    [Senate Hearing 115-384]
    [From the U.S. Government Publishing Office]

                                                            S. Hrg. 115-384

                            INTERNATIONAL TAX REFORM

    =======================================================================

                                    HEARING

                                   before the

                              COMMITTEE ON FINANCE
                              UNITED STATES SENATE

                         ONE HUNDRED FIFTEENTH CONGRESS

                                 FIRST SESSION

                                   __________

                                OCTOBER 3, 2017

                                   __________

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

                Printed for the use of the Committee on Finance

                                       _________

                           U.S. GOVERNMENT PUBLISHING OFFICE

     32-785-PDF                      WASHINGTON : 2018

                              COMMITTEE ON FINANCE

                         ORRIN G. HATCH, Utah, Chairman

    CHUCK GRASSLEY, Iowa                 RON WYDEN, Oregon
    MIKE CRAPO, Idaho                    DEBBIE STABENOW, Michigan
    PAT ROBERTS, Kansas                  MARIA CANTWELL, Washington
    MICHAEL B. ENZI, Wyoming             BILL NELSON, Florida
    JOHN CORNYN, Texas                   ROBERT MENENDEZ, New Jersey
    JOHN THUNE, South Dakota             THOMAS R. CARPER, Delaware
    RICHARD BURR, North Carolina         BENJAMIN L. CARDIN, Maryland
    JOHNNY ISAKSON, Georgia              SHERROD BROWN, Ohio
    ROB PORTMAN, Ohio                    MICHAEL F. BENNET, Colorado
    PATRICK J. TOOMEY, Pennsylvania      ROBERT P. CASEY, Jr., Pennsylvania
    DEAN HELLER, Nevada                  MARK R. WARNER, Virginia
    TIM SCOTT, South Carolina            CLAIRE McCASKILL, Missouri
    BILL CASSIDY, Louisiana

                         A. Jay Khosla, Staff Director

                  Joshua Sheinkman, Democratic Staff Director

                                      (ii)

                                C O N T E N T S

                                  ----------

                               OPENING STATEMENTS

                                                                       Page
    Hatch, Hon. Orrin G., a U.S. Senator from Utah, chairman,
      Committee on Finance...........................................     1
    Wyden, Hon. Ron, a U.S. Senator from Oregon......................     5

                                   WITNESSES

    Wells, Bret, professor of law and George R. Butler research
      professor of law, Law Center, University of Houston, Houston,
      TX.............................................................     8
    Clausing, Kimberly A., Ph.D., Thormund A. Miller and Walter Mintz
      professor of economics, Reed College, Portland, OR.............     9
    Shay, Stephen E., senior lecturer on law, Harvard Law School,
      Harvard University, Cambridge, MA..............................    11
    Grinberg, Itai, professor of law, Georgetown University Law
      Center, Washington, DC.........................................    13

                   ALPHABETICAL LISTING AND APPENDIX MATERIAL

    Clausing, Kimberly A., Ph.D.:
        Testimony....................................................     9
        Prepared statement...........................................    47
    Grinberg, Itai:
        Testimony....................................................    13
        Prepared statement...........................................    57
    Hatch, Hon. Orrin G.:
        Opening statement............................................     1
        Prepared statement...........................................    66
    Shay, Stephen E.:
        Testimony....................................................    11
        Prepared statement...........................................    69
    Wells, Bret:
        Testimony....................................................     8
        Prepared statement...........................................    78
    Wyden, Hon. Ron:
        Opening statement............................................     5
        Prepared statement...........................................    83

                                 Communications

    American Council of Life Insurers (ACLI).........................    85
    A. Philip Randolph Institute et al...............................    90
    Association of Americans Resident Overseas (AARO)................    92
    Center for Fiscal Equity.........................................    93
    Democrats Abroad.................................................    95
    FACT Coalition...................................................    96
    Hunt, Gina M.....................................................    98
    Investment Company Institute (ICI)...............................    99
    Kadet, Jeffery M.................................................   101
    Reinsurance Association of America (RAA).........................   106
    Tax Innovation Equality (TIE) Coalition..........................   108

                            INTERNATIONAL TAX REFORM

                                  ----------

                            TUESDAY, OCTOBER 3, 2017

                                           U.S. Senate,
                                          Committee on Finance,
                                                        Washington, DC.
        The hearing was convened, pursuant to notice, at 10:05
    a.m., in room SD-215, Dirksen Senate Office Building, Hon.
    Orrin G. Hatch (chairman of the committee) presiding.
        Present: Senators Roberts, Thune, Isakson, Portman, Toomey,
    Cassidy, Wyden, Stabenow, Cantwell, Nelson, Carper, Cardin,
    Bennet, Casey, Warner, and McCaskill.
        Also present: Republican Staff: Jay Khosla, Staff Director;
    Jennifer Acuna, Senior Tax Counsel and Policy Advisor; Tony
    Coughlan, Senior Tax Counsel; Jennifer Kuskowski, Health Policy
    Director; Alex Monie, Professional Staff Member; Eric Oman,
    Senior Policy Advisor for Tax and Accounting; and Jeff Wrase,
    Chief Economist. Democratic Staff: Joshua Sheinkman, Staff
    Director; Ryan Abraham, Senior Tax Counsel; and Tiffany Smith,
    Chief Tax Counsel.

     OPENING STATEMENT OF HON. ORRIN G. HATCH, A U.S. SENATOR FROM
                  UTAH, CHAIRMAN, COMMITTEE ON FINANCE

        The Chairman. I want to thank everyone for attending this
    morning. Before we begin, I just want to say something about
    the awfulness of this past weekend. I think I speak for the
    entire committee when I say that our thoughts and prayers go
    out to those who were impacted by the horrific shootings in Las
    Vegas and to everyone in that community and across the country.
    It has been shocking to everybody.
        Nevada and Utah share a border, and a number of people from
    both States frequently travel back and forth. I have gotten to
    know a number of great people from Nevada over the years, not
    the least of whom is our colleague on this committee, Senator
    Heller. I am sure he is hurting today, as are so many people in
    that community.
        Our hearts go out to all of them, and I am praying that
    everyone who has been impacted by this terrible tragedy will be
    able to find peace, comfort, and, hopefully, a speedy recovery.
        With that, I would like to turn to the business at hand.
    Today's hearing will focus on another piece in the complex tax
    reform puzzle. But before I get to the details of international
    tax reform, let me briefly address the elephant in the room.
        Last week, I joined with the Secretary of the Treasury, the
    National Economic Council Director, the Senate Majority Leader,
    the House Speaker, and the chairman of the Ways and Means
    Committee to put forward a broad, unified framework for tax
    reform. As the document makes clear, this is just one step in
    the larger tax reform effort. But let us not mince words: it is
    a big step.
        I would be hard-pressed to remember the last time the White
    House and the House and Senate leadership were in agreement on
    an issue as complicated as tax reform.
        We began discussions earlier this year, and at that time
    there were a number of high-profile differences among us. I am
    very pleased that we have been able to bridge so many divides,
    and I am optimistic about our chances going forward.
        I particularly want to thank our ranking member for his
    open mind and his ability to look at these matters and do so in
    a constructive way. He has worked very hard on tax reform for
    years, and, frankly, I hope we can do something together.
        I want to express my gratitude to the others who worked on
    the framework and to the members of the committee who have
    helped us move the tax reform effort forward. I particularly
    want to acknowledge the work of Senator Grassley who, as a
    former chairman and ranking member of this committee, laid much
    of the groundwork for the ideas we are discussing and for the
    progress we have made. It was under Senator Grassley's
    chairmanship that the Finance Committee in 2003-2004 initiated
    the last package of international tax reforms.
        Now, as some have already pointed out, the framework
    released last week is not, by design, a complete plan. Of
    course, that has not stopped think tanks and analysts from
    speculating about its fiscal and distributional impact. We have
    already seen groups attempting to reverse-engineer a completed
    tax plan from the framework, generally filling in blanks with
    their own ideas and assumptions and reaching conclusions about
    a plan they have essentially written themselves. Generally
    speaking, it seems that the blank-filling exercise is designed
    to cast the framework in the worst possible light.
        The framework does not include any specific information
    about things like the break points for the individual tax
    brackets, the value and indexing of the enhanced Child Tax
    Credit, or the precise rate for the top bracket. Without those
    and other key pieces of information, there is simply no way for
    any outside party to produce a credible analysis of the
    framework, let alone a detailed estimate of revenue and the
    distribution of tax burden.
        But that did not stop a certain think tank from issuing a
    ``preliminary analysis'' of the framework at the end of last
    week, nor did it stop any of the framework's critics from
    citing that analysis as authoritative. It is odd, however, that
    the analysis came with a disclaimer that it was expressing only
    the views of the authors, not the think tank itself. Even more
    unusual, no specific authors were listed on the analysis,
    probably because no respectable academic or researcher was
    willing to have their name associated with something so
    haphazardly cobbled together.
        But I digress.
        As the framework makes clear, this committee will be
    responsible for writing the Senate tax reform bill, and I am
    going to work with members of the committee to make sure we are
    successful. For now, everyone should take every estimate or
    analysis about the plan from outside groups with an
    exceptionally large grain of salt.
        Moving on, I also want to say that my preference has always
    been for this to be a bipartisan effort. And I think there are
    several elements in the framework where Democrats and
    Republicans can work together, and I hope we will be able to do
    so.
        The subject of today's hearing is a great example of an
    area where both parties are largely in agreement. Under our
    current system, U.S. multinationals that accrue overseas
    earnings can defer U.S. tax on those earnings until they are
    brought back to the United States.
        In 1962, due to concerns that businesses were moving
    passive and highly mobile income-producing assets offshore,
    Congress enacted subpart F of the Internal Revenue Code. Under
    subpart F, income from these sources is immediately subject to
    U.S. tax, while taxes on active and less-mobile offshore income
    remain deferred until the earnings are repatriated.
        This is a bit confusing in the abstract, so let me provide
    a hypothetical. Imagine that an American company headquartered
    in the United States and subject to our corporate tax rates
    opens a factory in Germany, incorporating a subsidiary there.
    The income generated by the subsidiary, legally a German
    company, will be subject to German taxes paid to German
    authorities. So long as the American company does not bring
    that income back to the United States, its income from the
    German subsidiary will not be subject to U.S. taxes. And in
    fact, we are finding that many American companies have been
    keeping this type of income offshore in order to avoid our
    punitive corporate taxes.
        Now, imagine if the American company parked its money in
    stocks, bonds, or other passive investments and moved the
    income generated from those assets to an offshore low-tax
    jurisdiction. Under subpart F, that type of passive and highly
    mobile income is immediately subject to U.S. tax without any
    deferral. Now, I know this is a bit arcane. And frankly, I
    would be nodding off if I did not know how this story ended.
        As a result of subpart F, American companies have engaged
    in a number of sophisticated and complex tax-planning schemes
    to keep earnings offshore to avoid the U.S. corporate tax.
    According to the Joint Committee on Taxation, American
    companies are currently holding more than $2.6 trillion in
    earnings offshore, thanks in large part to our worldwide tax
    system, something often referred to as the, quote, ``lock-out''
    effect.
        That is $2.6 trillion held by foreign subsidiaries of U.S.
    corporations that the parent companies are unable to invest
    here at home. That is income that could be used to create more
    American jobs and grow wages for American workers. And that
    income has attracted the interests of foreign tax authorities,
    particularly in Europe, who wish to tap into what is, by all
    rights, part of the U.S. tax base.
        Now, I know some of my colleagues have proposed to solve
    this problem of earnings being locked out of the United States
    by transitioning to a pure worldwide system with no deferral.
    And while that would rid us of the lock-out problem, it would
    significantly increase pressures for American multinationals to
    invert or be acquired by foreign-based multinationals.
        Many of us have talked at length about inversions in recent
    years and the problems they pose for our economy and our tax
    base. Perhaps even worse than an inversion is when a larger
    foreign corporation simply acquires a smaller American
    corporation. Either way, the result is the same. A foreign
    corporation becomes the parent of the restructured
    multinational group.
        Companies takes these routes for a number of reasons.
    First, they want to escape the high corporate tax rate in the
    United States, which, as we have heard in our last hearing, is
    the highest in the industrialized world. Second, they want to
    minimize the damage caused by our worldwide tax system. If an
    American multinational can successfully move its tax situs out
    of the U.S., it will only owe taxes on the earnings accrued
    here.
        There is also the matter of earnings stripping, which is
    another complicated topic that I look forward to our witness
    panel discussing today. All of these problems are key for
    today's hearing because they highlight the shortcomings of our
    outdated worldwide tax system.
        The solution to these and other problems, to put it very
    simply, is to transition to a territorial-based system like
    virtually all of our foreign competitors. Under such a system,
    an American company would owe taxes only on income earned in
    the United States. Income earned in foreign jurisdictions would
    only be taxed by those jurisdictions, not here.
        This type of reform would have to be accompanied by
    enforceable anti-base-erosion rules to make sure companies,
    both domestic and foreign, do not exploit loopholes in order to
    unduly avoid paying taxes here. That approach is endorsed in
    the united framework. It was also suggested in the last
    Congress by our committee's bipartisan working group on
    international tax, which was co-chaired by Senator Portman and
    by current Senate Minority Leader Schumer.
        Other members of the committee have also made significant
    contributions in the area of international tax reform,
    including both my colleague Senator Wyden, whom I have great
    respect for--I have respect for everybody on this committee--
    and of course, Senator Enzi, who is always working to try to do
    good things here.
        Finally, as many of you know, I have been interested for
    some time in the idea of better integrating our individual and
    corporate tax systems. I continue to believe that corporate
    integration by means of a dividends paid deduction can
    significantly help with some of our existing problems. And I
    look forward to talking more about that today as well.
        Once again, international tax reform is an area that is
    rife for bipartisanship if we are willing to work together on
    goals that members from both parties share. I hope people will
    note that the international portion of the framework is
    particularly short on details. That is because these problems
    cannot be solved in a nine-page framework document. That will
    require the work and effort of this committee.
        Long story short: today's hearing will surely be
    informative, important, and timely.
        And with that, I turn to my good friend and ranking member,
    Senator Wyden, for his opening remarks.
        [The prepared statement of Chairman Hatch appears in the
    appendix.]

