- Okay, welcome back
from the afternoon break.
It's generally agreed
from a policy perspective
that an effective system
of international taxation
is one that is consistent
with the concept of tax neutrality.
That is the system should
strive to be neutral
so that decisions are made on the basis
of their economic merits and
not based on tax reasons.
Most would agree that the
current U.S. international
tax system is riddled with
many non-neutralities.
Redesigning the international tax system
in a way that would be
consistent with the concept
of economic neutrality is the subject
of our next presentation by Alan Viard.
Alan is a resident scholar
at the American Enterprise Institute
where he studies federal
tax and budget policy.
Alan is currently at adjunct
professor at NYU Law School.
Prior to joining the American
Enterprise Institute,
Alan was a senior economist
at the Federal Reserve Bank.
He has also been a visiting scholar
at the US Department of the Treasury's
Office of Tax Analysis,
a senior economist at the White House's
Council of Economic Advisors,
and a staff economist at the
Joint Committee on Taxation
of the US Congress.
Alan, over to you.
(audience clapping)
Thanks, Larry.
Thank you all for attending today
and thank you for inviting me to speak.
So as he indicated,
I'm gonna try to discuss
the concept of neutrality.
I'll be doing this from
an economic perspective,
but I hope with a minimum
of economic jargon.
So you can let me know at the
end of the session I guess
how clear I was or was
not in trying to present
this economic perspective.
So neutrality in the mind of an economist
is synonymous with the idea
of minimizing distortions,
and so I have to start I think by defining
what I mean by distortion.
And there is an important choice
to make at the very outset
which really shapes how you
think about corporate tax policy
or about any other topic
that you might be analyzing.
The question is, are you
analyzing these issues
from a national perspective
or from a global perspective?
Much could be said about this.
We could devote a whole session
or a couple of sessions
to that topic alone.
I'm not gonna obviously
be able to do that.
Instead, I'm simply going to state
and very briefly defend my choice here,
following the same principles
that Dan Shaviro has mentioned
in many of his writings.
I do adopt a perspective
of national wellbeing
from the standpoint that we should choose
a US corporate tax system
that advances United States wellbeing.
Of course, that doesn't mean
pursuing destructive policies
that bring us into conflict
with other countries
and then feedback to cause
harm to the United States,
but it does mean that we ultimately
seek the wellbeing of Americans.
I think that's a perspective
that's well-accepted in other contexts.
Nobody really blinks an eye, for example,
about the fact that
the Affordable Care Act
is intended to provide health insurance
to tens of millions of Americans
who would otherwise lack health insurance,
while doing absolutely nothing
for the hundreds of millions
or even billions of people
elsewhere on this planet
who are even in greater need
of receiving healthcare.
We all understand that US policy
is by and large aimed at
the wellbeing of Americans,
although we take some
steps to try to combat
world poverty and human rights violations.
Our primary focus is at home.
And so that's the perspective
that I'll adopt here.
So from a national perspective,
a distortion exists whenever one activity
bears heavier US tax than another activity
that has the same payoff
to American society.
Any of these distortions will introduce
some change in behavior
done for tax reasons
that would reduce wellbeing
in American society,
but not all distortions are created equal.
Some are more harmful than others.
In general, a distortion is more harmful
when the penalized activity
is more tax sensitive.
So in other words, it's
harmful to penalize something
that people would then readily change,
but it's also more harmful if
the activity is already taxed
or if it's already under-supplied
for some other reason.
And this would apply to
many forms of real activity,
that if we're piling one distortion
on top of preexisting distortions,
we're already starting
from a harmful situation,
and so it's more harmful to be
imposing that new distortion.
While all taxes carry some
distortions with them,
certainly any tax system
that tries to be cognizant
of people's ability to
pay will have distortions.
And so the task is not to say,
well, let's try to eliminate
every distortion that exists,
but try to find a tax
system that's progressive
and that minimizes distortions
relative to the feasible alternatives.
It's my view and the
view of most economists
that the corporate income tax
fairs rather poorly along this dimension,
that the corporate income
tax has more distortions
than a typical tax, many
of them quite arbitrary
and quite capricious.
So many of them would apply
even if we had a closed-economy
and I'm gonna briefly mention those,
but then devote the bulk of my remarks
to the open-economy
that we actually live in
where those distortions
remain, but are accompanied
by other perhaps even
more serious distortions.
So in a closed-economy,
the corporate income tax
would impose a penalty on C corporations
relative to pass-thru firms.
It would impose a penalty
on equity relative to debt,
and it would impose a penalty
on some types of capital
relative to other types.
The evidence shows that when
you look at the tax rules
that apply to different types of capital,
and then look at the
economic depreciation rates
on those types of capital,
that some assets receive
favoritism relative to others,
assets that receive special
tax credits, of course,
receive favoritism through
that means, and so on.
But my focus today will indeed be
on the open-economy distortions
of which there are several,
that we have a penalty on repatriation,
we have a penalty on the
avoidance of foreign income taxes,
we have a penalty on
investing to earn profits
in the United States,
and on the booking of
profits in the United States.
We also have a penalty on investing
through US-chartered corporations
rather than through
foreign-chartered corporations.
So I think that as we
look at different reforms
to the corporation income tax system,
we need to pay careful attention
to whether we make these
distortions bigger or smaller.
There will often be
trade-offs between them,
although as I'll argue,
some of these distortions
actually could be eliminated quite easily.
Others might be a little more tricky.
Actually, I do wanna start
with the low-hanging fruit,
the repatriation penalty, which
I think is one of the more
senseless features of the current system.
Now I think the costs of this distortion
are more modest than many
people have estimated.
There is a view, for example,
that we have $2 trillion overseas,
and that if the repatriation
penalty didn't exist,
that $2 trillion would be, or
in the past would have been,
devoted to real investment
inside the United States.
There's no evidence or logic to suggest
that's even remotely true.
The level of real investment
in the United States
is probably little affected by the fact
that this $2 trillion is unrepatriated.
But what the penalty does
mean is that corporations
have to jump through hoops
to move money around,
that they have to engage
in financial transactions
different from what they
otherwise would have
to avoid doing something
that would be classified
as a repatriation.
And that's just economically senseless,
because it doesn't advance
any inherent policy goal.
There's no reason why tax should be linked
to this particular event that
we denominate as repatriation.
Dan Shaviro's argued I think rightly
that it's an odd side effect
of the realization doctrine
that we don't think that the
US parent has realized income
until the repatriation occurs.
There is good reason why we might use
the realization doctrine
at least to some extent
in our individual income tax system,
although I'll argue we
oughta curtail its use later.
But it certainly makes no
sense to apply it here.
So we really ought to eliminate
the repatriation penalty.
Now that's actually quite easy to do
and we can do it without resolving
some of the other contentious issues
that arise in the corporate
tax reform debate.
In particular, the
existence of this penalty
is irrelevant to the choice
between the so-called
worldwide and the territorial system,
because you can and should
eliminate the penalty
under either system.
What we do, of course, is
just that we would impose
for future overseas income,
we would impose any tax
that we want to apply to it
when the income is earned,
and then there'd be no
additional tax upon repatriation.
Of course, that's the approach taken
in the president's most recent proposals.
And of course a similar principle applies
with respect to this $2 trillion pool
of past unrepatriated earnings.
We should impose whatever tax
we want to impose on them today
and then the repatriation will be tax-free
if and when it occurs.
And of course, once again,
the administration's proposals
actually reflect that approach
of putting a one-time tax
on that pool of unrepatriated earnings.
So we can really eliminate
this penalty quite easily
and remain agnostic I
think about the choice
between territorial and
so-called worldwide taxation.
Maybe we want a zero tax
on overseas earnings,
maybe we want a 35% tax,
maybe we want a 10% tax,
but the tax shouldn't be triggered
to when repatriation occurs.
Another penalty that's often overlooked,
and once again I find myself
citing Professor Shaviro,
is of course the penalty on the avoidance
of foreign income taxes.
The foreign tax credit
and the Subpart F regime
both penalize the avoidance
of foreign income taxes.
To state it differently,
they create an incentive
for the subsidiaries of US multinationals
to pay additional foreign income taxes.
From the standpoint of national wellbeing,
this is not something that
makes particular sense.
We don't really want our companies abroad
to be paying additional foreign income tax
any more than we would want them
to be paying higher costs than necessary
for utility costs or supplies
or raw materials or whatever.
If foreign income taxes
really are the same
as other overseas costs, and
from a first blush they are
with respect to the national viewpoint,
then they should be deducted
like other expenses.
They should not be credited.
There is a caveat here I
think that it is possible
that curtailing the avoidance
of foreign income taxes
may help protect the US tax
base, and if then that is true,
that would justify providing
some degree of disincentive
for foreign tax avoidance,
so you might in fact want to
treat foreign income taxes
more favorably than a mere deduction,
although it's hard to imagine
that the full-fledged credit
we have today is optimal.
Once again, I think that
issue can be largely resolved
apart from the issue to which I now turn,
the debate between territorial system
and the so-called worldwide system.
This rather contentious issue
gets a lot of discussion,
and I think from an economic perspective,
much of the discussion on
both sides is misdirected.
So the proponents of the
so-called worldwide system
will talk about keeping
jobs in the United States
and not giving companies an incentive
to take jobs and investment overseas.
Proponents of the territorial system
will talk about the need
for the United States
to maintain its competitiveness.
Well, from an economic perspective,
these may not be the right
ways to frame the issues.
Jobs are really not the right metric.
The overall employment in the economy
is going to be determined
by the labor supply that people provide
and by the functioning
of the labor market,
not by whether we are
discouraging certain companies
from investing overseas or not,
and from a competitive's perspective,
no country can or should
have a comparative advantage
in all sectors, and so what
we really wanna talk about,
if we're gonna use the term
competitiveness at all,
is competitiveness in particular sectors.
And we will see that as a
valid argument in a minute.
In particular, one
argument that's often made
for the territorial system
is that we need to clearly
have what people say
because we do have these $2
trillion of earnings overseas.
Indeed, at a recent presentation I gave,
an audience member during the Q&A
said he was surprised that I
hadn't spoken more effusively
about the territorial system,
even though I'm actually
inclined to favor it,
as I'll mention in a minute.
But he thought he was
surprised I hadn't spoken
more effusively about
it because, after all,
isn't that solution to the $2
trillion overseas earnings?
Well, as previously explained, no,
that issue can and should be
resolved completely separately.
So I'm gonna try to suggest
what I think this debate
really is or should be about,
and I'll begin with a
statement about terminology.
At the risk of being tiresome perhaps,
I keep referring to the
so-called worldwide system
and using the scare quotes in my slides.
I do believe that the term is a misnomer.
If we had a truly worldwide system,
that would of course be
a most splendid thing
for the United States to have,
if we were able and
prepared to tax all income
everyone in the world had earned.
It would be hard to
imagine a better tax base
for the United States or for any country.
I do think of course that
would be quite impossible
to implement for a whole host of reasons,
and the United States cannot tax
the overseas income of
foreign corporations,
so clearly the so-called worldwide system
is not that type of splendid system.
It is instead something quite different.
The worldwide system actually
combines a territorial system,
because all firms are taxed on income
that's deemed to be earned
in the United States,
and then layers on top of that
a charter-based tax system
where US-chartered firms are
taxed on their overseas income
as well as on their income
inside the United States.
And so what we really wanna think about
is whether introducing that overlay
of charter-based taxation,
or as some would call it,
residence-based taxation,
corporate residence-based taxation,
whether that actually is a useful addition
to the system or not.
