BERKELEY – Corporate tax reform is one of the few issues that garner bipartisan support in a deeply divided US Congress. The current system, all agree, is deeply flawed: the corporate tax rate is too high by global standards, and the corporate tax base is too narrow, owing to numerous credits, deductions, and special provisions that distort economic decisions.
But there is significant debate about how to fix the system. One major area of disagreement is how to tax the foreign earnings of US multinational companies (MNCs), a disagreement highlighted by the recent proposals issued by Senator Max Baucus, the chair of the Senate Finance Committee.
The current US system is based on a worldwide principle: the foreign earnings of US companies are subject to US corporate tax, with the amount owed offset by a tax credit for taxes paid in foreign jurisdictions. Most other developed countries, by contrast, have adopted “territorial” systems that largely exempt their MNCs’ foreign earnings from home-country taxation.
MNCs headquartered in countries that employ a worldwide tax system are at a disadvantage when they compete in third-country markets with MNCs headquartered in territorial systems. Whereas US MNCs must pay the high US corporate tax rate on profits earned by their affiliates in low-tax foreign locations, MNCs headquartered in territorial systems pay only the local tax rate on such profits.