                 OPENING STATEMENT OF HON. RON WYDEN,
                       A U.S. SENATOR FROM OREGON

        Senator Wyden. Thank you, Mr. Chairman.
        I will turn to taxes in just a moment, but like you, I want
    to comment briefly on the horrifying shooting in Las Vegas.
        Mr. Chairman and colleagues, here is my takeaway from this.
    It is just unconscionable that this epidemic of violence goes
    on and on and on and on, and policymakers in Washington, DC sit
    on their hands and do nothing about it.
        Now, we are going to talk about a different subject today,
    but I think all of us are just heartsick about this. I continue
    to believe that there is an opportunity for common sense to
    prevail and reduce gun violence in America.
        Mr. Chairman, on taxes, let me first of all thank you for
    your very kind words. And I continue to believe that there is
    an opportunity for us in the Finance Committee to find common
    ground.
        Democrats have laid out principles that are important to
    us. And I would just say, colleagues, the principles Democrats
    have laid out in the letter very much resemble the bipartisan
    bill I wrote with Senator Dan Coats, now a member of the Trump
    Cabinet. And I see Senator Cassidy--that is where Dan Coats sat
    when we put together the bill.
        And Chairman Hatch has ideas that are important that we
    talked about. So I continue to believe that there is an
    opportunity for common ground here. And I think the principles
    that Democrats have talked about in our letter--where our
    caucus was thoroughly united around where we ought to be
    headed--and some of the ideas Chairman Hatch has talked about,
    are an opportunity to find common ground here.
        Now, the Trump team says their international tax framework
    is about creating jobs and firing up the country's economic
    engine. The details, however, show it is really a con job on
    America's middle class.
        Behind the scenes, the administration recently scrubbed
    from the Treasury website a 2012 paper showing that workers do
    not primarily benefit from a corporate rate cut--that trickle-
    down economics are pretty much a fantasy. Apparently, that
    mainstream economic analysis had to be purged because it
    basically did not jibe with the Trump team's patter.
        They claimed the study was out of date, but they did not
    find reason to take down any of the other papers that date back
    as far as the 1970s. That sure makes it look like the Trump
    team is simply afraid of the American people getting the facts
    about taxes.
        And the con job is not just about hiding those facts that
    are inconvenient. The administration is currently working to
    pick apart the rules that were designed to curb the scourge of
    inversions, what we call the inversion virus, which is a big
    factor in decimating our tax base.
        Now, folks at home in Oregon at town halls tell me they
    want tough policies to stop companies from shipping jobs
    overseas, especially in towns where mills and factories are
    shuttered and Main Street is vacant. The American people want
    red, white, and blue jobs with good wages. They believe
    corporations ought to pay their fair share.
        What is on offer, based on what we know today about the
    Trump plan, is going to disappoint. The Republican tax
    framework that has been okayed is essentially a corporate wish
    list, a massive rate cut, a pure territorial system, barely a
    nod to tough rules to prevent companies from sending jobs
    abroad or running away to set up a headquarters on some zero-
    tax island.
        Base erosion, a minimum tax--these vital parts of the
    international tax debate seem to be an afterthought. This is an
    invitation for corporations to game the system, and the tax
    lobby has got to be licking its chops this morning.
        Bottom line, the President is giving multinationals a green
    light to pay no taxes. Then, for the benefit of people reading
    the news, there is a lot of happy talk about jobs, economic
    growth, and the biggest tax cut ever. It is not hard to predict
    what will happen if this multi-trillion-dollar tax giveaway to
    the wealthy and corporations is enacted.
        Our tax base will keep eroding, and the deficit will
    skyrocket. Lawmakers are going to come after Social Security,
    Medicare, and Medicaid yet again. And by the way, this is not
    without precedent. Privatizing Social Security was the first
    priority, the very first priority, of the Bush administration's
    second term after its big,
    unpaid-for tax cuts.
        Let us remember that every percentage point decrease in the
    corporate rate results in a loss of $100 billion in revenue.
    Perhaps that is the kind of issue that caused Senator Corker
    over the weekend, when I caught him on one of the TV shows, to
    say that he has some big concerns about the deficit.
        Democrats have reached out to the majority with our
    principles for tax reform. There are a lot of members on this
    side with big ideas of how to help the middle class, create
    jobs, bring some fairness to the tax code through bipartisan
    reform. As I said, that is the kind of thing Dan Coats and I
    put our names on; that is the kind of reform that Ronald Reagan
    signed into law back in 1986.
        But the framework that was released last week does not
    resemble what Ronald Reagan accomplished, and it is nowhere
    near, as I say, the reforms built on fairness and fiscal
    responsibility that Senate Republicans over the years have
    worked with Democrats to write into bipartisan plans.
        And wrapping up, I believe international taxation is going
    to be a key part of the debate and involves a lot of very
    complicated questions.
        The committee has a terrific panel of witnesses here. I am
    particularly pleased that Kim Clausing, professor at Reed
    College from my neighborhood in southeast Portland--which
    Senator Stabenow has visited, by the way--is going to give us a
    very thoughtful presentation, as Oregonians invariably do.
        And I also respect the views of our other witnesses as
    well, and we have heard from a number of them over the years.
        Mr. Chairman, thank you, and I look forward to working with
    you.
        The Chairman. Thank you, Senator.
        [The prepared statement of Senator Wyden appears in the
    appendix.]
        The Chairman. International taxation is a very complex
    issue area, and we are grateful to each of our witnesses for
    being with us today to discuss it with us. We will hear from
    each of the witnesses in the order they are introduced.
        First, we will hear from Professor Bret Wells, a professor
    of law and George Butler research professor at the University
    of Houston Law Center. Professor Wells teaches in the fields of
    tax law and oil and gas law. Prior to joining the University of
    Houston Law Center, Professor Wells served as the vice
    president, treasurer, and chief tax officer for BJ Services
    company. He received his bachelor's degree from Southwestern
    University and then went on to earn his law degree from the
    University of Texas School of Law.
        Next up will be Dr. Kimberly Clausing, the Thormund A.
    Miller and Walter Mintz professor of economics at Reed College.
    Dr. Clausing's research is focused on the taxation of
    multinational firms and how their decisions are impacted by
    government decisions. She is the recipient of two Fulbright
    Research Awards and has worked on related policy research with
    many different think tanks. She has worked previously as a
    staff economist for the Council of Economic Advisers and also
    served as an associate professor of economics at Wellesley
    College. Professor Clausing received her B.A. from Carleton
    College and her Ph.D. from Harvard University.
        Third will be Professor Stephen Shay, a senior lecturer on
    law at Harvard Law School. Before joining the Harvard Law
    School faculty, Professor Shay served as the Deputy Assistant
    Secretary for International Tax Affairs at the U.S. Treasury.
    Before that, Professor Shay was a tax partner for 22 years with
    Ropes and Gray LLP. Prior to that work, Professor Shay served
    in the Office of International Tax Counsel at the Department of
    Treasury, including as International Tax Counsel from 1982 to
    1987. Professor Shay graduated from Wesleyan University with
    his undergraduate degree and earned both his J.D. and M.B.A.
    degrees from Columbia University.
        And finally, we will hear from Professor Itai Grinberg, a
    professor of law at Georgetown University Law Center. Professor
    Grinberg's research interests center on cross-border taxation
    and development and U.S. tax policy. Prior to his work at
    Georgetown, Professor Grinberg worked at the Office of
    International Tax Counsel at the Department of Treasury. Before
    that, Professor Grinberg practiced tax law at Skadden, Arps,
    Slate, Meagher, and Flom LLP. In 2005, Professor Grinberg
    served as counsel to the President's Advisory Panel on Federal
    Tax Reform. Professor Grinberg earned his B.A. from Amherst
    College and his J.D. from Yale Law School.
        I want to thank you all again for being here, and you are a
    particularly great panel. We all look forward to hearing your
    testimony here today and your expert views on these important
    matters.
        So, Mr. Wells, will you please get us started then?

    STATEMENT OF BRET WELLS, PROFESSOR OF LAW AND GEORGE R. BUTLER
     RESEARCH PROFESSOR OF LAW, LAW CENTER, UNIVERSITY OF HOUSTON,
                              HOUSTON, TX

        Mr. Wells. All right. Thank you. My name is Bret Wells, and
    I want to thank Chairman Hatch, Ranking Member Wyden, and the
    other members of the committee for inviting me to testify.
        Before addressing international taxation, I want to make a
    preliminary statement about the related topic of business tax
    reform.
        As to business tax reform, Chairman Hatch is to be
    commended for his work on corporate integration. Under his
    partial dividends paid deduction proposal, the dividend
    deduction can be limited to preserve corporate-level taxation
    for earnings in an amount broadly equal to the equity ownership
    of nontaxable shareholders. A partial dividends paid deduction
    regime narrows the tax distinction between debt and equity.
        A partial dividends paid deduction regime in combination
    with a dividends and capital gains preference can result in a
    combined tax rate on corporate business profits that
    approximates the individual rate, thus eliminating the
    disparity in tax rates between C corporations and pass-through
    entities. Thus, a partial dividends paid deduction regime is a
    critical step in the right direction and should be part of the
    final business tax reform legislation.
        Now I want to make a few statements about outbound
    international taxation, but I want to start this thought
    process from the perspective of the foreign-based multinational
    enterprise.
        From the perspective of the foreign-based multinational
    enterprise, outside of its country of residency, only the
    business profits attributable to a particular territory are
    subject to taxation in the various inbound host countries. So
    the inbound, foreign-based enterprise is afforded a territorial
    result regardless of the formal international tax choices that
    might be made by a particular inbound host country. Faced with
    this reality, each country must decide whether or not to have a
    system of international taxation that would disadvantage their
    own resident corporations or would instead afford comparable
    territorial tax results for resident multinational enterprises
    as are afforded by the country to inbound,
    foreign-based enterprises.
        This committee is well aware that every other G7 country,
    after facing this Hobson's choice, has opted for some form or
    variant of a territorial tax regime. For the same
    competitiveness reasons that motivated those decisions, this
    Congress should now adopt a territorial tax regime to level the
    playing field. But at the same time, this Congress must take
    steps to protect the U.S. tax base from inappropriate profit-
    shifting strategies. Under current law, the U.S. subpart F
    regime provides a fairly narrow set of exceptions to the
    deferral privilege, and these anti-deferral provisions serve as
    an important backstop to prevent tax avoidance of U.S.-origin
    profits.
        Another means to attack profit shifting with respect to
    U.S.-
    origin profits would be to adopt greater source-taxation
    measures. Attacking the profit-shifting problem with a source-
    taxation solution has the favorable benefit of implementing
    base protection measures that apply equally to both U.S.-based
    multinational enterprises and foreign-based multinational
    enterprises.
        In contrast, solutions that rely on residency taxation
    principles, such as a minimum tax under the U.S. subpart F
    regime, only protect against the profit-shifting strategies of
    U.S.-based multinationals. Thus, I favor source-taxation
    measures over an expanded subpart F regime, exactly because
    subpart F measures create divergent tax results for U.S.-based
    multinational enterprises and leave in place the inbound
    earnings-stripping advantages for
    foreign-based multinational enterprises.
        With the balance of my time, I want to highlight three key
    issues with respect to inbound international tax reform.
        First, leveling the playing field requires that Congress
    address each type of inbound earnings-stripping technique that
    unfairly advantages the U.S. activities of foreign-based
    multinational enterprises and companies that have engaged in
    corporate inversions. We should not treat those companies more
    harshly than U.S. companies, but they should not have an unfair
    earnings-stripping advantage.
        Second, corporate inversions are a telltale symptom of the
    larger inbound earnings-stripping cancer. Thus, instead of
    attacking the corporate inversion messenger in isolation,
    Congress should focus attention on the inversion message,
    namely that the earnings-
    stripping techniques available to foreign-based multinational
    enterprises, if left unchecked, create an unlevel playing field
    that motivates U.S. companies to engage in corporate
    inversions. Corporate inversions are simply the alter ego of
    the inbound earnings-
    stripping problem and should not be viewed as a separate policy
    problem.
        Third, Congress needs a new approach to the earnings-
    stripping problem. And again, Congress must address this
    problem in a comprehensive way. I believe that a base-
    protecting surtax does comprehensively address the inbound
    earnings-stripping problem, so I urge this committee to
    seriously include this proposal in the final legislation.
        This concludes my opening statement. Thank you for allowing
    me to speak at today's hearing. I would be happy to answer any
    of your questions.
        The Chairman. Thank you so much.
        [The prepared statement of Mr. Wells appears in the
    appendix.]
        The Chairman. We will now go to you, Dr. Clausing. And we
    are looking forward to hearing your testimony as well.

     STATEMENT OF KIMBERLY A. CLAUSING, Ph.D., THORMUND A. MILLER
        AND WALTER MINTZ PROFESSOR OF ECONOMICS, REED COLLEGE,
                              PORTLAND, OR

        Dr. Clausing. Chairman Hatch, Ranking Member Wyden, members
    of the committee, thank you for inviting me to share my views
    on international tax reform.
        The most essential trade-off we face in international tax
    reform is between tax competitiveness and corporate base
    protection.
        First, let us think about this idea of competitiveness.
    When folks talk about competitiveness, they are usually
    referring to multinational companies. These companies are
    mobile and they are very profitable, but they also tend to face
    low effective tax rates.
        Of course, we also have many smaller companies that face
    higher tax rates. But our most mobile multinational companies
    simply do not have a competitiveness problem. These companies
    are some of the most successful companies on the planet.
        If you look at after-tax corporate profits over the last 10
    years, they have averaged 9 percent of national income, 50
    percent higher than they averaged over the previous 40 years.
    Our companies dominate lists of the world's most successful
    companies, and their dominance has not dimmed in recent years.
        And our corporate tax revenues are about one-third lower
    than those in peer countries relative to our economy's size. It
    is therefore difficult to claim that our companies need even
    more after-tax profits to be successful or to unleash
    investment.
        That said, there is far more to competitiveness than tax.
    We do need more investments in infrastructure, education, and
    research to equip workers for the modern global economy.
        Now, let us also consider our serious corporate tax base-
    erosion problem. My past research shows that international
    profit shifting to tax havens now costs the U.S. Government
    more than $100 billion every year. This is big money, money
    that could be used to lower tax rates or pay for key
    investments. Our corporate tax base is also quite narrow.
        Beyond that, the proposed new preferential rates on pass-
    through income are likely to create a huge new base-erosion
    problem. This step will drain revenue from our tax system on a
    large scale. So I suggest four guiding principles for future
    international tax reform.
        First, let us not make a bad base-erosion problem worse.
    Moving to a territorial system further tilts the playing field
    toward earning income abroad, and it will make our base-erosion
    problem larger.
        If a territorial system is adopted, lawmakers should be
    very serious about tough base-erosion protection mechanisms.
    Slashing the tax rate is not going to be enough here. There
    will always be jurisdictions with lower and even zero rates.
    Over 80 percent of our profit-shifting problem is with havens
    that have rock-bottom tax rates.
        To reduce profit shifting, a per-country minimum tax could
    be helpful. And this would be far more effective than a global
    minimum tax. But a simpler and more intellectually coherent
    plan would be to simply combine a rate reduction with the
    elimination of deferral. This evens the tax treatment of
    foreign and domestic income, no longer tilting the playing
    field toward tax havens. And this is the approach behind
    several bipartisan proposals put together by Senator Wyden and
    his Republican cosponsors. This approach should be combined
    with steps to limit inversions, such as toughening earnings-
    stripping laws and other measures.
        A second principle is regarding repatriation. It simply
    does not make good economic sense from either an efficiency or
    an equity perspective to give a big tax break for income that
    has already been earned and moved to tax havens. Special tax
    breaks on haven earnings are not warranted, and evidence
    suggests they will not help investment, they will not help
    employment, and they will not help the middle class.
        Third, let us pay serious attention to the middle class.
    Business tax cuts primarily benefit those at the top of the
    income distribution. All major respected models distribute
    business tax cuts primarily to capital or shareholders, and
    there is a good reason for that.
        Recent analysis of the Big Six framework by the highly
    respected and nonpartisan Tax Policy Center showed that, when
    fully phased in, it would give the top 1 percent 80 percent of
    the tax cuts with an average tax cut of over $200,000, whereas
    the bottom 80 percent of the distribution get a tax cut that
    averages less than $300. After decades of increasing inequality
    and middle-class economic stagnation, tax policy should be
    working to counter, not reinforce these inequalities.
        Finally, let us not increase the deficit. We already have a
    debt-to-GDP ratio over 75 percent, and our Social Security and
    Medicare commitments are due to increase deficits by 2
    percentage points over the coming decade. We need to keep
    budget flexibility so we are ready if another recession
    arrives.
        Deficits are basically taxes on our children and
    grandchildren. And on this topic, we also owe future
    generations a serious response to climate change. Recent
    hurricanes in Houston and forest fires in Oregon serve as a
    reminder of this urgent priority. A carbon tax is both a very
    effective response but also a key step towards more efficient
    taxation. Economists throughout the political spectrum back
    this idea, for good reasons.
        Thank you so much for your invitation to testify today. I
    look forward to your questions.
        The Chairman. Thank you.
        [The prepared statement of Dr. Clausing appears in the
    appendix.]
        The Chairman. Mr. Shay, we will turn to you now.