It's not really a worldwide system.
So turning to just a
30,000-foot comparison
of these systems, which will
really be quite inadequate
in terms of comparing
how they actually work,
but hopefully will be useful
in fixing broad ideas,
the pure territorial system would involve,
regardless of charter,
all corporations would be
taxed only on US income.
Now this would impose a high penalty
for both foreign-chartered
and US-chartered firms
on investing in the United States
and on booking profits
in the United States,
and obviously that is
one of the criticisms
that's imposed against
the territorial system
is that it does put a...
You give a strong incentive
to try to have profits
either earned or at least booked
outside of the United States borders.
On the other hand, it does
eliminate one of the distortions
that I mentioned earlier,
the penalty on investing
through US-chartered corporations.
In the pure system that I'm describing,
that penalty would evaporate all together
because corporate charter
or other notions of corporate residence
would simply not play any
role in the tax system.
Again, I'm speaking about
a pure territorial system,
not about the systems that
we necessarily observe
in different countries
that are referred to
as being territorial.
Those will diverge to a
greater or lesser extent
from this pure version.
Again though, useful
to fix ideas, I think.
So now let me turn to the pure version
of the so-called worldwide system.
My definition of such a pure system
is different I think from other people's,
and so that may be something
that will be discussed in the Q&A.
I think that if you were
trying to achieve in full
the objectives from a national viewpoint
that worldwide taxation can advance
that what you would do is,
of course, you would have no deferral.
That I think is a common
definition, common component,
of what people think of
when they're talking about
the so-called worldwide system.
But from the premise that foreign income
should not be treated any more favorably
than US income for US corporations,
you would provide a deduction
rather than a credit
for foreign income taxes.
So this really would be a pure
system in the sense of saying
that we are for US-chartered companies,
we're gonna treat that foreign income
the same as US income.
Today we treat it more
leniently in two respects.
One is deferral, one is
the foreign tax credit.
So I would define a pure worldwide system
as being a system where you eliminated
both of those provisions.
If you eliminated only deferral,
I would do that as a partial movement
towards a pure worldwide system.
So this system, of course,
puts a high penalty
on investing through
US-chartered corporations
that they are subject to tax
on their overseas income,
a tax that they would not pay
if they were foreign-chartered instead.
On the other hand, it does reduce
one of the other distortions.
For US-chartered corporations,
there would be no penalty on investing
and booking profits in the United States.
Those profits would be treated the same
as if they had been
invested and booked abroad.
On the other hand, the
penalty for investing
and booking profits in the
United States, of course,
would still be in full force and effect
for those corporations
that are foreign-chartered.
It would be eliminated only for
those that are US-chartered.
Well, if these are pure systems,
they're obviously different
from what we have in the United States.
They're actually different
from what any country has
because all of the countries are hybrids
between these two pure
systems in one way or another.
The deferral and the foreign
tax credit both greatly reduce
the US tax on overseas
income of US parents.
So what's the effect of those provisions?
Well, just as if you had granted
an explicit rate reduction
to the overseas income,
the deferral and the credit
have the same kind of
effects as any movement
in the direction of
territoriality would have.
They reduce one penalty
and increase another.
So they reduce the penalty
on being a US-chartered corporation
on investing through
US-chartered corporations,
but of course at the same
time, they increase the penalty
on investing and booking
profits in the United States
for US-chartered corporations,
because those profits once
earned and booked here
will not receive deferral
and will not receive
the foreign tax credit.
So it is one way, deferral
and foreign tax credit
are one way, or I guess
I should say two ways,
to move towards a territorial system,
but they're actually not
very good ways to do that,
because they create other penalties,
which I discussed earlier.
They create a penalty on repatriation
and they create a penalty on the avoidance
of foreign income taxes.
And so it would be better if we thought
that we wanted to make
a move of this magnitude
towards a territorial system
to do it through an
explicit rate reduction,
instead of doing it through
these two particular provisions
that just create their
own set of problems.
So I would argue that as a first point
in thinking about this,
we should try to move away
from deferral and foreign tax credit
and the problems that they generate,
and instead just ask ourselves,
what rate do we wanna impose
on the foreign income
of US-chartered parents?
Do we want to tax it at the same rate
as US source income, or at zero rate,
or do we wanna tax it
somewhere in between?
Well, I think this is a choice
between two imperfect systems,
and we may quite likely not
want to go to either extreme.
My own personal view, which is
a prediction about the future
and therefore could, of course, be wrong,
is that the so-called worldwide system
probably has a dim long-run outlook,
and I do emphasize the term long-run here.
We know that the worldwide
system puts a penalty
on investing through
US-chartered corporations.
It therefore creates an
incentive to do investment
through foreign-chartered
incorporations instead,
and we can see that play out potentially
through a variety of behavioral channels.
It would encourage foreign acquisitions,
including the particular
subset of acquisitions
that we refer to as inversions.
It could encourage
newly-established corporations
to be incorporated abroad
instead of having their
initial incorporation
in the United States.
It could encourage American
savers and other savers
to do their portfolio investment
through foreign-chartered corporations,
and here is where competitiveness
in a particular market comes into play.
It also results in the
competitiveness displacement
of US-chartered firms that are competing
with foreign-chartered firms
in overseas investment opportunities.
So these are challenges that the so-called
worldwide system has to confront.
There are measures that can be taken
to counteract them, of course,
and some such measures have been taken,
others will be taken in the future.
The question is how effective
those counter measures
will be in the long-run,
and I'm inclined to think that
they will ultimately fail.
Anti-inversion rules are stopgap measures.
They're stopgap measures by construction
because they say that
if you had a US-charter
on a particular date back
in 2003 or some other date
that we will continue to treat you
as if you have a US-charter,
even if you swap that
for a foreign-charter,
unless of course you do
it through certain types
of transactions that we
will choose to recognize.
Well, by construction then,
you're trying to prop up
the charter basis of
taxation by simply saying
we're gonna look at the past charter
instead of the current
charter in some instances.
By definition, looking at some past date
cannot be a permanent
solution to these challenges.
For some time, economists I think
have been puzzled and surprised
that there were so few
inversions taking place.
We thought that there were
large tax savings to be had
for multinational companies
from shedding their US charters
and acquiring foreign charters,
and yet for many years, of
course, very few corporations
actually took advantage
of that opportunity.
That shoe finally did drop,
and of course we saw a wave
of inversions in recent years.
The other thing that has
long puzzled economists
is why newly-established corporations
are not incorporated abroad
instead of in the United States.
The initial foreign
incorporation would, of course,
allow you to be outside the US tax base
on your foreign income from the get-go,
and it would spare you
from being tripped up
by any anti-inversion rules
because you never had a US-charter.
Now, the evidence I
think quite clearly shows
that although there have
been a few instances
of initial foreign incorporation,
that they're quite rare,
and that so far, corporations
being established by Americans
are generally being incorporated
here in the United States,
perhaps because the
establishers of the company
don't initially anticipate
becoming a multinational
with large overseas
profits, because, of course,
most of them will indeed do no such thing.
A few of them will, and if they do,
they'll probably regret having done
their initial incorporation
in the United States,
but of course it will be too
late for them at that point.
I do wonder, I pose the question
of whether initial foreign incorporation
is gonna be the next shoe to drop.
So I think all of these
things kind of dim the outlook
for the so-called worldwide system.
I think the charter location
is gonna become more tax sensitive,
and so we know that makes it
more distortionary to tax it,
and that taxing it may
ultimately become unviable.
We could, of course, replace
the charter-based definition
of corporate residence
with a different one,
such as the place of
management or control.
It would be less tax sensitive, I think,
and therefore would be a better
definition in that respect,
but it would also be more
closely tied to real activity
and it would be more
distortionary in that respect,
that you would actually be more likely
to drive real activities
out of the United States
if you were putting a heavy
multi-billion dollar tax
in some cases on the privilege
of having your management
inside the United States.
Nonetheless, that may be
the step that we see next
for the so-called worldwide system.
But my view is that we
probably will find ourselves
moving in the direction
of the territorial system.
I don't think that we
necessarily will do it
or would want to do it in the short-run.
We would need to address
questions of base erosion,
there would be a transitional issue,
we would wanna put a one-time tax
on those unrepatriated earnings,
and it is a choice of one
imperfect system over another.
And I'll just close since I do
have a couple of minutes left
by saying that there
are a couple radically
different approaches that could be used
that would address virtually
all of the distortions
that I've mentioned,
and that would be either
shareholder taxation
or consumption taxation.
Eric Toder of the Urban Institute
and I outlined a proposal
in April and you have a
report in your binders
where we proposed eliminating
the corporate income tax
and taxing the American shareholders
of publicly-traded corporations
on dividends and capital gains
at ordinary rates on a
market-to-market basis.
That would eliminate the penalty
on investing through
US-chartered corporations
and the penalty on investing
and booking profits
in the United States
because none of those
things would matter anymore.
You'd only be looking at the
residence of the shareholder
not at where the income was
earned, not where it was booked,
not where the corporation was chartered.
It would also either eliminate or reduce
the various closed-economy distortions
that I mentioned earlier.
But it would pose a number of challenges.
There would be a net revenue loss
that would have to be made
up through other means.
There would be thorny transition issues.
It would be a volatile tax based.
It would be politically problematic
for a number of reasons.
To my mind, these are challenges
we should confront and accept,
but they certainly can't be ignored.
A still more far-reaching approach
would be to switch to
consumption taxation,
which would also eliminate the penalties
that shareholder taxation eliminates,
and it would also eliminate the penalty
on saving for the future
rather than consuming today.
There's a number of ways
to move towards consumption taxation.
We could expand expensing,
we could adopt a value-adding
tax alongside the income tax,
which is likely to occur I think
at some point in upcoming decades,
or we could completely
replace the income tax system
with a progressive consumption tax,
which could be either a
personal expenditure tax
or a Bradford X-tax.
Needless to say, this
type of sweeping change
would involve a whole host
of transition and design challenges,
which again would have to be confronted.
They cannot be ignored.
In conclusion, I would
say that in the near term
that I think that Congress is likely
to continue tweaking the odd
hybrid that we have obtained
between worldwide and territorial system.
I think in the long run or
the medium run perhaps even,
Congress probably will be forced
to consider making a partial move,
most likely not a complete move,
towards shareholder taxation
or consumption taxation or both.
Thank you, I'll take questions.
(audience clapping)
- [Audience Member] You
mentioned during your remarks,
that economists were
puzzled as to why inversions
had not taken place before they started
in the last couple of years.
Has there been any analysis
as to why that has been the case?
- I've heard various explanations.
I think there's others
who are better equipped
to address than me.
The question in case anyone didn't hear it
is whether there's been any explanations
as for why it took so long
for the wave of inversions
to start occurring.
I've heard partial explanations,
companies giving up on
tax reform being adopted
and other things like that,
but I think my own view is probably
it's must more likely
a question of inertia.
There's been examples in the
past of where corporations have
and other taxpayers have only adopted
tax saving strategies gradually.
So I'm inclined to put
it into that category,
but I think it's actually
an excellent question.
I wish I knew the answer.
- [Audience Member] On
your slide where you talk
about the dim long-run
outlook for worldwide systems,
you've indicated that
perhaps the next wave
is US-resident people would
be incorporating overseas
as opposed to-
- Possibly.
- [Audience Member] But
hasn't there been studies
that foreigners are
disinclined to register
in the US because of the US system?
