base protection. Proposals that address competitiveness by further lowering tax burdens on foreign income would make the base erosion problem worse, while proposals that address base erosion may increase the tax burden on foreign income.
Since there is scant evidence that U.S. multinational firms have a competitiveness problem, reform efforts should prioritize addressing corporate tax base erosion. Modest, incremental reforms could be quite effective, among them:
- Repealing check-the-box regulations that facilitates income shifting
- Tougher earnings stripping laws
- Anti-inversion rules such as an exit tax
More systematic reforms, however, are highly desirable. These include:
- Worldwide consolidation of corporate returns for tax purposes
- Formulary apportionment of international corporate income, using a method similar to that used by U.S. states in taxing national income
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