     STATEMENT OF STEPHEN E. SHAY, SENIOR LECTURER ON LAW, HARVARD
             LAW SCHOOL, HARVARD UNIVERSITY, CAMBRIDGE, MA

        Mr. Shay. Thank you, Mr. Chairman. Good morning, Ranking
    Member Wyden, members of the committee.
        I want to start with two general observations before
    getting into international tax reform in particular. I agree
    with Professor Clausing. Tax reform should be revenue-neutral
    or increase net revenues. We need to raise the revenue to fund
    needed public expenditure, not add trillions to the national
    debt. In the face of pressing needs for public investment in
    human capital and infrastructure, and demographic trends that
    cannot be reversed, we will be forced to spend more in the
    future, even as we need to spend today to help our neighbors in
    Texas, Florida, Puerto Rico, and elsewhere where there are
    crises.
        It would be foolhardy to adopt a revenue-losing tax reform,
    particularly one that would benefit those with high incomes, in
    the unsupported hope based on ``tooth fairy'' economics that
    short-term growth will outweigh longer-term effects on interest
    rates and inflation.
        The second general observation I would make is that tax
    reform should maintain or enhance our tax system's current
    level of progressivity in distributing the benefits and burdens
    of government. The taxation of cross-border income of U.S.
    multinationals should be analyzed under the same fairness
    standards that apply to other income. In particular, a reduced
    holiday tax rate on U.S. multinationals' pre-effective-date
    offshore earnings will overwhelmingly benefit high-income
    Americans and foreigners who are shareholders of these
    companies. And it is not justified on policy grounds.
        Turning to international taxation, my first choice also
    would be to proceed along the lines of the Wyden-Coats
    Bipartisan Tax Fairness and Simplification Act of 2011. Why do
    I say this?
        The evidence does not support claims that U.S.
    multinationals are overtaxed or noncompetitive as a consequence
    of U.S. tax rules. In April 2016, the U.S. Treasury Department
    found that the average tax paid by U.S. companies from 2007 to
    2011 on their book earnings plus foreign dividends--actual
    dividends, not deemed dividends--was 22 percent. I have charts
    in my testimony at pages 4 and 5 that illustrate that study.
        The most recently available statistics of income data for
    2012, which is the most recent year, show that foreign
    subsidiaries of U.S. multinationals--so this is the income that
    was not paid out in actual dividends--paid in the aggregate an
    average foreign tax rate of 12 percent. This is not just a few
    outliers, this is the average rate of foreign tax on foreign
    subsidiaries' earnings and profits before tax--12 percent. If
    you are thinking in terms of a minimum tax on foreign income,
    you have to deal with that.
        And I also have a chart in my testimony at page 6 that
    shows that 52 percent of those low-taxed earnings are earned at
    even lower tax rates in some of those countries, in five
    countries that I consider tax havens.
        So a territorial system has been suggested, at least in the
    GOP tax reform plan that was issued on September 27th. If not
    designed properly, it can leave us worse off than we are today.
    I have suggested several principles that will help maintain a
    strengthened minimum tax that has some prospect to actually
    improve from where we are today.
        First, the minimum tax should be a relatively high
    percentage of the regular U.S. tax rate adopted in tax reform,
    no less than 60 percent and preferably 80 percent of the
    regular rate that you end up at. And I personally think 20
    percent is fantasy in a revenue-neutral deal, so we are talking
    higher rates.
        Second, it absolutely needs to be applied on a country-by-
    country basis and not a global basis. If you do it on a global
    basis, people like myself in my prior career can blend high and
    low foreign tax rates, and in some cases this will incentivize
    foreign investments. You need to do it country by country.
        You should allow a foreign tax credit, but the foreign tax
    credit should be prorated so that the amount of foreign taxes
    you credit will not be greater than the portion of those taxes
    that the minimum tax rate you choose bears to your regular tax
    rate.
        That is complicated. I will be happy to take it up with
    your staffs. But it is absolutely critical to prevent foreign
    taxes from eroding any minimum tax you actually adopt.
        So, Mr. Chairman, I have other ideas in my testimony.
        I agree with the sentiment that we need to strengthen our
    source taxation rules. I disagree perhaps with Professor
    Wells's specific proposal, but directionally we are very much
    on the same page there, so I think there is a lot to work with.
        And I thank you for your time, and I will be happy to
    answer any questions.
        The Chairman. Well, thank you.
        [The prepared statement of Mr. Shay appears in the
    appendix.]
        The Chairman. Professor Grinberg, we will turn to you.