I thought years ago there
was some sort of study
that they said the amount of companies
from overseas incorporating
or people starting initial
corporations in the US
had declined because of the US tax system.
- That's interesting, I
don't think I'm familiar
with the specific study.
I'd actually love to see it.
That does make good sense to me.
You would think that,
yeah, foreigners who might
in the absence of tax considerations
give some thought to incorporating
in the United States,
they might well be disinclined
to incorporate here.
It does seem at this point that Americans
who are setting up companies
are still inclined to
incorporate here at home.
So I think it will be
interesting, but if so,
that could be the first bit
of that shoe dropping, so we'll see.
- [Audience Member] I
haven't read your paper,
but have you done estimates
for the welfare benefits
of moving to a shareholder
level, market-to-market system
in eliminating the corporate income tax?
- I sorry, I didn't hear.
- [Audience Member] Have
you done any estimates
of the welfare benefits
of moving to that system?
- Sort of quantifying the benefits?
- [Audience Member] Yeah,
because if you're gonna
advocate it, then you'd wanna
be able to be support that.
- Well, absolutely, Eric Toder and I
are doing a followup project now
to look at some of the
implementation issues in it,
and as part of that, we're
also hoping to provide
a more informed estimate
of what the magnitude of
the benefits might be.
I do think that whether we
quantify the gains or not,
there's ample grounds for thinking
that they're very substantial.
They just have this whole
range of distortions
in terms of where corporations
are being chartered,
where profits are being earned,
and where profits are being booked,
distortions and whether you're set up
as a C corporation or a pass-thru,
whether you're using debt or equity.
Eliminating just this
whole host of distortions
has to confer significant benefits.
So we would hope to quantify those,
but I think the case, and some
it's at a qualitative level,
arguably is stronger than some particular
numerical estimate that
somebody could pick apart.
But it would still be useful, of course,
to try to provide an order of magnitude,
and we do hope to do that.
- [Audience Member] Yeah, I'm curious,
what are your thoughts,
either academically or
from a policy standpoint,
on having a worldwide system
where a company's worldwide
profits would be apportioned
based upon some
income-producing activities
like property, payroll, and sales,
or some other type of
income-producing assets?
- Formulary apportionment is
probably worth considering
if we stay within the context
of the current system,
but of course it's no cure all.
It trades again some
distortions for others.
So on the one hand, you
eliminate the distortions
associated with where
profits are being booked,
but then of course you impose distortions
on where those real
activities are located, right?
If I apportion based on, well,
say on sales and property and wages,
then you penalize
locating those activities
in the United States.
Sales is superficially
an attractive tax base.
If you could really
attribute to the income
to where the final sales to
consumers are taking place,
that is something that would probably
not be very tax-sensitive,
and so it would be appealing
I think to try to attribute
the profits there.
As we know, however, that
faces formidable challenges
that if a company is selling
some type intermediate input
to another company, we
cannot directly observe
where the final consumer market is,
and allocating the
income based on the sales
to the other corporation lends itself
to innumerable forms of manipulation.
Between those challenges
and the difficulty
of reconfiguring the
international tax architecture
to accommodate formulary apportionment,
which obviously it has no
room for at the moment,
I think the near term prospects for that
are probably limited.
In the longer run, if we choose to stay
within the context of the
current type of system though,
it may be something we
will need to confront.
Perhaps looking at its
challenges will persuade us
that we do need to think outside the box
in terms of shareholder
or consumption taxation.
- [Audience Member] You
talk about the benefits
of a certain system over another,
but in terms of the benefits
of the taxation system as a whole,
I think you have to look to the benefits
of combined I guess activities,
like education building infrastructure,
that need to support the
economies of the world, of the US.
So it seems to me that all
this talk about the taxation
doesn't take into account
the benefits that are derived
from the combined activity,
governments or otherwise.
- Okay, as I'm not quite
sure what the question means,
obviously if one of these systems
could provide the funding
for education infrastructure
and the others couldn't,
that would be a pretty strong argument
in favor of the system that
could provide the funding.
But we can raise revenue
through any of these systems
for all those pressing purposes,
so I think when we look at
how to raise that revenue,
we want to do it in a way
that has as few distortions as possible
while maintaining progressivity.
The question of how beneficial
those expenditures are
by the government would
certainly play a key role
in deciding how much
revenue we need to raise
and in how we want to spend that revenue,
but I don't think it would
have much bearing, if any,
on the question of how
we raise that revenue,
and in particular, which
of these different systems
we would choose to raise it.
- [Audience Member]
Hi, you just slipped in
that while retaining progressivity.
I'm not sure everybody agrees with that,
but how do you address that
as between US and foreign corporations,
US and foreign individuals?
What's appropriate?
- So I think that our ability
to tax foreigners is limited.
If we were a small perfectly open-economy,
it would not actually be
possible for the United States
to impose any net tax on foreigners
who engage in transactions with us.
If they have unlimited opportunities
to earn some fixed rate of return
everywhere else in the world,
and we were just a
small part of the world,
then no tax could ever
actually lie on them.
They would exit the United States
and not pay the tax at all,
unless market forces adjusted
so that they could continue
to earn that same rate of return
here in the United States.
If the latter happened, then
it would have to be true
that the burden had been
shifted to the Americans
with whom they were
carrying out transactions.
Now, the United States is not
a small perfectly open-economy
so there is some ability
to extract rents as it were
from those foreigners who do invest here.
I think that my view on this
is that if it was administratively easy,
we would extract what rents
we could from foreigners,
since their wellbeing I think is not part
of our underlying objective
function as a country,
and then the tax burden
on Americans, of course,
would be distributed in
a progressive manner,
which can be done of course
under all of these systems.
Obviously, a worldwide
system or territorial system
can be equally progressive in its taxation
of American shareholders.
The same can be true of a
shareholder-based system
and the same can even be
true of a consumption tax
if you use a Bradford X-tax
or a personal expenditure tax
rather than a regressive consumption tax
like a sales tax or a value-added tax.
- [Audience Member] On
your shareholder proposal,
how would you handle the fact
that so many shareholders
in the United States are tax-exempt?
- So you'd have to decide what
rate of tax is appropriate
for the income of these organizations.
Whatever rate you
choose, it could be zero,
it could be 35, it could
be somewhere in between
neutrality would call for
that rate to apply uniformly
regardless of whether the entity
is earning interest income
or is earning corporate equity income.
Today, of course, we do tax
the corporate equity income
earned by these organizations indirectly
by imposing corporate
tax on the corporations
whose stock they own, but we
exempt the interest income
of those organizations
because we've decided
that they should, in
some sense, be exempt.
If we move to a system that eliminates
the corporate income tax, then
I think we would wanna apply
neutral tax rule to these organizations
and tax them the same
on their interest income
as we tax them on their
corporate equity income.
We would make that tax transparent
and we would apply the tax
directly to the entity itself.
One reasonably appealing if
ad hoc approach, I think,
is to say we would impose a uniform tax
at the entity level on the interest income
and on the corporate equity
income that they earn
that would raise roughly
the same amount of revenue
as we're indirectly
collecting from them today
through the corporate income tax
on the shares that they own.
But depending on your view
about these organizations
and whether they deserve
favorable tax treatment or not,
you could of course argue
for a higher tax rate
or a lower tax rate,
and I suppose you might want
to apply that rate differently,
you might wanna have different rates
to different types of tax-exempt entities.
For example, you might wanna distinguish,
perhaps in either direction,
between a tax-exempt
entity such as Harvard
and qualified retirement plans.
But a whole range of
options would be available.
The premise would be though
that there should be neutral,
transparent taxation of the entity
uniformly across its interest income
and its corporate equity income
that could be set at any rate
from zero to 35 or whatever.
- All right, thank you.
(audience clapping)
- Thank you, Alan.
- Thanks, Larry.
- Alan, thank you very much.
Well, we've talked a lot
today about the worldwide
with deferral taxing
jurisdiction of the United States
and this combined with the
high corporate tax rate
has caused a lock-out effect
of cash parked overseas,
causing severe economic inefficiencies.
Some are of the view
that a territorial system
of taxation is the solution.
Our next speaker, Rosanne Altshuler,
will discuss the characteristics
of a territorial tax system,
and she's going to compare and contrast
lessons learned from
several other countries
that have already gone down this path
and implemented a territorial tax system.
Professor Altshuler has served as Chair
of the Department of Economics
at Rutgers University from 2011 to 2014.
She was an assistant professor at Columbia
and has been a visiting
professor at Princeton University
and also at NYU School of Law.
Rosanne currently is on the
Panel of Economic Advisors
of the Congressional Budget Office.
Rosanne has also been
active in the policy world,
serving as director
of the Urban-Brookings Tax Policy Center,
Senior Economist at the 2005
President's Advisory Panel
on Federal Tax Reform,
and Special Advisor to the
Joint Committee on Taxation.
Professor Altshuler, over to you.
- Great, so that's a timer.
- When it's over, you can
begin to answer questions.
- Okay, fantastic, so I don't need this.
Okay, well, thank you for inviting me.
It's a pleasure to be here.
And as you can see from the slides,
the title of my talk
is, "What Can We Learn
"from Other Countries'
Territorial Tax Systems?"
So, I think it makes sense
to step back a second,
even though maybe you've
seen this already today,
and ask, what makes a
tax system territorial?
Territorial systems exempt
all or 95% of dividends
resident multinational
corporations receive
from foreign affiliates
from home country tax.
Countries with these systems
are often referred to
as having dividend exemption systems, why?
This is because what they do
is they remove home
country tax liabilities
on active foreign income by
exempting dividend remittances
from foreign affiliates to
home country parents from tax.
So for that reason, they're
called dividend exemption,
and what I'm gonna be doing in this talk
is going kind of sloppily back and forth
between dividend exemption
and territorial taxation,
but I'm really talking
about dividend exemption.
Now, worldwide systems
tax foreign-source income
of multinationals either as
accrued or when repatriated.
So by that definition, most countries,
and in fact all of the G7
except the United States,
are territorial.
All but six other OECD countries
have adopted dividend exemption systems.
So the outliers, besides
the United States,
are Chile, Ireland, Mexico,
Israel, Poland, and South Korea.
So that's where we are.
We really are an outlier.
I believe that there is broad agreement
that our current system is very complex
and induces inefficient responses,
and this is agreement among policymakers
and among companies.
Our system provides
incentives for multinationals
to invest in tangible
and intangible capital
in some locations instead of others,
to engage in costly strategies
to avoid US taxes on foreign dividends,
to shift reported income from
high to low tax locations
by using inappropriate transfer prices
or paying inadequate royalties,
and further, the pressure,
as you've already talked
about this morning,
exists to redomicile, which
is a really fancy word
for saying moving out.
The pressure exists when the
tax burden under US rules
exceeds what could be achieved
through a non-US parent structure.
So, whether or not you characterize
all of these incentives
as making our system a mess or not,
and we're not gonna vote on that now,
there certainly are a lot
of distortionary incentives
in the system, and that's something
that Alan was just talking about.
So, as a result,
many in the US are calling
for reform of our system
for taxing international income
and support moving to a
territorial tax system.
What I'm talking about
today is based on a paper
that I did with Steve
Shay of Harvard Law School
and Eric Toder of the
Urban-Brookings Tax Policy Center.
And we thought it would be a good idea
to look at some countries
that we thought we could learn from
to see what we could glean
from their dividend exemption systems,
from their territorial tax systems.
And so what we decided to do,
we embarked on this project,
and as projects go, this one took a while,
like most of them do.