       STATEMENT OF ITAI GRINBERG, PROFESSOR OF LAW, GEORGETOWN
                 UNIVERSITY LAW CENTER, WASHINGTON, DC

        Mr. Grinberg. Chairman Hatch, Ranking Member Wyden, and
    distinguished members of the committee, good morning. My name
    is Itai Grinberg. I am a professor of law at Georgetown. It is
    a pleasure to appear before you today.
        There is now a widespread consensus the United States needs
    to abandon its abhorrent worldwide corporate tax system, lower
    the rate, and go territorial. Although some of today's other
    panelists disagree, this general consensus was even reflected,
    to some extent, in the final proposals of the Obama
    administration.
        Our corporate tax rate and international tax rules are just
    totally out of line with international norms. Continuing to lag
    behind would cost us an opportunity and employment for our
    kids.
        The United States statutory corporate income tax rate is
    the highest in the OECD, and our effective corporate tax rate
    is also very high. We are the only major developed economy that
    has not adopted a territorial tax system.
        But what I want to emphasize today is that dropping the
    rate and going territorial are not enough. One of the most
    senseless aspects of our current law is that, more than any
    other major economy, we create relative tax disadvantages for
    being a U.S. multinational as opposed to a foreign
    multinational, most upsettingly with respect to income earned
    in the United States.
        We make foreign ownership of almost any business more
    attractive than U.S. ownership from a tax perspective. That
    creates incentives for foreign takeovers, for inversions, for
    U.S. companies to produce abroad, and for income shifting.
        The consequence is obvious: we are creating incentives for
    companies to become foreign with negative consequences to U.S.
    employment. Our reliance on subpart F, a regime that affects
    only U.S. multinationals, as our main anti-base-erosion device,
    is the source of the problem.
        Some may argue that rectifying the situation and leveling
    the playing field would discourage foreign investment. But last
    year, 97 percent of inbound foreign direct investment was an
    acquisition of an existing U.S. business rather than a new
    investment. Acquisitions of existing U.S. businesses do not
    necessarily create jobs, and they can cost U.S. jobs.
        Foreign acquisitions of U.S. businesses can also be
    beneficial. We should welcome them when it makes a business
    more economically productive on a pre-tax basis and, therefore,
    liable to create employment. But if a business is acquired
    primarily because of the tax benefit of being foreign-owned,
    that is not economically efficient, and it can hurt U.S.
    employment. Unless we lower the corporate tax and level the
    playing field, the benefits in terms of jobs that prior
    generations obtained from the United States being the world's
    most important headquarters country for multinationals, will
    simply bleed away. Meanwhile, the relative tax advantage given
    to foreign multinationals results in a revenue loss to the
    United States.
        Separately, the foreign tax credit that comes with our
    worldwide system encourages revenue grabs from U.S. companies.
    As the committee knows, this has become a massive problem in
    recent years.
        Globally, we used to have multilateral principles that
    organized the international tax architecture around residence-
    country taxation. That is all simply falling apart. Countries
    around the world are shifting towards greater source-based
    taxation, and that is irreversible. Moreover, that process,
    which has already harmed us, is liable to be long, messy, and
    arbitrary.
        At this point, if we sit still, both our fisc and our
    companies are disadvantaged. If we continue to insist on the
    idea of worldwide residence-country taxation with a foreign tax
    credit for U.S. multinationals and current law advantages for
    inbound multinationals--neither of which other countries do
    anymore--we will simply make our companies uncompetitive
    outliers subject to further foreign revenue grabs and continue
    to lose businesses and revenue at home.
        Meanwhile, with respect to source taxation, there is simply
    no international status quo. As a result, this time, inbound
    reform will not be a one-step process. We are going to have to
    respond over time to the policies of other countries.
        So, when addressing inbound corporate tax reform now,
    policymakers should give the United States leverage. It is
    important to put the United States in a good position to
    bargain internationally about future rules that will most
    likely be agreed to multilaterally at a later date. For now, we
    should choose a pragmatic administrable policy that levels the
    playing field for our national interests and our companies
    alike.
        Unlike Europe, our policies should be based on a defensible
    principle, for instance, an inbound corporate minimum tax that
    applies to U.S. and foreign multinationals alike. An inbound
    minimum tax can provide base protection without all the
    negative consequences of a subpart F-type minimum tax.
        Moreover, the inbound policy we come up with now need not
    be perfect. That can come later, either through global
    negotiation, domestic legislation, or both.
        The key for now is to choose inbound measures that maximize
    our national interests, do not give implicit approval to things
    we would not want to see done abroad, and provide the U.S.
    leverage to help end this period of instability in the
    international tax regime and shape a principled global
    settlement.
        Thank you, and I would be happy to answer any questions you
    may have.
        The Chairman. Well, thank you.
        [The prepared statement of Mr. Grinberg appears in the
    appendix.]
        The Chairman. This has been an excellent panel. I really
    appreciate you.
        This is a question for all of you to briefly respond to. I
    want to be clear that our view is that foreign direct
    investment fuels new jobs across the country. In fact, if the
    corporate rate drops from 35 percent to 20 percent, foreign and
    domestic investments should grow markedly.
        It is important to distinguish legitimate business
    transactions from tax-driven earnings-stripping deals. So I am
    very concerned about that.
        So the question for the witnesses is, do you believe that
    foreign multinational companies have significant tax-planning
    opportunities such as earnings stripping that U.S.
    multinational companies do not have?
        I think some of you have talked on that a little bit, and I
    would just have you repeat.
        Professor Wells, we will start with you.
        Mr. Wells. There is just no question that that is the case.
    There is just no question. And the reason there is no question
    is that our main base-protection measure since 1962 is subpart
    F that only applies to resident companies.
        So if you are not a resident company, you are not subject
    to that regime; you get a pass. You can be excused from the
    room.
        Senator Hatch, when I was vice president of tax, half of my
    peer group engaged in a corporate inversion transaction. Our
    executive officers were compensated based upon relative
    performance versus a peer group. So I spent quite a lot of time
    trying to understand, what were the tax advantages that reduced
    their taxes on their U.S. operations in our sandbox, in the
    United States?
        And it is clear to me--and it should be clear to everyone
    here--that a corporate inversion is the U.S. company saying, I
    just want to be treated like a foreign-based multinational with
    respect to owning U.S. assets.
        And what techniques are they using to strip the U.S. tax
    base? The same ones that inbound investors use every day.
        When I put together my tax footnote disclosures for SEC
    filings, in the footnotes to that you can see a rate table of
    what taxes you pay in the U.S. versus what taxes you pay
    internationally. Professor Shay is exactly right:
    internationally, the U.S. is competitive in the international
    markets and able to achieve a tax rate that is comparable
    outside of the United States. But in the United States, the tax
    rate that is applied on U.S. companies--because they do not
    have the same earnings-stripping benefits--is significantly
    higher than exists for a foreign-owned company that runs those
    exact same U.S. activities. I think that that is a huge issue
    that ought to be addressed.
        We do not want to treat foreign companies in a
    discriminatory way, but we should not give them an advantage
    that we do not give our own domestic businesses.
        The Chairman. Professor Clausing?
        Dr. Clausing. I agree that we should even the treatment of
    foreign and U.S. firms in the U.S. And it is easier for foreign
    firms to strip income out. My understanding is that there are
    off-the-shelf remedies that would help with that, including
    tougher
    earnings-stripping regulations.
        There was an article in Tax Notes that went over 10
    different proposals to tighten earnings-stripping regulations.
    I believe that is 163(j), but I will leave that to the lawyers.
    So I would suggest something like that to create a more even
    treatment.
        The Chairman. Professor Shay?
        Mr. Shay. I have said previously that I agree that we need
    to take steps to improve our source taxation.
        But I think it is very important for all the members to
    understand that there are structural advantages in every income
    tax system of the world for a company that is not a local
    resident to invest locally. So this is not a United States-only
    problem, and our companies are vigorous in taking advantage of
    their external status in relation to other countries.
        So we should take steps to strengthen our source taxation,
    but we should do so mindful that what we do is likely to be
    copied by other countries and that we have to be balanced and
    nondiscriminatory.
        Notwithstanding that, it seems to me that the concept of
    nondiscrimination has been taken too far in formal terms and
    not been applied in substantive terms.
        And when we look at the kinds of issues that Professor
    Wells is talking about, I think our substantive differences
    give us plenty of room, and not just room, but encourage us to
    adopt strengthened source taxation to make sure that we do have
    a level playing field for carrying on business in the United
    States.
        The Chairman. Thank you.
        Professor Grinberg, you will be the last one.
        Mr. Grinberg. Thank you, Chairman Hatch. Look, I love
    foreign investment and want it to create jobs when it is
    actually creating jobs. But basically the reality is,
    multinationals can structure their internal affairs between
    their relateds as they choose, subject to legal constraints.
    And U.S. law keeps a U.S. multinational from having its foreign
    affiliates loan the U.S. money or charge the U.S. royalties to
    lower U.S. tax and increase the tax base in a low- or no-tax
    jurisdiction. U.S. multinationals cannot do that because of
    subpart F, as Professor Wells explained.
        In contrast, foreign multinationals can. They get their
    U.S. affiliates to agree to pay their foreign affiliates for
    expensive intercompany obligations, subject to much less
    binding constraints under our law. All they need are basically
    good transfer pricing studies, and they have to live with the,
    by international standards, weak limitations of section 163(j).
    That gives them a significant financial advantage, because it
    allows them to reduce their U.S. tax liability effectively
    through self-dealing.
        So why does this link back to jobs? Well, this advantage
    makes foreign acquisitions of U.S. firms more common than U.S.
    acquisitions of foreign firms. And firms continue to have a
    home-country bias for headquarters and R&D jobs as well as the
    support jobs that go around those.
        And you know, if you want to see the data about this, look,
    there is this great German ZEW--Centre for European Economic
    Research--study by Feld and Voget that basically finds that, if
    we went territorial, we would make the U.S. the acquirer
    instead of the acquired 17 percent more of the time.
        Meanwhile, you know, since the productivity of assets
    depends in part on their owners, if tax reasons are producing
    less productive ownership, the underlying business is going to
    grow less well and produce fewer jobs.
        So not only is the U.S. losing jobs, actually, globally we
    are decreasing well-being, because the most productive owner is
    not necessarily owning the asset.
        The Chairman. Senator Wyden?
        Senator Wyden. Thank you very much, Mr. Chairman.
        And I am very glad that we have the four of you
    distinguished academics, professors, spanning the philosophical
    spectrum. And I think that is exactly why this is an important
    hearing.
        And I want to start by mentioning, tomorrow the Senate
    Republicans are going to start, apparently, discussion of a
    budget that eliminates the requirement that the reported tax
    bill be scored at all. Now, I am not sure there is a precedent
    for it. But what I know is, we are going to hear an awful lot
    of talk about this magical growth fairy. And I want to get into
    with all of you specifically what we are talking about.
        Now, Secretary Mnuchin on Sunday said, again, that the tax
    cuts pay for themselves. He said the President's framework is
    going to cost $1.5 trillion on a static basis. Through a budget
    gimmick arguing for a policy baseline, you can take $500
    billion off the score.
        Then he said the tax cuts are going to create $2 trillion
    of economic growth so that the bill would actually raise a
    trillion dollars. It was almost like this administration was
    comatose for Reagan trickle-down economics.
        Now, here we are with this terrific panel. And I would just
    like to put to rest this growth fairy theory with respect to
    tax cuts. So I would like to just kind of go down the list, go
    down the four of you, and have a ``yes'' or ``no'' answer to
    the question.
        Do you believe tax cuts pay for themselves?
        Professor Wells?
        Mr. Wells. From my perspective, other things need to be in
    the system to offset the revenue. So by themselves, I do not
    think tax cuts are going to pay for themselves.
        Senator Wyden. We will count that as a ``no.'' Okay.
        Dr. Clausing?
        Dr. Clausing. No, I do not think so.
        Senator Wyden. Professor Shay?
        Mr. Shay. No.
        Senator Wyden. Professor Grinberg?
        Mr. Grinberg. Appropriate tax reform can increase economic
    growth, but only by a certain amount.
        Senator Wyden. So tax cuts do not pay for themselves?
        Mr. Grinberg. Yes.
        Senator Wyden. Look, the reason I am asking is, it is very
    important we define what this debate is all about. I am one who
    believes, when we talk about our bipartisan bill and the
    Democratic principles, behavior does matter. That is not the
    debate. The debate is whether we are going to have this magical
    growth fairy, and then we are not even going to score the
    proposal.
        I do not even know of a precedent like that. And it
    certainly defies the public interest to do a major outline for
    tax reform and budget judgments for years to come and then just
    say, well, gee, we are not going to score this thing at all. So
    I appreciate your being clear about that.
        Now, let me go to you, Dr. Clausing, with respect to the
    Trump tax framework claims. One of the arguments for the
    corporate rate reduction is--and again, we understand you need
    competitive rates--they say that the corporate cut is going to
    primarily benefit the U.S. worker.
        My question to you--and I am certainly willing to have
    anyone else be part of this discussion--my understanding is,
    the mainstream consensus of economists is that overwhelmingly
    the benefit of corporate tax cuts goes not to the U.S. worker,
    but it goes to the shareholders. Is that true?
        And my understanding is it might be, in terms of the
    ballpark, at most 20 or 25 percent as it relates to the
    benefits that get to workers.
        Dr. Clausing. That is correct. And all the mainstream
    models, and this includes the CBO, the JCT, the Treasury----
        Senator Wyden. Go slowly on that.
        The mainstream models, colleagues.
        Dr. Clausing. All the mainstream models, yes.
        Senator Wyden. The Joint Committee on Taxation----
        Dr. Clausing. The Congressional Budget Office, the
    Treasury--in the study that you can still find on the National
    Tax Journal website and from the nonpartisan Tax Policy
    Center--all of them give the benefits of corporate tax cuts,
    about 80 percent, to capital or shareholders.
        And if you want to think intuitively about why this is, we
    have to recognize that businesses really do understand their
    own interests. If they are coming in to talk about lower tax
    rates and how it is important to them, but it is actually the
    case that the workers would pay the tax and not them, then you
    are presuming that businesses do not understand their own
    economic interests.
        And I am inclined to think that businesses do understand
    their economic interests, which is why they push for these
    corporate rate cuts which primarily benefit managers and
    shareholders.
        Senator Wyden. Thank you, Mr. Chairman.
        The Chairman. We next go to Senator Thune.
        Senator Thune. Thank you, Mr. Chairman.
        Professor Grinberg, you note in your testimony that the
    number of U.S. multinationals in the Fortune 500 has declined
    by over 25 percent from 202 in 2000 to 147 in 2016.
        I would argue, clearly, that the United States' antiquated
    international tax rules contribute to that and bear much of the
    blame. And we have an opportunity in tax reform to modernize
    these rules, which have not kept pace with our economy or the
    global marketplace over the past half century. So we have a
    chance to seize this opportunity to make our code competitive
    again.
        So let me ask you this: if we fail to capture or pick up on
    these recent trends in international tax reform that a lot of
    other countries have implemented, what do you see as the cost
    of failing to do so?
        Mr. Grinberg. I mean, I think there are many costs. The
    cost I am most concerned about is opportunity for our kids. I
    think that multinationals, both U.S. and foreign, produce jobs
    that the data shows pay about a third higher than anything else
    in the private sector, on average. And you know, having more
    U.S. multinationals produces more of those jobs at home,
    because companies are not totally de-centered yet. There is
    still a home-country bias to R&D, headquarters, and support
    jobs. And that probably will not change for the duration of
    this tax reform.
        So fewer U.S. companies means fewer high-quality
    opportunities for our kids, and that is my biggest fear.
        The other thing is, and you know, the CBO estimates show
    this too, slowly the corporate tax base is going to whittle
    away. So it is maybe pennywise but pound foolish to try to get
    more revenue there.
        That is why the CBO long-term scores show erosion of the
    U.S. corporate tax base, because they are concerned about this
    trend too.
        Senator Thune. Thank you. I would direct my next question
    to you and to Dr. Wells as well. Do you see reforming our
    international tax system and, generally, overall tax reform, as
    is being contemplated here, leading to greater economic growth?
    Does it contribute to growth?
        Mr. Wells. Yes, I do believe it will contribute to greater
    economic growth, absolutely. But more importantly than that, I
    think that when we think about base-protection measures that
    will level the playing field, that will provide revenue for
    this Congress to meet the other needs.
        And I think what you and others need to consider is,
    foreign-based companies and corporate inverted companies, they
    have self-helped themselves to a territorial regime. No matter
    what you do, this country is territorial as to them.
        You really have just one question: are you going to have
    the same playing field for U.S. companies? That is the
    question.
        And if we are concerned about earnings stripping and base
    erosion, let us set up a set of rules that applies to U.S. and
    foreign companies equally to raise the revenue that you need,
    then the tax system is not creating winners and losers. You are
    collecting revenue in a thoughtful way.
        Proposals like subpart F only apply to U.S. companies and
    excuse the foreign-based companies. That is the issue that I
    would address.
        So yes, I believe it raises economic growth, but I also
    believe that the way to raise revenue is by leveling the
    playing field.
        Senator Thune. But growth would generate revenue as well.
        Mr. Wells. Growth would also generate more revenue.
        Senator Thune. I think this was in your response or maybe
    part of a statement that you made, Mr. Grinberg, too, but you
    talked about, when addressing inbound corporate tax reform in
    this Congress, policymakers should seek to give the United
    States leverage. ``It is important to put the United States in
    a good position to bargain internationally about a future set
    of broadly accepted rules that will most likely be agreed to
    multilaterally at a later date;'' and that is your quote.
        Would you elaborate on that point? And specifically, what
    form do you see that leverage taking? And how do we balance
    that with the important role that foreign direct investment
    plays in this country, which you also noted?
        Mr. Grinberg. So again, I do believe that foreign direct
    investment that creates new investment or otherwise supports
    increases in jobs is important. And therefore, I believe that
    we should try to level the playing field. I do not want to be
    understood as protectionist, we should simply level the playing
    field.
        But the bottom line is that, abroad we see countries taking
    a series of measures that are intended to go after U.S.
    multinationals. So two obvious examples are the state aid
    investigations out of the EU and the recent suggestion by the
    EU that it would do a turnover tax on just digital businesses,
    which means just U.S. tech. This is not principled.
        Instead, what I am suggesting is a principled approach in
    which we create an inbound minimum tax that treats U.S.
    multinationals and foreign multinationals alike and that
    defends the base that we can protect, which is the base of
    income earned in the United States from U.S. citizens and
    customers.
        Senator Thune. Okay, thank you.
        Mr. Chairman, thank you. My time is expired.
        The Chairman. Okay, thank you.
        Senator Stabenow?
        Senator Stabenow. Thank you very much, Mr. Chairman, for
    this hearing.
        And I want to talk about one specific industry as we are
    talking about moving production facilities and profits
    overseas.
        One of the concerns I hear the most from Michigan families
    is about the rapidly rising cost of prescription drugs. Drug
    prices in the United States are increasing at an astronomical
    rate, outpacing the increase in Social Security benefits,
    wages, and inflation by a factor of 10.
        Despite record profits from the sale of prescription drugs,
    many pharmaceutical companies have moved their production
    facilities and profits overseas to get out of paying their fair
    share in taxes. These companies have aggressively taken every
    possible approach to lower their tax liabilities, from
    inversions to abusing tax havens.
        Dr. Clausing and Mr. Shay, do you think the proposal put
    forward last week will help solve any of these problems?
        Dr. Clausing. I did not see anything that really addresses
    in a serious way tax base erosion in that proposal last week.
        There was mention of a global minimum tax. And as Steve
    Shay already mentioned, with a global minimum tax you have this
    opportunity to use taxes paid in one country to offset the
    minimum tax that would be due in another country. So in a way,
    it encourages foreign income in both high- and low-tax
    countries. So I did not think that was a serious response, so
    far at least, to the corporate tax base erosion problem.
        Senator Stabenow. So nothing at this point yet to solve
    that.
        Dr. Clausing. Nothing yet.
        Senator Stabenow. Mr. Shay?
        Mr. Shay. Well, in fairness, nothing other than the word
    ``global'' has been specified, so we have no idea what is being
    contemplated. And the idea of moving forward without knowing
    what is being contemplated and without a score for what is
    ultimately done is indefensible as a policy matter.
        But if it is under any normal conception of a global
    minimum tax--and of course we do not know what that is, so I
    hope I am not impugned for inferring from what we do not know.
    But if it is any normal conception of a global minimum tax--I
    have already testified that the average rate of taxes paid on
    all foreign CFCs as reflected in the 2012 data is 12 percent,
    12.10 to be precise, so if the minimum tax is anywhere below
    that, then you almost certainly have not accomplished a lot.
    You have accomplished maybe a little for Ireland, which has
    about a 2-percent effective rate.
        But without a per-country approach, it will be relatively
    toothless. That and the height of the rate are the two key
    points, and we just do not know what those are yet.
        Senator Stabenow. So we are at a point where we have
    companies raising prices through the roof, getting tax benefits
    to do research and to create new kinds of medicines that they
    are charging astronomical prices for, many of them lifesaving
    medicines, and at the same time being subsidized by taxpayers
    through Medicare and Medicaid expenditures. And yet, there is
    nothing in here to address what is one of the most important
    issues I hear about from my constituents.
        What specific steps should we be taking to address the
    problem of drug companies not paying their fair share?
        Dr. Clausing?
        Dr. Clausing. Yes, I think this is a big problem. And if
    you look at the Fortune 500 companies, the ones that have
    achieved effective tax rates in the single digits are often
    those such as pharma that have a lot of intangible value, which
    makes it easier for them to shift profits abroad.
        So there is a lot that we can do here, from very simple,
    small, incremental steps to big steps. I think the approach
    that both Mr. Shay and I have recommended is to simply lower
    the rate and combine that with eliminating deferral. You have
    no disincentive to repatriate, and you are treating income
    abroad the same as you are treating income at home.
        But if you do go to a territorial approach, a per-country
    minimum tax, I think, is a more promising step than many. And
    the higher that rate is and the closer it is to the U.S. rate,
    the less distortion there is and the less incentive to move
    income to tax havens.
        Senator Stabenow. Thank you.
        I would like to ask each of you just really quickly in my
    time, one of the most important things for me is closing tax
    loopholes that send our jobs overseas, and basically supporting
    American businesses. And there is a simple bill called the
    Bring Jobs Home Act I have introduced for multiple years that
    would just take away the deduction for moving expenses. At
    least we should not be paying for the moving expenses when a
    company is moving overseas.
        Do you think--I would like to ask each of you, would you
    support stopping the deduction for ordinary and necessary
    business expenses for a business moving their jobs overseas?
        Mr. Wells?
        Mr. Wells. I think that the problem is larger than that.
    For example, on your pharma question----
        Senator Stabenow. Well, no question it is larger, but----
        Mr. Wells [continuing]. A minimum tax under subpart F would
    not apply to any of the pharma companies, because they are not
    U.S. companies anymore. And so if you are looking for a minimum
    tax or a subpart F regime or worldwide, all that discussion you
    heard does not apply to that sector. We need another discussion
    about base protection.
        Senator Stabenow. Well, let me ask though, simply, for any
    company picking up and moving overseas, should their workers,
    the community, through their taxes, pay for the move?
        Mr. Wells. I think that what we should have is a base
    protection that is broad and comprehensive to protect the U.S.
    tax base. I think cherry-picking one observation and allowing
    all the other earnings stripping to occur is the bigger
    problem. So I think targeted reforms are not a solution.
        Senator Stabenow. I realize that is not enough, but it
    certainly would help, though, if they did not have the insult
    of having to pay for the move.
        Dr. Clausing? Just ``yes'' or ``no,'' I know my time is up.
        Dr. Clausing. Yes, I think that is justified, but there are
    bigger things I would worry about too.
        Senator Stabenow. Of course, of course.
        Mr. Shay?
        Mr. Shay. I am reluctant to pick out pieces. I think as a
    symbolic matter, it could be helpful.
        Senator Stabenow. Yes.
        Mr. Grinberg?
        Mr. Grinberg. It is peanuts. We should do something much
    more comprehensive. I do not see any reason for just making
    that change.
        Senator Stabenow. I agree with you: we should have a big
    bowl of peanuts, a lot more than just that, but that would be a
    nice place to start.
        Thank you, Mr. Chairman.
        The Chairman. Thank you.
        Senator Portman?
        Senator Portman. Mr. Chairman, thank you. Thanks for
    holding this hearing. And I appreciate our witnesses today. And
    what a great opportunity we have before us.
        There is a big bowl of peanuts, as my colleague from
    Michigan just said, and that is a tax code that is outdated,
    antiquated, and broken. And it is no wonder; I mean, it goes
    back to the 1960s. Our tax code could qualify for AARP benefits
    on the international side.
        Many of the members on this panel, at least to my left,
    were not even born when this thing was thought up, and it does
    not make any sense. And you look at the G7 countries, you know,
    all of them are territorial except us.
        And with all due respect, Dr. Shay and Dr. Clausing, I
    appreciate your testimony, and I know you actually agree with a
    lot of what I think, at least in terms of base-erosion rules,
    but we have to catch up.
        I mean, at one point we were the leader in terms of global
    tax policy. Now, you know, we are struggling to catch up, and
    it is hurting us. And it is hurting the workers I represent.
    And, darn it, we have to figure this out as a committee.
        So you know, E&Y recently came up with a study, Ernst and
    Young, saying there would be 4,700 companies that would be
    American companies today, just in the last 13 years, if we had
    a 20-percent rate and a territorial system--4,700 companies.
        Laura Tyson, former chair of the Council of Economic
    Advisers for President Clinton, just came out with her study
    showing that if you went to this kind of a policy we are
    talking about, 20-percent rate and territorial, it would result
    in $144 billion a year ongoing in repatriations coming back and
    about 154,000 jobs a year. And by the way, she said more in the
    short term because, during the transition, it would be even
    more positive. She is a Democrat, and she looks at this and
    just says, this makes no sense.
        And companies are voting with their feet. Between 2003 and
    2011, there were seven inversions. Between 2012 and 2016, just
    in those 4 years, 33 inversions.
        And by the way, inversions are the tip of the iceberg. It
    really is not the bigger problem. The bigger problem is
    acquisitions. Foreign companies, as was said here today by Mr.
    Wells--I think all four of you agree with this--have a huge
    advantage. They can pay a premium for U.S. companies.
        And you know, it makes all the sense in the world that we
    would be losing companies. So here are the numbers. In 2016,
    foreign acquisitions of U.S. companies were over three times
    greater than U.S. acquisitions of foreign companies. That is by
    volume.
        You could either look at that or look at the study Mr.
    Grinberg cited, which is some German study he referenced: 17
    percent more U.S. acquisitions of companies. So it would flip,
    and the U.S. companies would have an advantage.
        Why does this matter? We did a study in the Permanent
    Subcommittee on Investigations. It was bipartisan. We all
    really drilled down into these inversions and acquisitions,
    what is really happening.
        I am not from Missouri, but if I was, on this committee, I
    would care a lot about this, because when Anheuser-Busch
    decided to move overseas, they took 5,400 jobs with them. I
    mean, they did--and it is all documented; we have all the
    information. It is a study you can look at.
        We went behind the curtain in these corporate boardrooms to
    listen to what Mr. Wells talked about today, and I appreciate
    your candor. What goes on in these boardrooms is, they want to
    be foreign companies for one simple reason: our tax code.
        And when they change their headquarters, they do not just
    move their situs, they move people and investment and
    commitment to the community. That does not include all the
    nonprofits and charitable institutions in St. Louis that lost
    out.
        So we have to do this; we have to fix it. And I know there
    are different ways to look at it, I get that, but I do not
    sense an urgency here today. And I hope that we can get to it.
        Now, in terms of this issue of balancing inbound and
    outbound so you do not end up continuing to benefit foreign
    investment in foreign companies here, we do need to do
    something. It has to be balanced, because we want FDI. It is
    important in my home State of Ohio; it is important in all of
    our States, but it has to be a level playing field.
        And I think Mr. Grinberg has laid out some interesting
    ideas of how we can come up with a way to have that right
    balance while we are encouraging investment here.
        I want to ask you about outbound for a second, because that
    is something we have not talked about as much today.
        Professor Grinberg, countries that have a minimum tax
    system that was talked about by Dr. Clausing and Mr. Shay--
    France, Germany, Japan, the entire EU, by the way, starting in
    2019 after they implemented their new policies--they have a
    carve-out for active business exceptions. Can you comment on
    these European-style carve-outs and how we should think about
    them when designing our own outbound base-erosion rules?
        Mr. Grinberg. Thank you for that question, Senator Portman.
    So territorial systems often have some rules for base
    protection that then allow an active business exception. The
    active business exception under EU law is incredibly narrow. In
    other words, all you need are five guys and a dog. Okay?
        And the reason you only need five guys and a dog is because
    of this case called Cadbury Schweppes out of the European Court
    of Justice that said that anything but wholly artificial
    arrangements have to be respected. And so the active business
    exception rule that is used in European jurisdictions is quite
    narrow, and we should understand that, if we are thinking about
    having a similar rule in the United States.
        We would not want to create a rule that required a higher
    level of substance, because the problem with rules that say you
    only get deferral if you put substance in a foreign
    jurisdiction is that the higher the substance bar is, the more
    jobs you are asking to move offshore.
        So those active business exception rules require a very
    limited amount of people and activity, especially the EU ones.
    And one should be concerned, if one writes a similar rule, that
    the IRS would up the bar and effectively ask U.S. companies to
    put more people offshore in order to avoid a minimum tax.
        Senator Portman. My time has expired. I appreciate that
    fact. Hopefully, we will have a second round and we can talk
    more about the outbound issues. But thank you very much.
        The Chairman. Well, thank you.
        Our next one is Senator Cassidy. You are up.
        Senator Cassidy. Mr. Shay, in your testimony you speak
    about not, I think, bifurcating cash, cash equivalence from
    non-cash. Very briefly, could you just comment on that, please,
    because I do not think you spoke to that in your spoken
    testimony.
        Mr. Shay. Yes. I was pretty clear in my testimony, I think,
    that I am not in favor of a reduced rate on pre-effective-date
    earnings.
        But if, as has been proposed, there is a different rate on
    earnings that are reinvested in illiquid assets--that is the
    term that is used in the framework--versus cash, so there is a
    higher rate on cash, it is not good. It is not a good idea to
    announce to sophisticated business people that if you shift
    your offshore earnings from cash into illiquid assets, which
    has already, in essence, been announced, you are going to get a
    lower rate by something like 4 percent. And then what is really
    an illiquid asset will become the subject of a definition.
        My strong recommendation----
        Senator Cassidy. So, can I interrupt you?
        Mr. Shay. Yes.
        Senator Cassidy. You are implying that it is perhaps
    ambiguous as to what is cash or cash equivalence as opposed to
    illiquid?
        Mr. Shay. It is unspecified at this point. But whatever you
    do as a rule, I will be testing the line of that rule as a tax
    planner.
        Senator Cassidy. Okay.
        Mr. Shay. And the issue for cash is--the reason there is a
    higher rate for cash, presumably, is liquidity. For the
    companies, as I demonstrate in my testimony, that have the most
    offshore earnings--and the vast preponderance are credit-worthy
    companies--you are better off picking a single rate, whatever
    it may be, forget what my preference may be, than a bifurcated
    rate, or else you are going to have----
        Senator Cassidy. Okay, let me interrupt, just because we
    have limited time.
        Mr. Wells, you have been in the boardroom and you have
    helped with those strategies, not that Mr. Shay has not been.
    Would you agree with that assessment?
        Mr. Wells. Again, I think that I agree with his assessment
    that people are going to do tax planning to try to minimize
    that outbound tax. So whatever system you put in place, there
    is going to be a reactionary planning.
        But the discussion we are having is only for U.S.
    companies. We are giving a complete pass----
        Senator Cassidy. I accept that; I totally accept your
    premise of that.
        Mr. Wells. Then the question is, well, why are we doing
    that? I mean, what we should do is have rules that are going to
    apply across the board.
        Senator Cassidy. I get that, but I want to narrow the thing
    right there.
        Mr. Grinberg, any comments on this?
        Mr. Grinberg. You know, on this point, I agree with the
    concern Steve describes. One needs to be careful about
    announcing in advance that if you take certain planning steps,
    you will receive a lower rate on previously unrepatriated
    earnings.
        Senator Cassidy. And, Dr. Clausing, I presume you feel the
    same way?
        Dr. Clausing. That is correct.
        Senator Cassidy. Okay.
        Mr. Grinberg, Mr. Shay is making the point that we should
    have a country-by-country variation.
        I think I follow what you said, Mr. Shay, that if you have
    a lower effective tax rate in one country and that is the
    country of domicile of the company of which we are--I am saying
    it in as complicated a way as you, but you know far more than
    I.
        Mr. Grinberg, would you agree with that?
        Mr. Grinberg. So my view is that we should have an inbound
    minimum tax, not an outbound minimum tax. And therefore, this
    question would drop away, so that would be my strong
    preference.
        But if one were to have an outbound minimum tax, then I
    would simply point out that a country-by-country approach is
    not consistent with the way multinationals do business around
    the world.
        In Europe, you know, you have a completely integrated
    economy. In Asia, it is that way too. Global supply chains
    cross borders.
        If you go with a country-by-country approach, it is pretty
    inadministrable because now you have to police the transfer
    pricing decisions on transactions between France and
    Luxembourg. Do not kid yourself that people will not manipulate
    that stuff in order to make sure that they get around the
    country-by-country approach.
        There are a series of reasons why we got rid of----
        Senator Cassidy. So, tax law arbitrage.
        Mr. Grinberg. Yes. A country approach is unworkable.
        Senator Cassidy. Mr. Wells, any comments?
        Mr. Wells. Yes, I think it would be extremely complicated,
    for the reasons Itai just said.
        Senator Cassidy. Okay, I am almost out of time. I yield
    back. Thank you.
        The Chairman. Senator Carper and then Senator Cardin.
        Senator Carper. All right. We are happy you are here.
    Thanks very much for taking a really complex subject and making
    it even more so. [Laughter.]
        I expect someday a light is going to go on in my head and I
    will say, oh, I get it now. It probably will not happen today,
    but it is not your fault.
        Thank you for joining us.
        I have four questions I always ask--my colleagues have
    heard me say this a few times--four questions I always ask
    whenever somebody comes to us and says, this is my proposal for
    tax reform. I ask these questions. One, is it fair? Two, does
    it stimulate economic growth? Three, does it simplify the tax
    code or make it more complex? And four, what is the fiscal
    impact, the budget impact, of what is being proposed?
        And I do not ask ``yes'' or ``no'' questions very often.
    But I am just going to ask a question of you, just starting
    with you, Mr. Grinberg. Are those four reasonable questions to
    ask? You can just say ``yes'' or ``no'' or you could say
    ``maybe.''
        Mr. Grinberg. They are reasonable questions to ask. I
    happen to believe that in the corporate tax space, revenue-
    losing corporate tax reform is better than revenue-neutral tax
    reform.
        Senator Carper. Okay, thanks. All right. Thank you.
        Are those, Mr. Shay, reasonable questions to ask?
        Mr. Shay. In the context of international tax reform,
    simplification is less important than it is for individuals,
    low- and middle-income individuals who have to struggle to do
    their returns.
        Senator Carper. Okay.
        Mr. Shay. And multinationals have more capacity to deal
    with complexity. And frankly, you need it more to deal with
    their economic issues.
        Senator Carper. Fair enough, thank you.
        Yes, please?
        Dr. Clausing. Yes, those are the questions I would ask too.
        Senator Carper. Thank you.
        Mr. Wells. In the multinational context, assuming ``fair''
    means a level playing field among multinational companies so
    that everyone is treated fairly, equally, then, yes, I think
    those are four great questions.
        Senator Carper. Thanks so much.
        One of the things we like to do here is, when we have a
    difficult subject to consider, and where there is a wide range
    of opinions on how to go about addressing it, one of the
    questions I like to ask is, where do you find consensus among
    the four of you?
        If we could just assume, maybe not a good assumption, that
    we are going to move closer to a territorial tax system as we
    go through these debates and legislation, where do you think
    there is some agreement amongst the four of you?
        And just very briefly, where do you think there is some
    consensus?
        Mr. Wells. I think we have broad agreement that on earnings
    stripping, inbound base erosion, source taxation, if not the
    preferred solution by everyone, is at least a respected point
    of view, that we need to broaden the base and protect against
    the inbound earnings-stripping problem that would exist for
    both in a territorial world.
        Senator Carper. Good; thank you.
        Where do you think there is some agreement here?
        Dr. Clausing. I think there is an agreement to have a
    combination of a lower rate and closing loopholes and better
    base protection.
        I think at least three of us are worried about the base
    protection aspect of this on both an outbound and an inbound
    basis. And I think that it is important to keep both of those
    margins in mind.
        Senator Carper. Thank you.
        Mr. Shay?
        Mr. Shay. I agree. There is a consensus that there needs to
    be some strengthening of the source taxation and, I think for
    all of us, anti-abuse constraints on territorial, but the
    difference within that is very substantial.
        Senator Carper. Good; thank you.
        Mr. Grinberg?
        Mr. Grinberg. Yes. I think we all agree that one needs to
    look at inbound reform and that one needs to lower the rate.
    That is where I have heard consensus.
        Senator Carper. All right; thanks.
        Mr. Shay, looking at your resume, my recollection is that
    you were serving in Treasury from 1982 to 1987, which is when
    we were trying to debate and adopt comprehensive tax reform
    during the Reagan administration. And it is interesting that
    now you are a panelist here. But drawing back on the process
    that we went through, the reason why we were successful in
    finding a compromise--it was difficult then, God knows it is
    difficult now. What advice can you share with us from your
    experience, 1980 to 1987 when this was running front and
    center, that would be helpful to us now?
        Mr. Shay. At the time, the Senate and the administration
    were under control of one party, and the House was under
    control of another party. There had to be a bipartisan starting
    point. That was one.
        Senator Carper. We need to flip. So you are saying we need
    to flip either the House or the Senate to get real, true tax
    reform? [Laughter.]
        Mr. Shay. I think bipartisanship is very important for a
    reform that will be sustainable. And there were arguments as to
    how much the 1986 act would sustain. In fact, it has. We are
    still dealing with huge portions of it today.
        Secondly, tax reform is in the details. You cannot get it
    done--it started at the beginning of 1984. We took a year to
    draft the proposals in Treasury. They went through the Baker-
    Darman political review in the first part of 1985. They got
    through the House at the end of 1985. They went to the Senate
    side at the beginning of 1986. There was a conference committee
    at the end of 1986.
        Every single step of the way we made corrections,
    improvements, changes. This cannot be done on the fly. It is
    just beyond my comprehension that we would try to make a major
    tax change as quickly as is being contemplated for political
    objectives.
        Senator Carper. All right; thank you all. Very good.
        The Chairman. Okay.
        Senator Cardin?
        Senator Cardin. Thank you, Mr. Chairman.
        I have been listening very carefully to this hearing, and I
    think the last point, Mr. Shay, is pretty telling because, as I
    understand it, the budget instructions would have us complete
    our work in the next 5 or 6 weeks, at least the Senate, so that
    is not realistic.
        But I was listening--and on the business tax issues, you
    all talk about harmonizing, that the United States business tax
    is an outlier, that we would like to have a level playing field
    for American businesses globally. All those I hear are
    objectives.
        And then I look at the Big Six proposal, Mr. Chairman, and
    I see that their way of getting there is to reduce the business
    tax rates so that we can be more competitive on business tax
    rates, but no real way to pay for it. The traditional ways of
    using the Joint Tax Committee and traditional scoring are not
    going to be done. They have identified very few of the offsets,
    even with knowing that they are going to blow a hole in the
    deficit.
        So we do not have time to analyze the consequences, Mr.
    Shay, of some of the issues you are talking about. We do know
    that State and local deductions will have an impact on real
    estate, will have an impact on federalism, will have an impact
    on the ability of our States to do their business. We do know
    that restrictions on business interest deductions will have a
    direct impact on businesses. They will be losers in that
    regard.
        And I mention all that because I think the point of
    harmonizing, the point of a level playing field, is legitimate.
    And I think the tax rate issues are certainly legitimate
    concerns. So if we want to significantly reduce our business
    tax rates, then the major difference that we have with
    harmonizing in the global community is the fact that we get
    virtually all of our income from income taxes, whereas every
    other country we are talking about has consumption taxes.
        And it is very interesting that, as we developed the
    international trade rules that Senator Portman is very familiar
    with, we had no difficulty in doing border adjustment on
    consumption taxes, but we do not have border adjustment on
    income taxes. So it is a double insult to the United States on
    international competitiveness.
        So it seems to me that if we really are looking at
    harmonizing, we have to tackle that problem. And I think the
    Big Six proposal underscores how difficult, if not impossible,
    it will be--impossible--to have competitive business tax rates,
    which is the driving force behind all of the base-erosion
    things you are talking about, unless we look at harmonizing
    with other revenues coming in other than income tax revenues.
        It seems like that is the only way that we are going to be
    able to get to deal with the fundamental problems that you are
    talking about. Where is my logic wrong?
        Mr. Wells. I would not say you are wrong. But what I would
    say is that an unlevel playing field needs to be fixed.
        Senator Cardin. And is it not the rates that we are mainly
    concerned about?
        Mr. Wells. What I am concerned about----
        Senator Cardin. Is it mainly the rates or not?
        Mr. Wells. To me, it is not mainly the rates.
        Senator Cardin. So we can continue with a 35-percent
    corporate rate and still be competitive?
        Mr. Wells. I think it would be great to drop the rates. But
    I think if a foreign----
        Senator Cardin. No, I want to drill down on that, because I
    was under that impression. So you believe we can be competitive
    globally with a 35-percent corporate rate?
        Mr. Wells. No, I think we need to have a lower rate.
        Senator Cardin. Okay, so you are agreeing with me that we
    have to lower the rate.
        Mr. Wells. Yes.
        Senator Cardin. Now, let me take it to the next step. The
    United States, as far as its percentage of its economy invested
    in governmental services, is near the bottom of the global
    community. And yet, we have the highest marginal tax rates.
    Have we not given away our competitive advantage because we
    have been stubborn, as we are--Americans are very stubborn--
    saying that income taxes are the way to finance the Federal
    Government?
        Mr. Grinberg?
        Mr. Grinberg. Senator Cardin, as I say in my testimony, I
    agree we should find a way to lower the corporate tax rate even
    further and not just meet, but beat our foreign competitors.
    But I would urge you not to make the perfect the enemy of the
    good. And I specifically reference your proposal in my
    testimony. And I am an advocate of having a value-added tax to
    let us sharply reduce corporate and individual income tax