It's more than a year of working on this,
gathering people together,
which I'll say something
about in a second.
And so what we decided to do
was to look at two countries
with longstanding dividend
exemption systems,
and that's Australia and Germany.
Australia, interestingly,
they've always had
a territorial dividend exemption system,
except in '87 through 1990
where they went to a worldwide
system with deferral.
So that's just interesting in itself,
although we don't talk a
lot about that in the paper.
And Germany is longstanding territorial.
Before 2001, however, dividend exemption
was only implemented with treaty partners.
So we looked at these two countries
with longstanding dividend
exemption systems,
and then two countries that
had just recently moved
to dividend exemption systems,
and that as I'm sure you're aware of
is those two countries are
Japan and the United Kingdom.
So it's very interesting to study.
And then we compared,
and we tried to compare
or draw lessons for the United States.
So what I've done on this slide
is I've cited the paper.
It's not in your package,
but if you were to look at the paper,
you'll see a cite to a companion paper
that's actually a report
from a full day gathering
of international tax experts
at the Urban Institute.
And I sat down and read it recently.
I recently testified before
the Senate Finance Committee
on international tax.
And it's a really interesting
read, I have to say.
Maybe it's I'm biased or I'm
just a complete total tax nerd,
but I thought it was really neat
to read what this group
of people had said.
We gave them some structured questions,
and I highly recommend it.
I don't have a cite for it.
I just remembered that
I should talk about it,
but it's referenced in the paper
that's referenced on the slide
that you have in front
of you in your book.
So, before getting started
to talk about the lessons
that we learned, we started
by noting to ourselves
that there's differences
across these countries
in more than just
international tax systems,
and so I thought that it's important
to put that on the table,
or as I've done here, put it on a slide.
And I'm not gonna through
each of these numbers,
just kind of draw some
observations from this,
and some of it's in the
table, some of it's not.
The US has the largest economy
by far, and except for Japan,
is actually the least exposed
to international trade.
Exports and imports accounted
for a much smaller share
of GDP than all of the others
and were similar to Japan.
The UK has the largest volume
of outbound and inbound
FDI relative to GDP.
I didn't show it in the table here.
They're very much exposed
to international capital movements.
The figures that we have here
on the economic differences
may have some implications
for the different constraints
that the five countries face
in designing international tax policies.
Well, what do I mean by this?
Australia is a large capital importer.
Therefore it's not surprising
that it's more concerned
about how it taxes corporate income
from production in Australia
and the portfolio income
of foreign investors
than rules for taxing
foreign-source income
of Australian companies.
The US is the largest economy
and it's the one least exposed
to trade and capital movements.
Therefore, we may have some ability
to impose higher taxes than
others on US-source income
of all corporations,
and to a lesser extent,
on the foreign-source
income of US corporations.
Japan is most similar to the US,
but has had a stagnant economy
and has a small amount of inward FDI.
Therefore, it may need to
focus on keeping rates low
to encourage investment at home.
Now, Germany and the UK, as you know,
are both members of the
EU where there's very free
internal movement of capital and people.
Therefore, they're highly exposed
to trade and capital movements,
so in designing tax policies,
they have to pay particular
attention to incentives
created for investment location
and headquarter location.
The countries, a little
bit on the bottom here,
the countries have different business
and industry characteristics.
Australia has large natural resources.
Germany and Japan have
a relatively large share
of value-added and manufacturing.
The US, UK, and Australia
have relatively large share
of value-added in finance and insurance.
Now, we also wanna look at
comparison of tax policies,
and this is when you look at the numbers,
you may be a little confused by them,
for instance, corporate tax rates.
This is looking at
national and subnational
tax rates and revenues.
So the US, I'm sure you're
familiar with the fact
that we have low revenues relative to GDP
compared to these other countries,
compared to OECD countries.
These countries differ substantially
in their reliance on the corporate tax.
The US has the highest combined rate,
again national and subnational.
I think the Japan combined
rate is now down to like 35%.
Germany was a little bit surprising here,
but looking at that last row,
the US has the largest share
of business profits from companies,
has the lowest share of
business profits from companies
subject to the corporate tax.
60% of business income is
in the non-corporate form
now in the United States,
so it's just going through flow-thrus.
So, that's just a little
short tour of tax policies.
And so with this background,
Steve Shay, Eric Toder, and I
examined the factors
that drive policy choices
in the four countries that we studied,
and we put forward some lessons
we believe the US can take
away from their experiences.
And some of this you've already heard,
but I think it's important
to go through again.
So, the remainder of my talk,
I'm gonna go through what we learned,
lessons that we learned.
So, the classification of tax systems
as worldwide or
territorial oversimplifies,
and Alan talked about that
a little this morning,
this morning, right before me,
and you may have talked
about it this morning,
but I was unable to be here.
I had to be at a meeting at Rutgers.
All systems are hybrids that tax
some foreign business income
at reduced effective rates,
when you take exceptions and
anti-abuse rules into account.
The distinctions are really not as sharp
as the labels worldwide and
territorial make them appear.
So just as examples, Japan and
the UK allowed multinationals
under their worldwide systems
to bring back foreign earnings
through related party loans.
Okay, that doesn't sound like
a worldwide system to me.
The US allows deferral and a
liberal foreign tax credit.
As a result, little tax is collected
on dividend repatriations.
So looking at little dividend
exemption-y, if that's a word.
Most territorial countries impose tax
on foreign-source income as accrued,
on some foreign-source income as accrued,
in order to protect their
domestic corporate tax base.
So, the classifications of tax systems
as worldwide or territorial
really does oversimplify.
The other thing that we learned
is that the circumstances
that caused other countries
to maintain or introduce
territorial systems
do not necessarily apply
to the United States.
Countries differ greatly in the extent
to which they weighed
conflicting policy concerns,
such as the effects of a change
in the corporate tax system
on domestic investment,
on residence decisions of multinationals,
on profit shifting,
on the burden of the
repatriation of foreign profits,
on the taxation of inbound investments.
And countries also differed in the extent
to which they took budgetary effects
of the corporate tax policy
changes into account.
Policy decisions don't
appear to have been based
on an analysis of how
foreign-source income
was effectively being taxed.
We were very surprised by this.
What I mean is that
the changes that we saw
in the UK and Japan don't
seem to have been driven
by analysis of administrative data.
So to the extent that
they were evidence-based,
they seem to have been
based on anecdotal evidence,
and from what we could see,
not based on a close look,
a close analysis of administrative data.
So that was a surprise to us.
This is similar to what I just said,
but the tax policies of countries
with dividend exemption
systems have been influenced
by their separate circumstances.
So as a net capital importing country,
Australia's main goal
for its corporate tax
has been to collect taxes from
foreign corporate investors.
They're less concerned
about outbound investment
by Australian companies.
Australia also has an
interesting imputation system.
It allows domestic
shareholders to claim credit
for domestic but not
foreign corporate taxes
paid by Australian companies.
So this may actually reduce tax avoidance
through shifting profits abroad
since Australian shareholders
aren't gonna get any credits
if domestic tax hasn't been paid.
So that's an interesting thing
about the Australian system
that I think some people find intriguing.
In terms of Germany, they
adopted dividend exemption
years ago to foster foreign
investment by their companies.
Other EU countries also had
dividend exemption systems.
That influenced German practice.
So that's kind of the Germany story,
I mean for what I have time to talk about.
Japan adopted dividend exemption in 2009
to make its companies more
competitive and to encourage them
to bring back accrued overseas profits.
One of the things that we learned
through the all-day conference that we had
that I'm telling you that you should read
the entire transcript of that conference,
one of the things that comes out
is that Japan appears to have a compliant
international tax planning culture.
We were told, advisors
told us that multinationals
are not aggressive tax planners.
So that would affect the
decisions that they make.
In fact, the government
didn't seem to be concerned
that income shifting would
increase with dividend exemption,
which is something that
we're very concerned about
in this country when
we start talking about
moving towards a dividend
exemption system.
Won't income shifting incentives go up?
They didn't enact new
anti-avoidance rules with the switch
and there was no transaction tax
on repatriations of
pre-effective date profits.
The UK was mainly concerned
with losing corporate headquarters
when it adopted dividend
exemption in 2009.
The loss of headquarters
is obviously facilitated
by their proximity to
countries with lower rates
and territorial tax systems.
So they lowered their
corporate rate to 21%
and introduced a patent box
when they went territorial.
They were less concerned
about tax avoidance,
and as I've said before,
had a system that was kind of equivalent
or close to equivalent to exemption
since they could return borrowed
funds to their shareholders
without paying a dividend
repatriation tax.
This next one I think is very important,
and I think Alan touched on it also.
The burden of the tax due
upon repatriation of foreign earnings
may be a lot higher in the US
than it was in the UK and Japan.
The burden includes the actual
tax paid upon repatriation
and the implicit costs
of keeping income abroad.
So the implicit costs
include, for example,
the cost of using parent debt
to finance domestic projects
as a substitute for foreign profits,
payments to tax planners,
forgone domestic investment opportunities,
and foreign acquisitions that
may not have been undertaken
in the absence of the tax.
I've worked with Harry Grubert
at the Treasury Department,
Office of Tax Analysis,
and we've done a estimate
using data from the tax returns
of multinationals corporations
of the implicit cost
of the repatriation tax
for a highly profitable company,
and we find it to be about 5% to 7%.
What is this?
You can think about this as the amount
a company would be willing to pay
to have the repatriation tax
on an extra dollar of
foreign earnings removed.
That's the implicit cost.
And we're finding it to be 5% to 7%
which I think is significant.
It's also higher than previous estimates
that Harry Grubert has done
and also we've done together,
and what we see is that it increases
this implicit cost of
keeping income abroad,
increases those deferrals
that accumulate abroad,
because it becomes more and
more costly, for instance,
to borrow against them as you
have more and more abroad.
I'm not aware of any estimates
of the burden of the repatriation tax
in the UK and Japan before
it went territorial,
but I would think that the
US repatriation tax burden
is much higher because
both Japan and the UK,
again as I've said many times,
were effectively dividend
exemption countries
because they could return
funds to the parent
via subsidiary loans or
investment in parent companies
without having to pay a repatriation tax.
Another thing that we
learned or we comment on,
I think everybody knows
we raise relatively little
corporate tax revenue as a share
of GDP than other countries
while having the highest
statutory rate in the OECD.
But this fact has multiple explanations
and doesn't suggest that US companies
in any given industry are more aggressive
at income shifting than foreign companies.
I would say that we really don't know.
I know that there are
other studies out there
that have used non-US data
to look at income shifting
of foreign companies.
I'm not thrilled with the
datasets that they have.
What's going on?
Well, we know a relatively large share
of business activity in
the US comes from firms
that don't pay the corporate income tax.
We also have corporate tax expenditures
with special provisions and rates
that reduce US corporate tax receipts.
So the fact that we have
little corporate tax revenue
as a share of GDP, while
having a high rate,
doesn't necessarily mean
that it's income shifting.
We just don't have good information,
and this is a problem
that they're running into
with the BEPS Project.
So, that is another
conclusion that we draw
or one of the lessons.
So, some conclusions from all of this.
One of the things that
we kind of go both ways
in this paper, we say you don't have to do
what everybody else does,
but we really are subject to the pressures
that other countries have been subject to.
So the US need not follow
other tax policies,
but we think it was really important
to do this type of a study.
The fact that we don't need
to follow other tax policies
doesn't mean that our reform process
should be done in a vacuum
or by a guy with a vacuum.