    rates. But we need to move on corporate tax reform.
        Senator Cardin. I could not agree with you more. And I
    agree with that. I am prepared to move on corporate tax reform,
    but not by increasing the deficit, not by dealing with
    additional problems that are going to be created because of the
    unintended consequences, not by jeopardizing entitlement
    programs that are critically important to the American people.
    I am not going to do it under those terms.
        But I am prepared to deal with it, but we have not seen any
    real effort here to isolate international tax reform. We have
    offered proposals coupled with infrastructure reform, different
    ways to do it. But if you look at the Big Six plan, I think we
    are heading down a proposed path that will be devastating and
    will not accomplish what you are trying to accomplish.
        Thank you, Mr. Chairman.
        The Chairman. Okay.
        Senator Bennet?
        Senator Bennet. Thank you, Mr. Chairman.
        And just to piggyback on what my colleague was saying, I
    think in the 9-page proposal, there are roughly 200 words, I
    think, devoted to international taxation. That is what this
    committee is looking at right now.
        And I gather--I apologize for being in the Education
    Committee this morning, which is where I was--but I gather from
    the conversation today, what we have learned is how complex
    this undertaking is and the possibility that real, unintended
    consequences can flow if we do not get it right.
        And we face now, because of our own fecklessness, an
    artificial deadline of November 13th here as a procedural
    matter, which is 23 legislative days away. That is when that
    deadline is. And it does not have anything to do with creating
    a better tax code, it just has to do with the legislative
    antics of the United States Congress.
        And I want to ask each of you for your honest view of
    whether you think we can reform the tax code in a way that is
    going to be productive to the American people without a bunch
    of unpredicted mistakes if we rush it through in a period of 23
    legislative days; in fact, you do not even need to use my
    language, if we use 23 legislative days to do it.
        Mr. Wells?
        Mr. Wells. Without seeing legislation, it is difficult to
    know how far apart you are.
        Senator Bennet. And that is another important point. We
    have no legislative language; we have not seen legislation.
        Dr. Clausing?
        Dr. Clausing. I think this will be very difficult. And if
    you try to rush it in that way, I think you run the risk of
    losing a lot of revenue by doing the tax-cutting part but not
    taking seriously the base-protection part. And that would be
    very costly in the future.
        Senator Bennet. Mr. Shay?
        Mr. Shay. I agree with that. And it is mind-boggling that
    you could think about having a major change with that little
    consideration.
        Senator Bennet. Mr. Grinberg?
        Mr. Grinberg. Thank you, Senator Bennet. I mean, we have
    had, like, a 6-year process on tax reform, so I think it just
    depends what the legislative text says. I mean, that is the
    thing. I assume we are not starting from zero, so I think it
    depends.
        Senator Bennet. Well, I think that is a fair comment, and
    we will see whether there is legislative language coming later.
        What is the risk that we could leave loopholes or make
    other mistakes that multinational corporations could take
    advantage of if we do not do the work thoroughly and well?
        Mr. Wells. It is hard to imagine that we could make more
    than we already have. I mean, we have earnings-stripping
    problems that are unaddressed. And the resulting legislation
    needs to fix inbound taxation, and we should be more
    competitive internationally.
        From my perspective, there is very little in the way of
    inbound base-protection measures today. And so for me, I think
    you have an open field with no tacklers in the area. I mean, I
    think moving forward is going to make progress, given how bad
    the current system is right now.
        But I think we should have a thoughtful move forward, but I
    do not think we need to, as Itai said, let the perfect get in
    the way of the good enough. We need to get a system that better
    balances the multinational and the business environment in the
    United States, because we are lagging behind and we need a
    sense of urgency to fix that.
        Senator Bennet. We also do not want the highly imperfect to
    be the enemy of the imperfect either.
        Dr. Clausing?
        Dr. Clausing. We have a very large problem at present, but
    that does not mean it cannot be an even larger problem.
        And we have been talking a lot about the inbound side, but
    let us look at the outbound side. My estimates suggest that
    multinational profit shifting to tax havens is costing $100
    billion a year. We have $2.6 trillion sitting offshore in tax
    havens. If we move to a toothless territorial system where we
    exempt all foreign income and we do not try to protect the
    base, those revenue losses will definitely increase, not
    shrink. And I think that that is a big risk here.
        Senator Bennet. Anybody else?
        Mr. Shay. I would agree with that. If you do not have
    strong anti-base-erosion, the clients who used to come into my
    office and say, ``Can I do what the big people do?'' and my
    question is, ``Do you really run your business back in the
    U.S., do you really need your money back in the U.S.?'' and
    they say, ``Yes,'' I say, ``Well, then you cannot do it very
    effectively.''
        If you move from deferral and its current restrictions on
    using that money in the U.S. to exemption, then any mom-and-pop
    business that is of even modest size, at that point can create
    a foreign office, use the five people and a dog that Itai was
    talking about, allocate income there, and then it is exempted.
        This system can be so much worse. Do not go there without
    knowing what you are buying into.
        Mr. Grinberg. An inbound corporate minimum tax is not a
    toothless territorial system, it is just a fundamentally
    different approach. Moreover, it takes advantage of the
    immobility of the U.S. customer base, something that Dr.
    Clausing praised in her testimony to the House Ways and Means
    Committee only a few months ago.
        Senator Bennet. Mr. Chairman, I am out of time, so I just
    want to thank you.
        I also want to thank the excellent witnesses here today
    whom I think give us a sense of how broad the array of choices
    are that we have to make, and I hope we will take the time to
    make them well, because this is something we only get to do
    once every 30 years.
        The Chairman. Okay. Let us go to Senator Isakson.
        Senator Isakson. Thank you, Mr. Chairman.
        Dr. Clausing, continue on this subject for a minute about
    the toothless territorial tax system. If it were yours to do
    and you were told to change the U.S. to a territorial tax
    system, what teeth would you install in that system to make it
    palatable for you?
        Dr. Clausing. I would have a tough per-country minimum tax.
    And I think that having it on a per-country basis is absolutely
    essential here. If you earn income in Bermuda, say, where the
    tax rate is zero, that per-country minimum tax would tax the
    Bermuda income right away.
        If you have a global minimum tax, you can just use taxes
    paid in Germany to offset the Bermuda income. And then you have
    an incentive to move income to both Germany and Bermuda.
        I would also protect the earnings stripping, have tougher
    earnings-stripping regulations. And there are other anti-
    inversion things that are off-the-shelf that Congress could
    have done a long time ago, things like an exit tax and raising
    the threshold that is required to invert. And I think those
    would be important off-the-shelf, easy things to do to help
    protect the tax base.
        Senator Isakson. In Georgia we benefit from a lot of
    foreign direct investment into our State and have been a big
    growth State in the last decade. If you had selected countries
    that you had different tax levels for, for those coming to
    invest in the country, could that possibly turn some of that
    around and send it somewhere else?
        Dr. Clausing. I am not suggesting different tax rates for
    inbound investment, so I do not think that that would apply in
    this context.
        Senator Isakson. Okay.
        Mr. Wells, what about you? If you were going to design a
    territorial system, what teeth would you install?
        Mr. Wells. The teeth I would have would be that we want the
    business profits that are in the United States subject to one
    level of tax in the United States, so that whether you are a
    U.S.-owned company or a foreign-owned company, you will pay one
    level of tax, that there is not one group of companies that can
    strip their profits to Bermuda or somewhere else.
        We do not want to tax the inbound investor in a punitive
    way that causes them to have a double tax or a triple tax. But
    they ought to be on the same playing field with respect to the
    profits in their U.S. business, whether you are a U.S. company
    or a foreign company.
        I think there are a lot of revenue offsets that are there
    if you leveled the playing field. And I think what you would
    say to the inbound investor is, if you can be on the same
    playing field as everyone else, do not have a tax disadvantage
    but do not have a tax advantage, you are not being
    competitively disadvantaged.
        And what I would say to the U.S. companies is, you do not
    need to do corporate inversions anymore because you are now on
    the same level playing field with respect to operating a
    business in the United States.
        So from my perspective, if you have a territorial regime,
    you need to make sure that the round-tripping problem that
    Professor Shay mentioned is not going to be possible. But
    please understand, that round-tripping problem is what
    multinational foreign-based companies are able to do today
    because we have not instituted any rules yet as to them.
        Senator Isakson. Effectively, going to a territorial system
    ends the repatriation issue for the Congress, because it goes
    away. Is that not correct?
        Mr. Wells. Depending on what you do with the one-time tax
    on the foreign earnings, but yes.
        Senator Isakson. Right, which is behind the question I am
    asking about the teeth. It is also important to all of us; we
    want to do the right ones.
        Mr. Wells. Correct.
        Senator Isakson. Dr. Clausing, one other question. I read
    your testimony, and one thing really struck me about it that I
    had not thought about. I knew it was happening, but I had not
    thought about it. Ninety percent of the people born in the
    1940s have out-earned their parents in their lifetime, but only
    about 50 percent of those born in the 1980s are going to out-
    earn their parents.
        And you talked about a number of solutions--or I do not
    know whether they are solutions, but ways to get to adjust that
    in our policy. One was increasing the EITC, if I remember
    correctly, and the other, I think, had to do with wage
    stabilization, which I took as probably a minimum wage or a
    wage table that people would have to meet. Am I right in that?
        Dr. Clausing. I talked about the EITC as an excellent tool.
    And I think economists and policymakers from throughout the
    political spectrum really like the Earned Income Tax Credit,
    because it encourages work and it brings more income to those
    lower in the income distribution.
        I also mentioned a wage insurance, which is different from
    what you just characterized. But basically, the wage insurance
    would mean if you lost your job due to technological change,
    domestic competition, or international competition, effectively
    you would be insured for some fraction of the difference
    between your current wage and the old wage.
        And that is part of our Trade Adjustment Assistance now for
    a small number of workers, but that could be expanded and would
    be an important ingredient to sort of help the middle-class
    workers adjust to a modern and technologically sophisticated
    economy.
        Senator Isakson. Thank you very much.
        Thank you, Mr. Chairman.
        The Chairman. Thank you.
        Senator Toomey?
        Senator Toomey. Thank you, Mr. Chairman.
        A couple of my colleagues on the other side have raised
    issues about the budget resolution that the Senate Budget
    Committee will be taking up tomorrow, and I just wanted to
    clarify.
        First of all, under the terms of the budget resolution that
    we will be considering tomorrow, the subsequent tax reform,
    should this committee report out a bill, will be scored. Let us
    just be clear about that: it will be scored.
        And in fact, the way the budget is drafted, it is my
    understanding that the score will have to be on a static basis
    against a current-law baseline, a legislation that would not
    expand the deficit by more than $1.5 trillion over the budget
    window, and if it were to do so, it would lose the
    reconciliation protection that it is meant to have. So I would
    like to be clear about that.
        Second point: several people have suggested that there is
    this 5- or 6-week deadline for getting the tax reform done. I
    happen to believe that there has been a tremendous amount of
    work done for years which can be compiled, much of which has
    been intensified over the last year, and we in fact can produce
    a very constructive tax reform in that period of time.
        But I would point out that the goal in the budget
    resolution is not binding. The reconciliation instructions do
    not expire until September 30th of 2018.
        A second point I want to push back on: Senator Wyden asked
    the question of whether tax cuts pay for themselves. To
    characterize this effort as simply a tax cut, I think is a
    gross oversimplification of what we hope to achieve here. And
    specifically, what I am referring to is, what we are
    contemplating is a multi-trillion-dollar series of pro-growth
    reforms, most of which would be offset by a multi-trillion-
    dollar series of base broadenings.
        So we are hoping to have significant rate reductions, a
    significant move towards expensing CapEx, a significant
    simplification which helps compliance, and, of course, a move
    to a territorial system to be mostly offset by diminishing the
    extent to which the tax code currently favors certain
    activities over others.
        Now, if the pro-growth elements are on the order of $4
    trillion and the base broadeners are on the order of $3
    trillion, there is what appears on a static basis to be a net
    tax cut of a trillion dollars, but until we have defined those
    things, I do not know how anyone can suggest that we can know
    in advance that we would not have enough growth to pay for the
    small fraction of this reform that will score statically as a
    negative. So I just wanted to make that point.
        Professor Grinberg, we have had a considerable discussion
    this morning about how uncompetitive the U.S. international tax
    system is. The combination of a very, very high statutory rate,
    together with being one of the very few countries in the world
    that has a global system, contributes to that.
        You have also made the point repeatedly that foreign direct
    investment in the United States, investment in American
    businesses, can be a constructive thing. And if it is done for
    economic reasons, then America wins, the foreign investor wins,
    the global economy is better off. But I wonder if you could
    just elaborate a little bit on how it is that the current
    uncompetitive international system is harmful to American
    workers.
        Mr. Grinberg. The system is harmful in a plethora of ways.
    First of all, there is just the fact that in lots of foreign
    markets U.S. companies are disadvantaged relative to foreign
    corporations because they face a worldwide system with
    deferral, whereas other companies face a territorial system. So
    you know, the other companies will only pay tax in the country
    where they are operating, not at home.
        But then beyond that, and what I tried to emphasize in my
    remarks, is that we have created a disadvantage for U.S.
    companies in the United States. And to the extent that we
    believe that U.S. companies, everything else being equal,
    right--I mean, I love foreign direct investment when it makes
    the asset most productive and when it adds jobs in the United
    States. And I do not want to be understood as discouraging
    that. I am for that; I welcome that kind of investment.
        But at the end of the day, there remains a headquarters
    bias for U.S. companies. And you know, you see it when you see
    an inversion happen, right? In an inversion, what we see happen
    is that, at first, you have just the tax re-domiciliation. But
    then there are a whole bunch of tax-based pressures, both in
    terms of our law and in terms of foreign law and in terms of
    the way the IRS audits, that create pressures to move the
    actual headquarters abroad, right, to move senior management
    abroad, to move R&D abroad, to move the support jobs associated
    with that abroad.
        And initially, amazingly, the company actually, when it
    does that, moves Americans, right? So Americans leave the
    United States.
        But here is the thing. Five years later, they want their
    kids to go to high school or college here, and so they come
    back. And who replaces them? Who replaces them is a European.
    And now you have taken a tax-driven re-domiciliation and you
    have turned it into a substantive change in the corporation, a
    substantive change in its leadership and its leadership's bias
    at the margins for where they are going to put jobs.
        Senator Toomey. So I will just finish, Mr. Chairman.
        So the bottom line is, we have a tax code that creates an
    incentive, apparently a powerful incentive, to headquarter
    multinationals somewhere other than the United States of
    America. And headquarters are very often a source of really
    good jobs.
        Mr. Grinberg. Yes.
        Senator Toomey. Thank you, Mr. Chairman.
        The Chairman. Thank you.
        Before I go to Senator Cantwell, I have been hearing some
    complaints about the committee's process for considering tax
    reform. Now, let me remind my colleagues, in the 6 years that I
    have been the lead Republican on this committee we have held
    roughly 70 hearings on tax reform. We have had the options
    papers that we have come forth with. There was the Baucus plan.
    There was the 200-page committee staff report on tax reform. We
    had the bipartisan working groups and all of their reports.
        Now, this is the third hearing we have had in the last
    month on tax reform. And I might add that we are going to have
    a robust and fair markup.
        Long story short, we have been at this a long time, and
    there are very few ideas and proposals that have not been
    exhaustively examined by this committee. So anybody arguing
    that we are rushing or ramming anything through has a pretty
    selective memory. So I just wanted to make that one point
    before I call on----
        Senator Wyden. Mr. Chairman?
        The Chairman. Yes, Senator Wyden?
        Senator Wyden. Just briefly to respond.
        The Chairman. Okay.
        Senator Wyden. Mr. Chairman, as you know, I and my
    colleagues on this side have enormous respect for you and your
    desire to have this committee work in a bipartisan way----
        The Chairman. Vice versa.
        Senator Wyden [continuing]. And of course your history,
    which we are going to talk about tomorrow with the CHIP bill,
    where you started with Senator Kennedy. So I want to be really
    specific what is so troubling.
        Gary Cohn, the President's top economic adviser, said last
    Thursday that he was presenting his first and last offer. His
    words, not mine. And when I heard that, I was just stunned by
    how dramatic the difference his words were with your words,
    which I know are very sincere, about wanting to do a bipartisan
    proposal, and I would say how different it was from the process
    that Ronald Reagan followed in 1986.
        I talk to Bill Bradley a fair amount, another tall Democrat
    who was on the committee, with a lot better jump shot than me.
    But the point is, Mr. Chairman, he has described many times the
    process where the administration spent time with leaders on the
    committee who worked with the administration trying to find
    common ground. There has been none of that--none of that.
        So I want it understood, this is not commentary about your
    intentions; quite the opposite. And I have appreciated your
    comments with respect to my work with Senator Coats and Senator
    Gregg, because I think that shows some bona fides for trying to
    get a bipartisan bill. And I continue to believe that the
    Democratic principles, particularly given some of your ideas,
    are very consistent.
        But let us make no mistake about it. When Gary Cohn says he
    has put his first and final offer on the table and we are
    completely in the dark about details, that is stepping all over
    the history of successful tax reform, which is to do it in a
    bipartisan way.
        And I just wanted to have that on the record. I did not
    want to take the time of my colleague.
        The Chairman. Well, thank you. Thank you.
        Senator McCaskill, you are next, and then we will go to
    Senator Cantwell.
        Senator McCaskill. Thank you, Mr. Chairman.
        Can any of you point to anything specific in the plan that
    has been laid out that would prevent the problem we have now,
    which is a wide disparity among U.S. companies in terms of how
    much they pay?
        We know the effective rate is 22 percent--not the
    percentage. We know that service providers, construction,
    retail, and agriculture are paying 28 or more. And lots of
    industries have effective rates in the teens. And this is for a
    variety of reasons; it is not just territorial. There are a
    variety of reasons why there is a wide disparity in what
    corporations pay.
        I have scoured this plan, and I see nothing that levels the
    playing field here. Is there anything specific that you see in
    this plan--or maybe this is a detail to be determined later? Do
    you see anything specific in the plan, Dr. Clausing, that would
    level the playing field among the various corporations?
        Dr. Clausing. No. As it is specified now, there is not much
    to hang your hat on in terms of leveling the playing field
    between different corporations. I mean, they are lowering the
    top rate, which means that the most you could pay would be
    less.
        Senator McCaskill. Right.
        Dr. Clausing. So I guess by definition that lowers the
    discrepancy.
        Senator McCaskill. No, I am talking about between
    corporations.
        Dr. Clausing. Yes, but on a relative basis, you are right,
    yes.
        Senator McCaskill. Right. On a relative basis, I see
    nothing here that gets away from some paying zero and others
    paying at the top of the rate.
        Dr. Clausing. That is right.
        Mr. Grinberg. So just one thing, Senator McCaskill. I just
    want to correct you on this 22-percent number. So that is a
    very particular way of calculating an average actual tax rate.
    Let me quote what the Obama Treasury in its final document said
    about that version of calculation. This is on page 42 and 43:
    ``Because it is backwards-looking, determined by tax rules,
    decisions, and economic events that occurred in the past, it is
    not necessarily helpful as an indication of the effect of taxes
    on a new investment, one whose returns will accrue in the
    future.''
        It is also very different in scope than other measures.
    Other people tend to look at effective marginal tax rates or
    effective average tax rates where the studies clearly show that
    U.S. companies are uncompetitive internationally. And I would
    urge you to look at those numbers, not the 22-percent number.
        Senator McCaskill. The point of my question--and I
    understand the point you are making, and it is a valid one--but
    the point of my question is this disparity between corporations
    based on other loopholes that are in the code. There is nothing
    being done that we can see to eliminate those problems, that
    you are going to have one type of industry that may have a
    certain business model pay very, very little and others pay at
    the top of the bracket. That is the point I was trying to make.
    And we have to address that.
        Mr. Grinberg. And I agree that we should try to clean that
    stuff out of the code.
        Mr. Shay. Senator McCaskill, in some respects, the proposal
    would worsen it to the extent it applies expensing to all
    assets.
        Senator McCaskill. Right.
        Mr. Shay. Some assets have longer lives, some shorter
    lives. It can have a disparate effect depending on the
    footprint of the business in particular. It also is quite
    costly from a revenue point of view; at least in the early
    periods. It turns eventually. But if you really want to get
    more equality in terms of treatment, I think you would move
    towards economic depreciation for all assets.
        That gets pretty much into the weeds and requires, frankly,
    a lot of work and a lot more effort. But that would go in the
    direction that you are asking about.
        Senator McCaskill. That makes sense.
        I want to make sure I spend just a moment at the end of my
    time here to talk about pass-throughs. The reason they are
    called pass-throughs is because the income passes through at
    the taxable rate of the person who receives it.
        So let us assume for purposes of this discussion that you
    have somebody who is in the top tax bracket. Right now that is
    almost 37 percent. Let us assume they have hundreds and
    hundreds of pass-throughs, like they were a real estate
    developer. And now all of a sudden, they are going to go from a
    tax rate of 30, almost 40 percent to a tax rate of 25. And this
    would be true for upwards of 90 percent of the businesses
    formed in America. And the vast majority of the income we are
    getting from these pass-throughs is in fact coming from people
    in the top tax bracket. This is real estate developers, law
    firms, doctors--you name it.
        So in essence, this is why, when you say ``pass-through,''
    most Americans' eyes glaze over. We are only talking about C
    corps when we talk about a lower corporate rate. We are
    dramatically lowering by 14 points the tax burden on anybody
    who is wealthy who has pass-throughs. Is that correct? Am I
    explaining that correctly?
        Dr. Clausing. That is correct. And if you look at the
    estimates, about 88 percent of the benefit of a tax cut on
    pass-throughs goes to the top 1 percent of the income
    distribution. It creates a massive new base-erosion problem as
    people will seek to characterize their labor income as business
    income, and you will also lose a lot of income out of the
    personal income tax base. So this is a huge problem.
        Senator McCaskill. A huge problem. Eighty-eight percent of
    the income coming from pass-throughs is for the 1 percent. And
    I guarantee you, anybody who looks somebody straight in the eye
    and says, ``This is not going to benefit me,'' who has hundreds
    and hundreds of LLCs, is just lying to the American people--
    flat out lying.
        Thank you, Mr. Chairman.
        Senator Wyden. Mr. Chairman?
        Senator Portman [presiding]. Senator Wyden?
        Senator Wyden. Per an agreement with Chairman Hatch, I just
    want to make a unanimous consent request to add section 4111 of
    Chairman Enzi's budget mark, which would repeal existing points
    of order requiring a budget score on a reported bill.* Thank
    you.
    ---------------------------------------------------------------------------
        * SEC. 4111. REPEAL OF CERTAIN LIMITATIONS.
        Sections 3205 and 3206 of S. Con. Res. 11 (114th Congress), the
    concurrent resolution on the budget for fiscal year 2016, are repealed.
    ---------------------------------------------------------------------------
        Senator Portman. Without objection.
        Senator Cantwell?
        Senator Cantwell. Thank you, Mr. Chairman.
        I want to note the impressive list of witnesses we have
    from prestigious universities here today. I am specifically
    speaking of the University of Houston and Reed College. Thank
    you.
        The other two institutions get a lot of credit, but we like
    the out-of-the-box thinking that comes from other parts of the
    country as well. So thank you both for being here.
        Dr. Clausing, on your statement about broader notions of
    competitiveness, you outline this issue of making investments
    in other things that help our economy grow and require earning
    higher wages, such as a well-educated workforce. I see later in
    your testimony you also talk about this from the perspective of
    the fact that there have been sharply declining shares of GDP
    that go to labor versus increasing shares of GDP that go to
    profits.
        So one of the things that I see, at least in my State,
    which I guarantee you has lots of economic activity, is the
    importance of skilling up the workforce. How important do you
    think this is to our competitiveness, and how much should our
    tax incentives reflect something that would help us get the
    skill level to maintain U.S. competitiveness?
        Dr. Clausing. Yes, I think that is an excellent question.
    There are a lot of aspects to competitiveness that are
    underappreciated in this debate. And if you think about what
    makes a business really succeed, there are a lot of components.
    Do they have skilled, innovative workers? Is the middle class
    healthy enough that they can purchase their products? Is our
    infrastructure sound? Do we have healthy spending on R&D? All
    of these can make our businesses more successful.
        And many of those things also require government revenue.
    So that makes attention to deficits particularly important
    because, if you are giving away the government revenue that you
    would use to repair bridges and roads and to fund education,
    that is a big hit to the potential for economic growth.
        Back when they were looking at repatriation tax breaks in
    previous years, they often paired that with the idea of the
    infrastructure investment. These days it seems to be paired
    with the idea of deficits. So I think that that is more
    problematic for competitiveness.
        Senator Cantwell. Well, I was thinking more specifically
    about incentivizing apprenticeships. You know, given the fact
    that there are so many people who are not skilled in the jobs
    that we have open--something like 67 percent of companies are
    saying they cannot find the skilled workers that they need--
    what about investing in that as a way to keep our
    competitiveness?
        Dr. Clausing. Yes, I think that is going to be a really
    important issue in the future, not just because of global
    competition, but also because of technological change. We have
    had a huge transformation in the economy with the role of
    technology. And computers and robots can do a lot of the things
    that unskilled workers used to do, which means that if you want
    good job opportunities, you need to have skills. So paying for
    programs and education to make our workers more skilled, I
    think, is essential.
        Senator Cantwell. What would you say, Mr. Wells? A more
    robust workforce--I think we define that in the Northwest as
    people who are flexible to change, that is in the context of
    being able to do a variety of things as models and businesses
    change. You know, going from aluminum in aerospace to
    composites is a big move and needs new skills.
        Mr. Wells. Yes, I agree with what Professor Clausing is
    saying. I think all of those are important factors. And to
    achieve those goals, we are going to need to have revenue to
    the government to be able to fund those objectives.
        And from my perspective, the question then is, what is the
    fair way to raise the revenue? And base protection, preventing
    earnings stripping in a way that levels the playing field, is a
    nice way to get the revenue to meet the goals that you said and
    that I agree with are important goals for the country.
        Senator Cantwell. Yes.
        Mr. Wells. So I see those as being--when you think about
    tax reform legislation, we need to have a competitive, neutral
    system, but we need to have a system that really does collect
    tax in a way that will fund the things that the government
    desires to promote.
        Senator Cantwell. Well, I feel like if I cannot convince a
    guy who had a TV show called The Apprentice to be for
    apprenticeships, then I do not know what I can convince him of.
    I am pretty sure that what we need to do to maintain the shares
    of that GDP going in the right direction for higher wages and
    better jobs is to make sure we make the investment in those
    people whom the companies are saying they need. So it is not
    like they are not saying they need them.
        So thank you, Mr. Chairman.
        Senator Portman. Senator Cassidy, do you have a question
    you would like to ask?
        Senator Cassidy. Yes.
        One of our challenges seems to be the treatment of highly
    mobile intangibles. I have read each of your testimonies, but I
    cannot recall which of you specifically addressed that. But I
    suspect you all have thoughts.
        And with the rise of the so-called modified nexus in the EU
    patent box regimes, we are seeing jobs and business activity
    move offshore--and I think you referenced this earlier, Mr.
    Grinberg--not just the intangible assets themselves.
        So I guess the question is--now, by the way, I mentioned
    this to Mnuchin, and Mnuchin said, ``Well, we have modeled it,
    and having an IP box actually costs the U.S. economy money.''
    So in their modeling, they did not think it worked.
        Now, that is a conversation over coffee, and I cannot say
    that that is their final position. I am just saying that at the
    time, that is what he raised.
        So I guess my question for any of you or all of you is,
    what is the proper balance of carrots and sticks for IP income?
    Because, by the way, I look at these companies with a lot of
    cash overseas, and a lot of them have a lot of IP. I gather
    that a lot of them park that license in Dublin and the income
    thereof goes to Dublin and not to us.
        Mr. Wells, do you want to take a crack?
        Mr. Wells. Okay. So I very much appreciate this question,
    because it will get me back to a dialogue I had earlier. Let us
    think about countries that have very strict rules on charging
    related party royalty arrangements, like China and Brazil. I
    cannot charge for those, so I will do interest stripping; I
    will do related party leasing into those countries; I will do
    supply chain transactions; I will charge my costs in in other
    ways.
        So a multinational comes to a jurisdiction with a toolbox
    of
    earnings-stripping strategies that are in a variety of
    categories. And then they just ask the question, ``Well, which
    ones work here?''
        So if you enact a targeted rule that deals with royalty
    stripping, that is great. But if you leave the other
    opportunities available, all that is going to do is allow for
    the multinational to say, ``Well, I cannot use a hammer, so I
    will use a different tool in my toolbox to do the same
    earnings-stripping technique.''
        And so what I would caution the Congress to consider is,
    instead of targeting IP or instead of targeting moving
    expenses, we need to deal with this as a holistic question.
    What are the things that are related party payments that are
    reducing the U.S. tax base and shifting profits overseas?
        Senator Cassidy. Now, I accept that point, but there are
    some industries that seem very IP-heavy, if you will. Now, this
    is more than moving expenses. This is the fact that you are
    generating such a percent of your income from a license.
        Mr. Wells. Yes. So there are two different aspects to that:
    inbound royalty stripping for the use of IP in the United
    States--and I think we need better earnings-stripping
    protections on that. On IP migration, this is something
    Professor Shay and I have written and spoken about in other
    contexts. I think, from my perspective, the Treasury Department
    should do more under section 367(d) to prevent the shifting of
    intangibles from the United States to a foreign jurisdiction. I
    think they have the authority to do that and have not done
    that. But that is a separate issue that would need to be dealt
    with.
        Senator Cassidy. Let me just work down the line.
        Dr. Clausing?
        Dr. Clausing. Yes, I think intangibles are an important
    part of this tax base-erosion problem. And one thing I would
    encourage you to think about, as you think about other
    countries' tax systems, is also to look at some of the things
    that other countries are doing to protect their tax base.
        It seems that we are in an important period where we can
    either, you know, all race to the bottom effectively, cutting
    rates and making tax evasion easier, or we can work together to
    try to combat that problem.
        The EU recently adopted an anti-tax-avoidance directive
    that works with CFC rules, exit taxes, earnings stripping,
    general anti-abuse rules. Member states are going to apply
    those----
        Senator Cassidy. A little bit more slowly. My ears turned
    60 years old this past week, so I apologize. [Laughter.]
        Dr. Clausing. Sure. Yes, so the EU is working on this anti-
    tax-avoidance directive with many components, including
    controlled foreign corporation rules, exit taxes to address
    inversions,
    earnings-stripping rules, and general anti-abuse rules. And the
    member states of the EU are going to be applying these rules as
    of 2019.
        And you know, I think it is clear that if we do not tax
    this intangible income, other countries will, but there are
    ways that we can support each other in these anti-tax-avoidance
    efforts.
        To the extent that we prevent our companies, for instance,
    from moving income to Bermuda, that also helps Germany and
    France and other countries where foreign-to-foreign stripping
    will occur too. So I think that there are a lot of ways that
    countries can work together to protect their tax bases in a way
    that will help the countries that are trying to tax, as opposed
    to the havens.
        Senator Cassidy. Mr. Shay?
        Mr. Shay. Can I take it back one step? I agree with
    everything that Dr. Clausing just said. But by the time we are
    talking about income shifting, we are talking about successful
    intangibles that have been moved--really paper shuffling by
    good tax lawyers to get profits to move.
        What we care about as a country is, where is the R&D
    conducted? R&D is a deduction. And so really, our ultimate
    focus is, we want the thinking, the knowledge economy to be in
    the United States. And for that, it is not just taxes or it is
    really not even taxes, it is education, starting from the
    primary, moving into secondary, going into higher education.
        My town and city of Boston and Cambridge lost a
    headquarters to Senator Portman's State a number of years ago,
    Gillette, when P&G took them. We just got back General
    Electric, a large amount. We got General Electric. Some of it,
    of course, was incentives, but most of it was a knowledge
    economy that they valued, because they know they need to bring
    their businesses into the digital age.
        Moreover, we have a very significant R&D center for
    Novartis, the Swiss-based company. We have to keep our eye on
    the ball here. It is not just about taxes. We need to preserve
    our revenue so we can fund the education and infrastructure and
    other things that really allow our people to----
        Senator Cassidy. But then the paper shuffling can still
    occur. And once that R&D has developed the marketable license,
    it could then be moved overseas.
        Mr. Shay. Under current law, and that can be substantially
    affected by the steps that Dr. Clausing was referring to.
        Senator Cassidy. Mr. Grinberg?
        Mr. Grinberg. You know, my view is that we need appropriate
    R&D incentives. We should have very, very strong R&D
    incentives.
        I have previously expressed concerns about a patent box,
    but I have made the point before--and it goes specifically to
    why Dr. Clausing is wrong--that both the BEPS project and the
    EU have blessed patent boxes. And that has made patent boxes
    less of a bad idea than they were before. And that was a
    decision of the Obama administration, so let us understand
    that.
        Nevertheless, what I think is, we should have appropriate
    R&D incentives that try to incentivize R&D. And if you have
    inbound rules that are appropriate, then there is less of an
    incentive to move to a jurisdiction with a patent box in the
    first place.
        Senator Cassidy. Okay. I yield back. Thank you.
        Senator Portman. I thank the witnesses for providing us
    some great input today.
        I am just going to end with a couple of questions that dig
    a little deeper into the outbound side.
        We have talked a lot about inbound. It is very important,
    and I appreciate the focus that all four of you have had on
    that issue. I do think we have to have a level playing field.
    And as difficult as it is to find sometimes, I think we have
    gotten some good ideas here today.
        We all want this FDI to be here in the United States,
    because foreign direct investment creates jobs. But at the same
    time, we do not want to be disadvantaging U.S. companies,
    particularly by putting in place round-tripping rules and other
    things on the outbound side.
        The one thing I will say about intangible income leaving
    our country--which is more mobile, and that, to me, is the
    primary problem--is that Mr. Grinberg just mentioned patent
    boxes. Increasingly, our competitive countries in the OECD are
    saying, it is fine if you want to take advantage of our patent
    box, but you also have to move your R&D.
        So to Mr. Shay's point, absolutely I agree we need a more
    competitive economy and a knowledge economy and trained
    employees who can handle it. But ultimately, if a company wants
    to take advantage of the lower rates from a patent box and they
    are told you can take advantage of it only if you include R&D
    work in that country, Ireland is an example, there is an
    incentive to move out of Boston or, in your Gillette case,
    Cincinnati. So I do think that has to be part of our focus
    here.
        I guess I would just ask you, on the outbound side, the
    balancing act is to prevent that base erosion, particularly
    intangible income going to a low-tax jurisdiction, but not
    making U.S. multinationals uncompetitive. So how do we strike
    that balance?
        Mr. Wells talked about 367(d) and how Treasury could do
    more with existing law. What do you all think about his idea?
    And what else can we do on the outbound side, particularly with
    regard to intangible income?
        I will start right in the middle with Mr. Shay, and then we
    will move out right and left.
        Mr. Shay. The patent boxes that I have examined, and I have
    examined quite a few, they are very difficult to design; they
    are very difficult to limit. They end up being essentially rate
    reductions. So let us be clear that generally they are very
    poor so far, and I am not sure we have seen much effect of
    anything other than changing titles to patents.
        With respect to how we achieve the balance of competitive
    versus uncompetitive, I think today we have had a suggestion of
    an array of ideas, but I think it does come down to--we cannot
    just look at source taxation, we cannot just look at outbound
    taxation; we need to have both be robust and protect U.S.
    interests. And U.S. interests are a level playing field in the
    United States and discouraging the kind of massive income
    shifting that Dr. Clausing's research has described.
        And I think if you go in the direction of territorial, if
    you do not have a robust minimum tax, then you are going to
    have an issue. The European Union minimum tax is only five
    people and a dog within the EU. They have a different standard
    with respect to non-EU countries. So we should really be--
    again, this comes down to details, and we need to be very
    careful in how we do it.
        Senator Portman. Mr. Grinberg?
        Mr. Grinberg. So the most important thing we can do is
    lower the rate, lower the rate as sharply as possible. That is
    the bottom line.
        Senator Portman. Lowering the rate helps, because if you
    have a 20-percent rate, you handle a lot of the potential tax
    avoidance problems. But still, there are jurisdictions well
    below that, some with as low as zero, others in the, you know,
    10 to 15 range.
        Mr. Grinberg. The other thing that I would hope we do is
    make it relatively easy in a transition to repatriate IP back
    into the United States so that, if you want to locate here, you
    can pretty easily.
        And then you want appropriate, strong R&D incentives to do
    work in the United States. And then, frankly, if the U.S. moves
    to a system that looks more like the rest of the world, then
    instead of the BEPS process harming us, it can begin to provide
    us some support, because it is getting harder to move IP, as
    you pointed out, to zero-rate jurisdictions where you do not do
    anything.
        And if there is an inbound tax, well, suddenly, you know,
    even if you go to the zero-rate jurisdiction, you are not going
    to pay nothing coming into the United States, so that is less
    of an attraction. You are not round-tripping, and you are not
    round-tripping successfully.
        And the same thing applies equally for foreign-based
    multinationals, so you are not concerned that you cannot do it,
    but your foreign competitors can, which is a big problem under
    current law that round-trippers rightly complain about.
        And so I think that you end up in a better place if you
    just lower the rate as much as you can, create strong R&D
    incentives, let people bring intellectual property back. That
    is my instinct. Do not create substance rules to force people
    to take jobs out.
        Senator Portman. Mr. Wells?
        Mr. Wells. Okay. I think I agree, and maybe all of us
    agree, lowering the rate is a wonderful idea that will help.
        I think that if you move to a territorial regime, which I
    think you should and you must, then what we are saying is that
    subpart F should not serve as an important backstop or it
    should not be expanded as a base-protection measure.
        As today's hearing has said, many times we say we worry
    about earnings stripping. Well, the answer to that is not
    simply to apply a tax on only U.S. companies under subpart F.
    And what I hope has come out of this hearing is that, no,
    subpart F is not the answer to base erosion.
        And if we do go toward a territorial regime and we do not
    make a robust subpart F regime with it, then we really do need
    source taxation. We have to get busy about, how do we protect
    the U.S. tax base from interest stripping, royalty stripping,
    and related party payments generally?
        And I think if we do that, then I think that you can come
    up with a system that will be a level playing field.
        And again, I would just caution with this comment. Every
    time we seem to talk about protecting what is the rate of tax
    in the U.S., to the extent an inbound company can get a tax
    advantage, that puts them at a competitive advantage versus
    U.S. companies. And we need a system that levels that playing
    field for competitiveness reasons.
        Senator Portman. Dr. Clausing, I am going to ask you to at
    least base part of your answer on the possibility of a
    territorial system, because I think that is what we are talking
    about in general here. And not that I am not interested in your
    other comments, but if you could think about, if there were a
    territorial system, how would it work?
        Dr. Clausing. Absolutely. The first thing I would note is
    that lowering the tax rate is definitely not enough, and it is
    not going to get you there. If you look at the actual data on
    the profit-shifting problem, over 80 percent of the profit
    shifting for U.S. multinational firms is destined to seven
    havens. And those havens have effective tax rates that are
    typically 2 or 3 percent or sometimes less. So simply slashing
    the rate is not going to handle that base-erosion protection.
        So, assuming you go with a territorial system, I think the
    key is to do tough base-erosion protection measures, including
    a per-
    country minimum tax, which I think would be one of the more
    effective measures you could take. This should be coupled with
    off-the-shelf remedies to deal with the inversion problem, like
    a 50-percent ownership threshold, exit tax, earnings-stripping
    limits, and the like.
        You can also address the check-the-box regulations and work
    with some of our trading partners on the BEPS steps. Some of
    these steps are Band-Aids, but they are better than nothing at
    all.
        And focusing on the fundamentals of the economy, I think,
    is also a really important thing that I would come back to--
    paying for your tax cuts, funding education, funding
    infrastructure.
        Senator Portman. Great.
        Well, listen, thank you all. I could stay here all morning
    and afternoon, but I am afraid you probably have better things
    to do. We have not even gotten into the repatriation and, you
    know, whether it should be bifurcated or not. Any thoughts on
    that are helpful--not today--but presenting those to the
    committee and the staff. Whether there should be differences,
    as the Camp draft had, with regard to subpart F is important.
        So, thank you for what you have done.
        I would just end by saying two things. One, there is an
    urgency here. And I know that people are saying we need more
    time, more time. We have spent, I think Mr. Grinberg said, 6
    years--it seems more like 20 years--talking about this. And
    there have been, you know, dozens of hearings, broadly
    speaking, on tax reform. This is not something that has not had
    a lot of debate, not to say we should not have more--I am all
    for it. And I am really happy we are in the committee process
    here, because we need to have public debate.
        Infrastructure--our health care was not subject to that,
    and that was a mistake, in my view. I hope that infrastructure
    will have that kind of debate as an example.
        And then finally, I just want to say I think we need to be
    very careful when we talk about this notion that somehow this
    is tax cuts that will pay for themselves. That is not what
    Secretary Mnuchin said over the weekend. I saw his comments.
    What he said was, there will be economic growth that will
    accompany good tax reform, the right kind of tax reform, which
    includes the business side, because our code is so out of date
    right now.
        There is an enormous opportunity to repatriate profits, but
    also to just allow American companies to be competitive and add
    more jobs here, and that will raise economic growth. And if you
    increase growth--I think it is about .4 percent over what the
    projections would otherwise be--I think that accounts for about
    the trillion and a half that is talked about.
        So it is not that tax cuts pay for themselves, it is that
    the right kinds of tax relief and, more importantly for me,
    reform will lead to better economic growth. And we should take
    that into account. And that is my view, anyway.
        For any of my colleagues who have written questions for the
    record, I ask that you submit them by close of business on
    October 13th.
        And with that, again, thank you so much for your time
    today. And please continue to give us input.
        This hearing is adjourned.
        [Whereupon, at 12:27 p.m., the hearing was concluded.]