(audience laughing)
So, after I put that
on, I thought to myself,
there should be a person
in a vacuum, not vacuuming.
But you never have enough time
to think about everything.
Territorial definition
is not the whole story.
The devil really is in the details.
Better data exists on US
multinational income shifting
than for other multinationals,
for foreign multinationals.
They may do as much as we
do, we just don't know,
and as I said before,
I think this is a problem
for the BEPS effort.
I know that they put something
out on this a week or so ago.
I just haven't had a
chance to look at it yet.
I think that the US, our
ability to retain high rates
and tougher rules on
foreign income is declining.
We face the same pressures as countries
that have lowered taxes and
moved to dividend exemption.
We face growing competition
as an investment location.
Our multinationals face
growing competition
from multinationals that are
based in exemption countries.
There are advantages of foreign residence.
So the pressure exists that may force us
to eventually abandon
our tax exceptionalism.
But the question of which way
we go is not all that clear.
I think Alan brought that up a little bit.
Maybe we'll abandon our tax exceptionalism
by adopting a VAT and using
that to lower the corporate rate
and the individual rate is
something that we could do,
that's another whole question,
but you could use a VAT
to lower corporate rates.
And that just takes a lot of pressure
off of the incentives that
I talked to you about.
So if you lower the rates,
those incentives just aren't as strong.
So I think that that is it.
That's it for what I had to say,
and I guess we're gonna
open it up for questions.
(audience clapping)
- Thank you.
- [Audience Member] You mentioned
at the end of your remarks
that we don't have good information
to compare across countries
about the income shifting.
Could you tell us a little bit
about why we don't have that information,
and whether you think
that there is a procedure
that could be employed to get it?
- That's a great question.
That's exactly what the BEPS Project,
what number is it, is it 11?
11, I got it first try, 11
is all about is trying to...
We have that Form 5471.
(laughing)
So we have that information form.
We have a Treasury Department
that has for many years
been able to do studies
based on the information from tax returns,
and it just doesn't seem
that other countries
have collected the same
type of information
that we've collected on our multinationals
and have not made the same efforts
to do the studies that we've done.
For whatever reason, the
data's just not out there.
And so the data that's out there
to do the types of studies
that economists are doing
are data from maybe
publicly available sources,
which has some pluses
and has some minuses.
Really, I think the tax return
data is where the action is,
is where we can learn the most,
and until the UK, I mean,
maybe they have a lot of stuff,
but they certainly don't
have a Harry Grubert
that's doing these types of
studies and putting them out.
You just are not seeing papers out there
that are using administrative data.
And even just the SOI
data that you can use,
that you can download yourself.
I mean, I can tell you 10 reasons
why there's problems with that data,
but at least it exists, okay?
Yes?
- [Audience Member] I have
sort of three related questions
with respect to countries
that have adopted,
let's call them pure territorial systems,
as pure as you can imagine.
I don't know which countries those are,
but maybe Germany, I have no idea.
Three questions, one,
does the system extend
to portfolio income of companies?
Two, do those countries do anything
about domestic deductions
associated with the exempt foreign income?
And three, what do those countries do
about foreign royalties paid
from abroad received at home?
- Okay, you know the answer
to all those questions.
- [Audience Member] No,
I don't, I really don't,
and I think it's assumed
and it has actually been stated here today
in a couple of the panels
that territorial would mean
non-taxing of foreign income.
That's simply not true.
- Okay, that's simply false.
So I believe, okay,
I believe that all of the countries
that are territorial tax portfolio income.
Yeah, to go back to David,
so I believe that all of,
what we would call...
They all have something
like Subpart F income.
- [Audience Member] So
they need a definition
of corporate residence
for that purpose, correct?
- I would think that they would, yes, yes.
- [Audience Member] Okay, thank you.
- In terms of allocation
rules, for like interest,
they don't, they don't, very few.
- [Audience Member] Do they
disallow any deductions
associated with foreign income?
- I know about interest,
not that I know of,
but again, somebody
correct me if I'm wrong,
I don't think so.
And then your third question, which I knew
I knew the answer to.
- Royalty income.
- Royalty income, so royalty income,
there's a lot of patent boxes out,
there's a lot of favorable
treatment out there.
- [Audience Member] No,
no, but I'm talking about
royalty income paid from abroad
and earned in the home country,
received by a home country recipient.
- Doesn't France...
- They do patent boxes.
- Patent boxes, I'm
thinking about patent boxes,
in France has a lower
rate on royalty income.
- [Audience Member] But that's independent
of territoriality.
- That's independent on territoriality.
Yeah, it doesn't have to be, right, right.
And in fact, one of the big differences
between our current system
and a dividend exemption system...
Let me start over again.
If we were to go to a territorial system,
there would be a very big difference
in how royalties are taxed,
because under the current system,
firms are using excess
credits to shelter taxes
that would be due in the US on royalties.
Under a dividend exemption system,
a royalty is not a
dividend, it's a royalty.
It would be taxed as US-source
income at the US rate.
So then there's a question,
so that would be a very
different treatment of royalties.
In fact, that's why you
can actually raise revenue
by going to a dividend exemption system.
Of course, the devil is in the details.
So I hope I answered your questions.
And nobody's protesting, so that's good.
(audience laughing)
Great, thank you.
(audience clapping)
Thank you, wait a minute.
Thank you very much.
- Thank you.
Thank you, Professor Altshuler.
Our final panel today will explore
the various US international tax reform
legislative proposals
that have been put forth,
compare and contrast them,
and suggest prospects for the future.
Our distinguished panel
includes representatives
from KPMG's Washington
National Tax office,
including Manal Corwin, Thomas
Stout, and Robert Wilkerson.
Manal leads KPMG's
international tax practice
and is the principal in charge
of Washington National Tax
international tax policy.
Prior to rejoining KPMG,
Manal was the deputy assistant secretary
of Tax Policy International Tax Affairs
in the United States Treasury Department.
Tom Stout is KPMG's director
of Federal Tax Legislative
& Regulatory Services based in Washington.
Tom is past chairman
of the AICPA Committee
on Tax Policy and Legislation,
and holds a graduate tax law degree
from Georgetown University School of Law.
Bob Wilkerson is an
international tax principal
in KPMG's Washington National practice.
Bob is a frequent speaker on
international tax matters.
Bob earned his tax
LL.M. at NYU Law School.
So welcome back, Bob.
And I'll introduce the panel
to the stage, thank you.
- All right, so the home stretch panel.
(laughing)
I'm impressed it's still
a fairly full audience.
So good afternoon, everyone.
So our charge this
afternoon is to go through
in a little bit more detail
the international tax proposals
that have been made so far.
I think they've been
alluded to numerous times
in almost every panel, but
we'll delve a little bit deeper
into the question, or into the
proposals that are out there.
The conference started
with the question of,
is our international tax system broken?
And I think that if you listen
to what we've heard today
and certainly the subject
has been the debate
or has been debated
over the last 20 years,
the emerging consensus is that in fact
our international tax system
is sorely in need of reform,
and where we are today is that
we have a number of proposals
now coming, not only
from the administration,
but from both sides of
the aisle in Congress,
as well as the business community
that are converging around a sense
that we do need to reform
the international tax system.
The reform proposals interestingly enough
while very different, and
actually let's talk about
what we've got, and
we're gonna focus on two,
but in terms of the proposals
that we've seen most recently
that address aspects of our
international tax system,
they include former
Senate Finance Committee
Baucus' framework for
international tax reform,
former Ways and Means
Committee Chairman Camp,
who put out a very comprehensive,
probably the most
comprehensive that we've seen,
international tax reform proposal,
broader than international, obviously,
but certainly comprehensively covering
the international tax rules,
the president's framework
on international tax reform
in 2012, followed by this budget,
the FY16 budget that we just saw
that picked up on that reform framework
and provided more detail.
And then we've also seen
now Senate Finance Committee
Chairman Hatch, current
Senate Finance Committee
Chairman Hatch issue a report
about the need for
comprehensive tax reform.
And then in terms of initiatives,
we've also now seen Senate
Finance Committee Chairman Hatch
and Ranking Member Wyden
put together a five member,
sorry, five bipartisan working groups
to focus on the need for reform
and international was one
of those working groups.
So that's a shift, too, in
that we haven't for a while
see bipartisan working
groups focusing on an issue.
So that's a significant development.
One of the things that you see
as you go through these proposals,
while certainly they have
many, many differences
in terms of the approach and the technique
to addressing international tax reform,
they actually have quite a
fair amount of common ground,
particularly in the international area.
I think they all converge
around the need for reform.
We've talked about that.
All of the proposals that are out there
converge around the need to reduce
the corporate income tax
rate and broaden the base.
There are differences in
how low that rate can go
and those differences are more related
to what can you pay for
than so much a policy view
as to what the exact right
corporate income tax rate,
but a consensus around the
need to lower that rate.
They all also converge around the need now
to eliminate the tax on
repatriated earnings,
so our worldwide system with deferral
has this lock-out effect
that's been spoken about
quite frequently that forces
taxation upon repatriation,
and the proposals that are out there
right now eliminate that.
So there's no longer
a tax on repatriation.
They all have recognized
that active offshore earnings
ought to be subject to a lower rate of tax
than domestic earnings.
Again, the approach to
and how much the lower tax
ought to be is different
and the definition of active
earnings is different,
but structurally there is a consensus
around a lower tax on
active offshore earnings
or an exemption in certain cases.
And then finally, all of the proposals
that are out there have a component
or recognize the need to do
something about base erosion,
express concerns about base
erosion and mobile income
and address that through
a number of provisions
that are common, including
widening in certain cases
the CFC rules, Subpart F rules,
denying deductions in certain cases
with respect to outbound payments
or earning stripping concerns,
and then limiting the
deductibility on interest expense,
like I said, a cap.
Again, we're seeing a commonality there.
That's a fair amount of common ground
in the world that we
live in, in legislation,
if you think about the
international proposals.
Again, technique is different in approach,
but scaffolding and structurally,
fairly close in structure,
with the debate really
being about how wide
each of the categories is.
The other I think significant development
that I alluded to earlier
is the fact that you've now got
these five bipartisan
working groups formed.
Again, it's been a while since we've seen
I think effective bipartisan cooperation
to at least look at the
issues and study the issues.
And so that's, I think, a
significant development.
The working groups have sought input
from the business community
and other stakeholders,
and are expected to provide a report
to Senate Finance Committee in May.
So if you look at that, you'd say,
well, okay, things are moving.
We've been talking
about this for 20 years,
but maybe we're moving in a direction
where something's gonna happen,
and earlier Deputy Assistant
Secretary Mazer suggested
that he's somewhat of an
optimist about the possibility.
I think a lot of people
are still skeptical,
but I think we are certainly at a stage
where the development and the discussions
that are happening now will form the basis
of what ultimately does
happen whenever that is.
So we want in today's panel
take a little deeper dive
in the two proposals that are out there
that are I think forming
the two sides I would say
of the debate, to the
extent there are two sides.
So former Chairman Camps'
comprehensive proposals for reform
and the administration's
proposals for reform,
and then turn to what
truly are the prospects
that we'll see change,
and we'll see if Tom
is as optimistic as--
- As ever.
(laughing)
- That's right.
So with that, let me turn it over to Bob
to talk about Chairman Camp's proposals.
- Okay, so what we're talking about now
are proposals included in Chairman Camp's
2014 comprehensive tax reform draft.
As many of you will
remember, a couple of years
prior to that, I believe it
was in 2012, maybe earlier,
but Chairman Camp had
released an initial draft
that was focused solely on
international tax reform
and a territorial system
was a key feature of that.
The 2014 comprehensive draft
includes the original proposals
but with modifications taking
into account comments received
after the initial draft was released.
So what we're focused here on
is just the international tax provisions
from the comprehensive draft.
And then, while not mentioned here,
a key feature of the draft was a proposal
to reduce the domestic
corporate tax rate to 25%
and that plays into some of
the specific provisions here.
So the key feature of the draft
was a proposal for a
participation exemption
in the form of 95%
dividends received deduction
for dividends received by
domestic corporate shareholders
who are United States
shareholders, so 10% shareholders,
from certain 10% owned
foreign corporations.
This proposal would include
not only dividends received from CFCs,
but also dividends received
from so-called 10/50 companies.
The 95% DRD means that 5%
of the dividend is taxable,
and the 5% taxable portion
is intended to be a proxy
for disallowed expenses
or expenses associated
with generating that exempt income,
rather than having a separate proposal
to disallow expenses allocable
to the dividend itself,
and you'll see that's different
from the administration's
proposal in some respects.
- Bob, it might be worth pointing out
with respect to that 95% DRD,
Manal mentioned at the beginning
that the Finance Committee staff
has produced a white paper on reform,
and one of the things
they discuss in there
are studies that have indicated
that if you really wanted
to fully allocate expenses
to foreign income under a
participation exemption system,
the percentage would
be more like 70 or 75%,
rather than 95%.
- In any event, it's 5% in this draft.
(laughing)
- In this one.
- It may be a bit ambitious.
- In exemption systems abroad,
95 is a common number.
- It's the marker.
- And they do use the 5% as the surrogate
for allocation of expense,
so the study is sort of a counterpoint
to whether that is sufficient.
- That's right, and with all these things,
you'll see including the
rates that would apply,
the rates that would apply
to repatriation, et cetera,
all of these things can
be adjusted up or down
to generate revenue or deal
with revenue needs as well.
So back to the proposal itself,
of course if you're gonna allow exemption,
no foreign tax credit would be allowed
for taxes attributable to dividends
that qualify for the exemption,
and the proposal includes a six-month
holding period requirement
to be eligible for the DRD.
Interestingly, the proposal
includes no specific exemption
for stock gains, so
gains on the sale of CFC
or 10/50 company stock.
There's no specific exemption for those,
unlike Chairman Camp's initial
draft released earlier.
It appears that selling shareholders
that recognize Section 1248
dividends from the sale of stock
would be able to apply the 95% DRD
to those deemed dividends
under Section 1248.
But otherwise, no
exemption for stock gains.
Foreign branches are not
subject to any special rules
in Chairman Camp's initial draft.
He proposed to treat
branches as corporations
that would then qualify for the DRD.
There were a lot of
complications with that.
He also had suggested that those branches
would be deemed incorporated
prior to being eligible for the DRD,
which would result in deemed transactions,
taxation and the like.
And so the 2014 draft just
abandoned that approach
and branches are not
subject to special rules
that then qualify for the exemption.
And there's some special rules
that deal with limiting losses recognized
with respect to stock that qualifies
for the participation exemption.
So another feature as in his initial draft
was a proposal to tax existing
deferred offshore earnings,
and he would implement a new Section 965,
like we had a few years ago,
that would subject any US shareholder,
so again 10% shareholders,
but not limited to 10% shareholders
who were corporations even,
but that owned 10% of
a foreign corporation
to a deemed repatriation of the earnings
of the deferred earnings,
untaxed earnings of that
foreign corporation.
A deduction would be allowed
with respect to those dividends
and the amount of the
deduction would vary,
depending on whether the earnings
underlying the dividend were
invested in cash offshore
or instead were invested in
operating assets and the like.
Earnings invested in cash,
dividends attributable to
earnings invested in cash
would qualify for a 75% DRD,
whereas earnings, dividends
attributable to earnings
invested in operating assets and the like
would qualify for a 90% DRD,
so a more favorable rate for earnings
invested offshore in active operations.
The inclusion would be affected
through our Subpart F rules
and a key provision is
that the deferred E&P
that's subject to this deemed repatriation
would be determined by looking
at all of the investments
of a particular shareholder
and allowing adjustments for E&P deficits
of foreign corporations,
10% owned corporations.
So a positive E&P in one subsidiary
and a deficit in E&P in another subsidiary
could be netted in effect for determining
the amount of net E&P that's
subject to repatriation.
And then another key
feature was an election
to pay the tax on the
deemed repatriated profits
in installments over eight years,
and it's actually a favorable
schedule for paying that out
that's more back-weighted
so that more of the tax
is payable in the later
of the eight years.
So Professor Rosenbloom
asked three questions
of the last speaker and
they're sort of all relevant
because Chairman Camp's talking about
going to a territorial system here,
he's also focused on the three things
that you raised questions on in his draft.
If you're gonna provide an
exemption for offshore earnings,
certain categories of earnings
are not gonna qualify for that exemption.
And so his proposal is to
retain our Subpart F rules
as a basis for determining what
qualifies and what doesn't,
and makes a number of
modifications to that,
including modifications that are designed
to ensure that certain types of earnings
are subject to a sufficiently
high foreign tax,
so a minimum foreign tax
in effect as a marker
for what qualifies for the
exemption and what does not.
So he has a new category
of Subpart F income,
foreign-based company intangible income.
I'll come back to explaining what that is
in just a few minutes,
but it would be a new
category of Subpart F income.
Otherwise, retains the Subpart F rules
with a couple of modifications
we'll mention now.
There's a mandatory high tax exception,
so earnings that are
subject to tax at a rate
at least equal to the US rate
would be excluded from Subpart
F, as a starting point.
Then also certain types of income,
foreign-based companies'
sales income in particular,
would qualify for this
high tax exception as well
if they were subject to a rate of tax
at least equal to 50% of the US rate.
So his proposal was for a 25% rate,
so foreign-based companies' sales income
taxed at a 12.5% rate would
be excluded from Subpart F.
I mentioned foreign-based
company intangible income,
which I'll describe in
more detail in a minute,
but the proposal would be
that foreign-based company
intangible income that's taxed at a rate
at least equal to 60% of the US rate
would be accepted from
Subpart F income as well.
Then for foreign-based
company sales income,
if it does not qualify for
this high tax exception
of at least 50% of the US rate,
then the inclusion would be 50%
of the foreign-based company sales income,
so 50% would be excluded.
So effectively, the 50%
of foreign-based company
sales income taxable in the
US under our Subpart F rules
at a 25% rate equates
to a 12.5% overall rate
on the foreign-based company sales income.
A deemed paid credit would be allowed
with respect to all of
these categories of income.
Section 960 would be preserved
as part of this regime.
Oh, and the last feature on the slide
is a provision that would actually exclude
from foreign-based company sales income
sales income earned by
CFCs that are themselves
qualified residents of a jurisdiction
with which the US has a
comprehensive income tax treaty.
So that's a new provision
and something that would
eliminate the high tax test
for CFCs resident in countries
that have a comprehensive
treaty with the US.
Active financing, these
are the deferral rules
that apply to banks and
active financing companies,
broker/dealers and the like,
he proposes not to make that permanent,
but to extend it for five years
and then also apply a minimum tax rule
to that category of earnings as well,
income that meets the definition
of qualified banking financing
income under Section 954(h)
or the comparable insurance
rules would qualify
for the exception from Subpart F
as long as it's taxed at a rate
at least equal to 50% of the US rate,
so again 12.5% rate under the proposal.
A couple of additional provisions,
including making the look-thru rule
in Section 954(c)(6) permanent.
And then as I mentioned,
he would add a new category of income,
foreign-based company intangible income.
The name is a little misleading
because in effect this category of income
is really a residual category of income,
the income that's not
actually defined as Subpart F
under the rules that we
just talked about briefly.
It's intended to work in parallel
with the proposal to
reduce the US tax rate
on domestic corporations
that earned income
from the exploitation
of foreign intangibles.
So again reflecting a favorable rate
for certain intangible income,
a question that Professor Rosenbloom
had asked about earlier as well.
So the domestic favorable rate
for royalties earned
domestically is sort of reflected
in this 60% high tax
kick-out in effect for income
that's foreign-based
company intangibles income.
There's a formula here that
describes what that income is,
but is effectively a
residual class of income
that's not otherwise caught
by the Subpart F rules,
and again, if taxed at a
60% rate would be excluded.
Also he includes a
provision that is designed
to disallow interest
expense in certain cases.
The way it works is it
works sort of similar
to Section 163(j), which applies
more in the inbound context
and it's simply a provision
that would disallow
a certain amount of net interest expense,
so it's a net interest expense item.
If a US company that's part of
a worldwide affiliated group
as defined in the proposal,
basically a US company
with CFC subsidiaries,
it would disallow a certain portion
of that in expense of that company
if it has a domestic debt equity ratio
that exceeds a worldwide debt
equity ratio for the group
and the net interest expense
exceeds a certain threshold,
which in this case would be
40% of adjusted taxable income.
And then lastly, just as you would expect
if you're going to an exemption regime,
you would end up repealing
the Section 902 deemed paid credit,
and the proposal makes a
variety of other recommendations
related to the foreign tax credit,
sort of emphasizing that it
has at least a lesser role
in this system than it
does under current law,
so a few of the changes
are outlined on this slide.
But with that, I think
those are the key features
of the proposal, and now I think
we're gonna turn it over to Manal
who's gonna talk about the
administration's proposals,
and you'll see some similarities,
but of course some big
differences as well.
- So the administration,
we obviously don't have
the level of detail
that we have in the Camp proposal,
which includes legislative language
and gets down to the real application
and implementation pieces,
but we have a fair amount of information,
and the themes are pretty
common, strikingly common.
The administration, the
president put out a framework
for reform in 2012,
that began to outline
the concept of reform
that the administration had envisioned,
and in that 2012 framework,
the administration introduced
the concept of a minimum tax
for the first time on offshore earnings.
At the time that was released,
it wasn't crystal clear
how the administration
intended that tax to apply,
whether that was an add-on
to the existing rules for deferral
and somehow there was
still a tax on repatriation
but adjusted at the
time for the minimum tax
or whether it eliminated
repatriation taxes altogether.
The 2016 budget sort
of clarified that issue
and made the minimum
tax really a substitute
or part of a package that
was a complete substitute
for our current rules on deferral
and the tax on repatriation.
So in general in the budget,
the administration
overall called on Congress
to begin work on business tax reform
that achieved five goals.
First, cutting the corporate tax rate,
paid for by structural reforms
and eliminating loopholes and subsidies,
strengthening American
manufacturing and innovation,
and I think Mark addressed
that in his address,
strengthening the
international tax system,
which is what we're focusing on,
simplifying and cutting
tax for small business,
and avoiding adding to the
deficit, so revenue neutral,
and in terms of the
administration's proposal,
it's revenue neutral from
a business tax perspective.
It doesn't include individual taxes,
but is broader than just corporation tax.
Again, they said the
policies needed to be part
of a revenue neutral business tax reform
and it included a transition
tax this one time,
14% transition tax.
The FY16 budget that ends up being a mix
of new and old proposals and they combine,
I think I skipped a slide here.
Nope, okay, so they do combine both.
They keep some of the old proposals,
which were introduced,
many of them introduced
in the FY15 budget, but
also add these new concepts,
including the minimum tax,
the 14% rate repatriation.
In terms of numbers, the transition tax,
the one-time tax on
repatriated earnings is slated
to earn around 269 billion
in the 10-year budget window,
whereas the other international
tax proposal's around 238 billion.
Notably, the minimum tax
proposal is a significant,
about 206 billion of
that whole 238 billion.
The general outlines or the concept
of the minimum tax in the budget
is to impose a per country tax of 19%
on the foreign earnings
of a US corporation,
on the active foreign
earnings of a US corporation,
so non-Subpart F earnings.
And it was intended to apply
not only to the earnings of CFCs,
but to the earnings of branches,
so directly earned foreign-source income
of the branches of US
corporations as well.
And again, it was effective
as of December 31, 2015,
and was intended to be about 206 billion,
so a significant portion of
the international provisions.
So what is this minimum tax?
I think viewed, if you step
back and look what it does,
effectively what the
administration proposal
divides up offshore
income into three buckets.
A category of income that's
completely exempt from US tax,
a category of income,
and you could argue that's sort of a pure
territorial exemption approach,
there's a category of
income that's subject
to current US tax at the
current corporate rate,
so that would be a pure
worldwide approach,
and then this middle category of income
that is currently taxed,
but taxed at a lower rate
than domestic earnings.
So in terms of what is
the bucket that is exempt,
and here's where you start seeing
some of the common strands with Camp.
I would say the difference is in how broad
each of these categories are
in Camp versus the administration,
but the concepts are the same.
In the administration's proposal,
the category of income
that would be exempt
includes two categories
or two types of income.
One would be non-Subpart F income,
that is subject to a
foreign effective tax rate
of 22.5% or more, and then
a second type of income
that's also non-Subpart F income,
but equal to what is referred to
as the risk-free return
on corporate equity.
So effectively what they're looking at
are assets of the corporation
that generate active income,
so non-foreign personal
holding company income,
and they're looking to the
risk-free return on that,
and to the extent however that's measured,
the risk-free return on that,
those assets would be completely
exempt from US taxation.
I think Mark referred to that,
he used the hotel example,
where you've got an asset
and it's not movable
and there's exemption.
So that's the category of exempt income.
On the other side of the spectrum,
you have Subpart F income.
So as we know it today
with some adjustments
proposed in the budget that
would broaden the category
of Subpart F income, and
that income would be subject
to tax currently at whatever
the corporate rate is,
and the administration's budget
proposed a 28% corporate rate, so at 28%.
So then in the middle, you
have this other category
of active income that would
be subject to a minimum tax,
and that category would include any income
that wasn't in the other two categories,
so it's neither exempt
nor Subpart F income,
and that income would be taxed
at a current rate equal to 19% minus 85%
of whatever the
foreign-effective tax rate was.
So the 22 I mentioned
in the exempt income,
that is derived from that formula.
The minimum tax is equal to 19% minus 85%
of the foreign-effective tax
rate, but not below zero.
So if you multiply 85% times
22.5%, you would get around 19,
and that's what you get zero
exemption on that income.
But that effectively
is the way it operates.
And in terms of getting to determining
your foreign-effective tax rate,
again you look at per country.
It's a 60-month analysis,
so you look at it
over a 60-month period of time.
And you ignore check the box entity,
so you look at income as if
it were in that jurisdiction
without regard to checked entity,
so you're looking at that taxation
and determining the tax rate on a base
that includes income
without regard to checking
US check the box or 954(c)(6).
The effective tax rate is also looked at
by neutralizing the effects of hybrids,
so again it's bringing in
some of the BEPS concepts,
if there's a hybrid where
you have a deduction,
no inclusion, for purposes
of determining the base
on which you're determining
what your revenue is
and your offshore earnings
and your effective tax rate,
you ignore that deduction
if there's no inclusion
in the hybrid payment.
So just looking at it
in comparison to Camp,
you'd say, okay, well, I've
got a category of income
that's exempt, I've got
a category of income
that's subject to a minimum tax.
The difference is that
in Camp's minimum tax,
the rate of the minimum tax
is different and varies,
depending on the category of income.
Here it's 19%, it's higher
there depending on the category.
It's 12.5 in certain cases.
- 12.5 or 15.
- Or 15.
The administration has
said that the numbers
that they've used to come up with this
actually are less relevant
than the concepts.
The math has to add up, but
they view the rates as dials
to get to an overall
revenue neutral answer.
So in terms of common ground,
the discussion around rate
is really can you get to neutrality,
with respect to how you
pay for the reduction
in the overall corporate rate
and having the overall reform.
So the debate will be about what category
should or shouldn't be exempt,
what's mobile and what isn't,
and whether you can get the math to work
at the end of the day
when you talk just about international.
In addition to those three buckets
creating this new structure for income,
you have sort of conforming amendments
to the Subpart F rules,
that again you see some
of the similarities.
You've got the high tax
exception being made mandatory,
just as in Camp.
There's repeal of Section 956
on taxation of investment in US property
and 959 because you've
eliminated the need for those
once you've gone to the structure
that doesn't tax income on repatriation.
In addition, you have
conforming modifications
to Section 1248 with respect
to sale of CFC stock,
attributable to undistributed earnings.
Again, you've taken care of that
because the income has either been exempt,
taxed under minimum tax,
already taxed under Subpart F.
And then in addition, to create parity
with respect to the builtin
gain of assets of a CFC,
there is an adjustment so that the gain
attributable to the unrealized
gain in those CFC assets
will be taxed in the same manner
as if the future earnings of those assets
would have produced.
So again you apply the same
concepts of the minimum tax,
depending on the character of that income.
With respect to the foreign tax credit,
because the minimum tax determination
or the taxation of offshore earnings
would be determined on
a per country basis,
there is a rule that would
prevent cross-crediting
of high-taxed earnings
against low-taxed earnings
or earnings that would have been exempt,
or sorry, taxed on high-taxed
earnings against US tax
on earnings that would have
been taxed immediately.
And similarly, with respect to
interest expense deductions,
there's a limitation on the
deduction of interest expense.
So if its interest is allocable to income
that's subject to the minimum tax,
the deduction for that interest
would be limited to
the minimum tax amounts
only deductible up to
the amount of that tax,
and any interest that would
be allocable to exempt income
would not be eligible for deduction.
So again, a matching of interest expenses
to the rate of income
to which it's allocable.
With respect to the transition tax,
both Camp and the administration
have a transition.
You've moved from a system
where you've got a worldwide tax system
and you've now got a system
that either exempts income
or taxes it currently,
and what do you do with all those earnings
that are offshore that
haven't been repatriated
and were supposed to be
taxed upon repatriation?
So in the case of the
administration's proposal,
it's a one-time tax at 14%,
again a dialable number.
The administration has
said it was what was used
to make the math work, but a one-time tax
paid over five years on those earnings.
Camp has the two-tier repatriation system,
depending on the
character of the earnings,
so slightly different
approach, same concept.
- But both significantly lower rates, yes?
- Yes, much lower than on the transition.
That's the headline news from
the administration's proposal,
and it really does flesh out the framework
that they had originally
proposed in more detail,
and really more detail than
most budgets usually go into.
Green books usually are fairly bare bones.
We've gotten a lot more window
into what they're thinking
and we see that clarity.
There's a number of other
new proposals in the budget,
including the permanent
extension of active financing,
which actually I think
Camp only did five years.
This is a permanent extension
as well as the permanent extension
of 954(c)(6) look-thru
with the reasons being
that the understanding is the minimum tax
takes care of any concerns
associated with that kind of income,
and so those can be permanent.
So that's a simplification.
They do some tightening of concerns
about what are referred
to as Subpart F loopholes
and technical run-arounds or concerns
about the way in which Subpart F is used,
so in dealing with the 30-day
rule from qualifying as a CFC
and the constructive ownership rules.
And they also accelerate the availability
of the worldwide affiliated group election
for allocating interest.
So interest is proposed.
We have a law passed effectively
to allocate interest expense
on a worldwide basis,
but the effective date of that
law keeps generating income
because it keeps getting
delayed to make more money.
Under current law, it's
delayed until tax years
after December 31st, 2020.
The budget would move that forward to 2015
so that it matches up the approach
to taxing offshore earnings
with the allocation of interest expense
and avoid the distortion
that that can create.
Then there's the modified version
of the inversion proposals.
The budget also includes
a lot of the proposals,
many of which have been
around for a while,
but some new ones that were introduced
in the last year's budget,
most notably the ones
that are echoing some
of the BEPS concerns.
And again, Deputy Assistant
Secretary Mazer indicated
that a lot of those budget
proposals were informed
by the work that was being done
at the OECD with respect to BEPS.
And the ones that stand out in that regard
and are repeat from last year
include the new category
of Subpart F income
with respect to digital income.
The expansion of Subpart F
was more of a US concern,
but echoes some of the
concerns that were made,
are being addressed at the OECD
with respect to CFC income
and manufacturing services,
but certainly the proposals
to deal with hybrids,
the denial of deductions
with respect to certain hybrid payments
are very much echo action item two
within the BEPS action plan
regarding neutralizing
the effects of hybrids.
So we're seeing that
included here as well.
And then in addition, you have the cap,
the limitation on interest expense,
which is being discussed
in the BEPS action plan,
although it's unlikely to see consensus,
but seems to be likely to be
part of any reform proposal
in the US which is a
cap on interest expense
that in this case in the
administration's budget proposal
would be a cap based on worldwide debt.
The rest of the proposals again
have been around for a while,
and then there's some proposals
that have been eliminated,
and they've been eliminated
because once you adopt
this minimum tax approach,
you get rid of the tax
on repatriated earnings,
you no longer need them.
So, the deferral of
deductions of interest expense
related to deferred income
is no longer necessary
because you don't have
deferred income anymore,
and that proposal's been substituted
with the limitation on deductions
depending on whether it's allocable
to income subject to the
minimum tax or to exempt income.
The foreign tax credit, the
very complicated proposal
to determine the foreign tax
credit on the basis of pooling,
is no longer necessary because
of the per country approach
to the minimum tax as well as the credit.
And then the last one,
taxation of excess returns
associated with transfers
of intangible income
again becomes superfluous
once you have a minimum tax
and you tax income either
currently or you exempt it
or subject it to minimum taxes.
So those are the proposals.
There's more in common other
than there are differences,
and the differences
really end up being on,
in my view, and a lot of
people will debate that,
but if you look at the differences,
they tend to be on the
dialing of the numbers
or on the scope of what's
worrisome income and what's not.
There are differences in things
like the taxation of royalties,
with Camp having a favored tax,
sort of a patent box type
or knowledge box approach
to intangible income,
and notably the administration's proposal
taxing royalty income at full US rates,
not even the minimum tax rates,
which is an interesting choice,
because it does mean that
if intangibles are in a CFC
and the royalties are received by the CFC,
that would receive the minimum tax rate,
assuming it's active,
but if the royalties are
received directly in the US,
they'd be subject to the
higher corporate rate,
and it does create
potentially an incentive
to continue to move
that intangible offshore
to get the favored rate on the royalty,
and Camp addresses that
through a favored rate
on royalties.
- That's right.
- So those kinds of things
I think will be debated
in the discussion, and
are actually very relevant
to some of the issues that are going on
in broader reform
considerations about behavior.
So with that and with
Mark's positive attitude,
do you think it's possible?
(laughing)
- Anything's possible.
- Yeah.
(laughing)
- So I guess it falls
on me at the end of this
to explain in 10 or 15 minutes,
given either the broken
or at least the damaged
state of the tax system,
why we haven't done
anything about tax reform
or at least try to explain
when that might happen
sometime in the foreseeable future.
And I was remembering
the last time I spoke
at this conference was about
four or five years ago,
and one of the subjects was tax reform,
and I boldly predicted at that conference
that nothing was going to happen
in the foreseeable future on tax reform.
So I will at least take credit
on being right that time.
(laughing)
Whether that prevails again, we'll see.
So we're gonna move from
tax policy to tax politics
'cause obviously it's the tax politics
that are gumming up the works.
Sort of the simplistic
view of the uninitiated
which we see here from
the "Washington Post,"
definitely the uninitiated,
is that tax reform shouldn't
really be that hard,
you just close some loopholes
and lower the rates.
Why shouldn't we do it right away?
The more astute political view
was expressed by the Speaker of the House,
knowing what the problems are,
recognizing the political
difficulties and trying to do it.
He famously said, "Blah,
blah, blah, blah,"
when someone asked him about tax reform
and why it wasn't getting
done, very eloquently spoken.
Both the Camp plan and the
administration's proposal
for international reform
and the Baucus proposal,
to the extent we wanna bring that in, too,
are all in the context of
more comprehensive tax reform,
either comprehensive individual
and corporate reform,
or in the administration's
case, corporate reform alone
or business reform alone.
The common element in these proposals
generally is you eliminate
corporate tax expenditures
or preferences as the
economists would call them,
and you use the revenue that
you save from doing that
to lower the rates.
And there are a number
of proposals out there.
They've been out there for years.
I'm unfortunately old
enough to have been around
for the '86 Act.
It was only about two or
three years after the '86 Act
that we started talking
about tax reform again.
There are any number of proposals.
Some of the major variations
we've listed here,
things like adding a VAT to
reduce the corporate rate
or taxing capital gains
as ordinary income.
You see these in a lot of the proposals,
but the main elements are
eliminating expenditures
and lowering the rates.
This is sort of a, I forget how many,
and what do we have here,
the top seven reasons
why we don't get reform.
You could make a top 10
if you count some of the sub-bullets.
But that's what I thought I'd
kind of run through quickly.
And most of these are the same
as they were four or five years ago.
Most of these are universal problems
with trying to do tax reform.
The first one that I've listed here
I think is more of a problem
now than it was in the past,
and that's the lack of agreement
about revenue neutrality.
Should we raise revenue with reform
or should it be revenue neutral?
Should all of the revenue that's saved
by eliminating tax preferences
and doing anything else you're gonna do
be used just to lower rates?
The reason that's a bigger problem today
is that we now have after the
Budget Control Act of 2011,
we've got caps on spending going forward,
caps that are limiting
the amount of revenue
that's available to be
spent by the government
on the one hand, and on the other hand,
a deficit that's coming down this year
and will come down a
little bit more next year,
but then starts heading up again.
And if you think that there
are things that need to be done
that require spending going forward,
the last thing you wanna do
is give up the relatively easier money,
the revenue that can be gained
by eliminating tax expenditures
and spending it all on reducing the rates
when you know politically
that raising rates
is about the most difficult
thing to do politically.
So there's a real difference
of opinion about what to do.
This is where the partisan politics
really plays a major role
to the extent that that's
gumming up the works,
other than people just not talking
to each other and getting along.
This is where partisan
politics really comes into it.
Inevitably, if you do pure tax reform
revenue neutral tax reform,
what you're doing at the end of the day
is you're redistributing tax burden,
and that means that a number of taxpayers
are going to see their taxes go up
rather than go down in reform.
And it's not surprising that
those who see taxes increase
in tax reform tend not to like it.
It becomes not their favorite thing to do.
And it's even worse politically than that,
because what happens inevitably
when a proposal's put on the table
that has tax expenditures
cut or eliminated in it,
is that the taxpayers
who enjoy those benefits,
seeing the difficulty in
doing comprehensive reform,
realizing that it may not happen,
begin to worry about something else,
and that's that tax reform won't happen,
but now their fully drafted,
fully scored revenue raising provision
is now sitting out there
for someone to pick off
when revenue's needed.
So that will start, even
though there may be winners
under the tax reform proposal as a whole,
will nevertheless come
out objecting vehemently
to the particular proposal
that affects them.
And we saw that, for
instance, in the Camp proposal
in spades when he
included in his proposal,
sort of to rebalance
the books a little bit,
a tax on bank assets.
The banks were financial
services, entities in general,
were big winners under the Camp proposal
because they didn't lose things
like accelerated cost recovery
and the manufacturing deduction.
So they enjoyed the rate
reduction without the pain,
so he wanted to add a little pain
to sort of balance
things out a little bit,
and the banks came out vehemently
against that bank tax that he'd included.
So the lobbying is even more intense
than you would expect
just from the losers.
Even the winners tend
not to like tax reform,
or at least enough elements of it
that they gum up the works.
Thirdly, the revenue that can be gained
by eliminating tax preferences
is not nearly as great as you would think,
given the talk about 25% rates and such,
and that's particularly true
if you look at the revenue
gained on a permanent basis
rather than on a temporary basis.
And what I mean by that
is if you eliminate
the biggest corporate tax preference
that's on the chopping block
potentially in tax reform,
is accelerated cost recovery
raises whatever it is,
$500 or $600 billion over 10 years.
The permanent revenue is
probably half of that,
because accelerated cost recovery
is, of course, a timing provision.
So it only raises permanent revenue
to the extent there are increases
in the capital stock going forward.
So if you look at what revenue is raised
on a permanent basis,
according to a congressional
research service report last
year or the year before,
you can really only get
the corporate rate down
to about 31.5% just by
eliminating preferences
if you leave alone the
deferred foreign earnings
that are allowed under the current system.
So the revenue is not there to
do the kind of rate reduction
that's generally out there.
The direction of that kind of
reform on the corporate side
eliminating things like
accelerated cost recovery
and the manufacturing deduction
and last in, first out
accounting for inventory,
heavily affect the US
manufacturing sector.
So it's not hard to
identify the loser here.
The loser is US manufacturing.
The winners in that kind of system,
if you don't do anything
about international
are financial services, four
of the top five categories,
if you look at it by industry codes,
and multinational corporations
who aren't losing anything
just by eliminating of preferences,
like accelerated cost recovery.
So that's not a particularly
politically appealing
direction of reform to increasing
taxes on US manufacturing
and using it to pay for financial
services rate reduction,
although the banks would
probably disagree with that.
The economic benefits, to the extent
that people look at that politically,
and they do to some extent,
I think are more questionable
than you would believe from the rhetoric,
and all you have to do to see that
is to look at the Joint Tax Committee
Macroeconomic Analysis of the Camp plan.
If you look behind the top line
of that analysis of that proposal,
what you see is on the second line
when they talk about the effect on growth
going forward under the Camp plan,
because of the nature of the preferences
that he's eliminating,
which are things like
accelerated cost recovery,
what you're doing in
effect by eliminating those
is you're actually increasing taxes
on savings and investment,
which is what those represent,
and using that for a rate cut,
which is effectively a change
in taxation of consumption,
a reduction in taxation of
using up of current assets.
So the longterm growth effect,
according to the Joint Committee,
is somewhere between zero and minus 6%.
So it actually has potentially
a negative effect on growth.
And I also mention here,
someone was talking earlier today
about what happened after the '86 Act
when we did cut the
corporate rate substantially,
from 46% down to 34%,
and what did happen in
the rest of the world
is the rest of the world followed suit
and reduced their rate
even more than we did.
To attempt to gain some sort
of competitive advantage
by reducing rates, when the US economy
still represents 20% of world GDP,
becomes something of a problem,
because the world invariably will react
to the largest player, doesn't
necessarily have to react
when Ireland cuts its rate by five or 10%,
but when the US does it, the
rest of the world reacts.
I guess one way to look at
it is we're probably the...
We're the turtle in
the race to the bottom,
if we ever try to do that.
So the competitive advantage
that could be gained
may not be there.
Surprisingly, given how much politicians
talk about tax reform,
and every politician has
to be for tax reform,
the public is sort of for it,
but it's not a huge issue.
And if you look at the polling,
you see that in spades.
There was a Pew survey of the top issues
facing the country a couple
of years ago, in 2012,
out of the 24 issues listed,
the public ranked tax reform
16th, not particularly high.
There was also a Gallup poll done
on issues facing the nation,
and the percentage of the population
that thinks that tax reform
is the most important issue was 1%.
There are lots of things
people consider more important.
It was mentioned earlier today.
I mean, it really is not at the top
of the public's mind either,
which reduces it somewhat
in the minds of politicians.
And then lastly, let me
talk about the potential
for corporate-only reform,
which is the direction things
seem to be going currently.
And there are reasons to be
looking at that, obviously.
One of the biggest holes in the system
as we've been hearing all day today
are the problems with the
taxation of foreign earnings
under the current system.
There are big dislocations there.
I think maybe the biggest one
that people talked around,
but the effective US tax
rate on domestic earnings
is somewhere about 27 or 28%.
Again, according to another congressional
research service report,
the effective tax rate
on foreign earnings
was 15.6% back in 2006.
There's a huge differential
in the effective tax rates.
That being said, a major
concern of politicians,
when you start talking
about corporate-only reform,
however much sense that may
make from a policy standpoint,
the rank and file member of Congress
is worried about how to
explain to constituents
when they go back to their district,
why we reformed the corporate
tax and reduced the rate,
but didn't do anything for individuals.
What did you do for me?
You fixed their problem, you
didn't fix any of my problems.
That is a significant barrier,
and we hear that right up to the people
who actually understand
what the problems are
in the corporate area and
in the international area.
So there are a lot of reasons
why we don't do tax reform very often,
and we haven't done it since
1986 in any significant way,
and I think the prospects
as always are kind of dim.
If I see some hope in any of this,
it's that, as we've
been talking about here,
there seems to be at least
in the international area
some convergence on the
framework for doing that,
for addressing the
international tax issues
and some outside reasons to do it.
The outside reasons and the kind of things
that push this through are
things like the publicity
that surrounds corporate inversions,
which look pretty ugly to the public,
and the potential need for
revenue that you can raise
by doing that kind of
international reform,
and we're gonna see that
coming up very shortly
in connection with the Highway Trust Fund
which needs a great deal of
money just to stay solvent,
about $16 billion a year,
but that's just the tip of the iceberg
in terms of the infrastructure spending
that Congress is looking
at as needed in the future,
which is in probably the
hundreds of billions of dollars,
because we have a highway
and utility system
that's falling apart.
So looking at things
like international reform
that raises revenue may be something
that Congress does actually
look at more seriously.
I'm not sure it's gonna happen this year.
I'm not as optimistic as Mark Mazer was,
but that's what he's looking at
I think at the moment
as a potential vehicle
for what the administration's proposing.
- Great, thank you.
Do we have questions, or no?
(audience clapping)
I guess we can just leave it right here.
Where's Larry?
- I don't know.
- Oh, there he is.
- There he is.
- Well, it looks like
there are no questions.
Thank you, Manal, Tom, and
Bob for that presentation.
We've covered a lot of ground today
and hope that you now
have a more informed view
as to whether or not the
US international tax system
is really broken or perhaps
just in a state of disrepair.
As a reminder for claiming
CPE or CLE credits,
all you need to do is
submit an evaluation form,
and for CLE, you need to
just drop your name tag
in the basket on the way out
designated for CLE credits.
Please join me in thanking
our distinguished speakers
and our participants for
a wonderful program today.
(audience clapping)
Meeting adjourned, thank you.