                                A P P E N D I X

                  Additional Material Submitted for the Record

                                  ----------

     Prepared Statement of Kimberly A. Clausing, Ph.D., Thormund A. Miller
             and Walter Mintz Professor of Economics, Reed College
        Chairman Hatch, Ranking Member Wyden, members of the committee,
    thank you for inviting me to share my views on the international
    aspects of business tax reform. Business tax reform is an important
    priority, and it should reflect the needs of our country. We need to
    raise revenue in a way that is simple, fair, and efficient. We can do
    this without resorting to increasing the budget deficit. And we can do
    this in a way that focuses on the needs of the American middle class.

        In my testimony today, I will discuss several crucial issues
    related to good business tax reform. First, I will discuss the concept
    of competitiveness, the contribution of our business tax system to the
    Nation's competitiveness, and other important features of national
    competitiveness. Second, I will address the issue of corporate tax base
    erosion, an issue that has plagued our business tax system. Third, I
    will suggest important priorities in business tax reform, discussing
    how the corporate tax can be modernized to make our tax system better
    suited to a globally integrated economy. Toward this end, our tax
    system must serve the interests of American middle-class workers,
    workers too often left behind in tax reform proposals.
                        are u.s. companies competitive?
        By any broad measure, our Nation's businesses are incredibly
    successful. Corporate profits are a higher share of GDP than they have
    been at any time in history, whether one considers corporate profits in
    before-tax or after-tax terms. Over the past 10 years, after-tax
    profits have averaged 9.3% of GDP, whereas over the 40 years before,
    they averaged 6.2% of GDP. In light of these clear facts, it is
    difficult to argue that our economy is being held back by a scarcity of
    after-tax profits. Indeed, our companies are awash in cash, but they
    are missing investment opportunities, due in part to the economic
    weakness of middle-class consumers. (See Figure 1.) Also, our companies
    dominate the Forbes Global 2000 lists of the world's most important
    companies. (See Figure 2.) While our economy is about one-fifth the
    size of the world economy (16% in purchasing power parity terms (PPP)
    \1\ and 22% in U.S. dollar terms), we have larger fractions of the
    world's top 2,000 firms: 28% by count, 33% by sales, 37% by profits
    (consolidated), 24% by assets, and 44% by market capitalization.
    ---------------------------------------------------------------------------
        \1\ PPP numbers adjust for price differences across countries. This
    makes the United States a smaller share of the world economy since
    price levels are lower in most developing countries.

    [GRAPHIC] [TIFF OMITTED] T0317.001

    [GRAPHIC] [TIFF OMITTED] T0317.002

    Is the U.S. Tax System Competitive?
        While our corporate tax system certainly has problems, high tax
    burdens for multinational corporations are not one of them. Due to the
    aggressive use of corporate loopholes, many U.S. multinationals have
    effective tax rates in the single digits, far lower than the U.S.
    statutory rate.\2\ And, our purportedly ``worldwide'' system of
    taxation generates no revenue from taxing foreign income, while our
    trading partners that use purportedly ``territorial'' systems of
    taxation frequently tax more foreign income than we do.\3\ Further,
    U.S. corporate tax revenues are lower than the corporate tax revenues
    of our peer trading partners by about 1 percent of GDP. Part of the
    revenue shortfall is explained by profit shifting to tax havens, and
    there are also other reasons for weak U.S. corporate tax revenues.\4\
    These considerations do not mean that U.S. business taxation cannot be
    substantially improved; I make suggestions below.
    ---------------------------------------------------------------------------
        \2\ The U.S. statutory rate is high relative to peer nations, but
    this is not the relevant measure of corporate tax burdens since most
    companies pay effective tax rates that are far lower than the statutory
    rate. See footnote 5 for evidence.
        \3\ Under the U.S. system, some types of foreign income are more
    lightly taxed. For example, foreign tax credits can be used to shield
    royalty income from taxation. Also, other countries often have tougher
    base-erosion laws, and their adoption of the OECD/G20 BEPS guidelines
    will continue this trend. See Joint Committee on Taxation JCX-42-11. In
    addition to tough CFC laws, many territorial countries have other
    provisions aimed at countering corporate tax base erosion, including
    thin capitalization (earnings stripping) rules, which are widely used.
    Beyond these measures, there are also new anti-base erosion measures
    such as the European Union Anti-Tax Avoidance Directive and Australia's
    anti-avoidance law.
        \4\ Much business income is earned by pass-through organizations;
    this is discussed below. Beyond that, the U.S. tax base is notoriously
    narrow and there are important distortions within the corporate tax
    code. For example, debt-financed investments are tax-favored relative
    to
    equity-financed investments. This increased leverage creates financial
    vulnerability for the U.S. economy.

    [GRAPHIC] [TIFF OMITTED] T0317.003

    Broader Notions of Competitiveness
        In discussions about the ``competitiveness'' of U.S. multinational
    firms, corporate interests often emphasize tax burdens as a
    determinative influence. Yet, for many companies, the U.S. statutory
    rate and our purportedly ``worldwide'' system have more bark than bite,
    and multinational firms are often able to achieve very low effective
    tax rates.\5\ In terms of the ability to generate after-tax profits and
    market dominance, U.S. multinational companies are already quite
    competitive.
    ---------------------------------------------------------------------------
        \5\ See Matthew Gardner, Robert S. McIntyre, and Richard Phillips,
    ``The 35 Percent Corporate Tax Myth,'' ITEP Report, March 2017. See
    also these studies on effective tax rates: Congressional Research
    Service: https://fas.org/sgp/crs/misc/R41743.pdf; General Accounting
    Office: https://www.gao.gov/products/GAO-16-363; Treasury: https://
    www.treasury.gov/resource-center/tax-policy/Documents/Report-
    Responsible-Business-Tax-Reform-2017.pdf; and the appendix of this
    academics letter: https://americansfortaxfairness.org/files/24-
    International-Tax-Experts-Letter-to-Congress-9-25-15-FINAL-for-
    printing.pdf.

        But broader notions of competitiveness emphasize the fundamentals
    that determine the health and well-being of our broader economy. Are
    workers well-educated, and do they have the skills required to earn
    high wages in the global economy? Are customers economically secure and
    sufficiently prosperous that they are not overleveraged? Are standards
    of living for the middle class rising at a pace that is consistent with
    societal expectations and a healthy middle class? Is our infrastructure
    sound? Are our political and economic institutions stable? Are we
    avoiding fragility in our financial system and other weak spots that
    ---------------------------------------------------------------------------
    could lead to recessions or crises?

        While we often take such things for granted, they are essential to
    the success of U.S. businesses and the workers within them. In short,
    the attractiveness of a particular country as a location for production
    depends on much more than the corporate tax environment. And many
    crucial ingredients for a competitive economy require government
    revenue to finance investments in education, infrastructure, and
    essential services. The investments in our economy that make the middle
    class prosperous will also make our businesses successful.
                         corporate tax base protection
        Offshore profit shifting has become a huge problem. My research
    suggests that this problem has increased dramatically over the past 20
    years, and profit shifting to tax havens now costs the U.S. Government
    more than $100 billion each year.\6\
    ---------------------------------------------------------------------------
        \6\ See Kimberly A. Clausing, ``The Effect of Profit Shifting on
    the Corporate Tax Base in the United States and Beyond,'' 2016,
    National Tax Journal, December, 69(4), 905-934. Similar facts regarding
    the scale of the problem are reported by many sources, including
    Keightly (2013), Dowd, Landefeld, and Moore (2017), and Guvenen,
    Mataloni, Rassier, and Ruhl (2017). These practices also hurt our
    trading partners, as discussed in Clausing (2016).

        Figure 4 shows the dramatic increase in the revenue lost to profit
    shifting in recent years, and Figure 5 shows that most profit shifting
    is artificially directed toward tax havens. Indeed, the income booked
    in low-tax havens is implausibly high by any reasonable metric. In
    2010, U.S. affiliate firm profits were many multiples of island havens'
    entire GDP: over 16 times GDP in Bermuda and over 20 times GDP in the
    Caymans.\7\ Further, estimates indicate that U.S. multinational firms
    have accumulated over $2.6 trillion in permanently reinvested earnings
    in tax havens, over $1 trillion of which is held in cash.
    ---------------------------------------------------------------------------
        \7\ See Jane Gravelle, ``Policy Options to Address Profit Shifting:
    Carrots or Sticks?'', Tax Notes, July 4, 2016.
        \8\ For the full analysis behind Figures 4 and 5, see Kimberly
    Clausing, ``The Effect of Profit Shifting on the Corporate Tax Base in
    the United States and Beyond,'' 69 National Tax Journal 905, 905-934
    (2016).

    [GRAPHIC] [TIFF OMITTED] T0317.004

        The tax havens that are destinations for profit shifting abroad
    have extremely low effective tax rates, often less than 5%. My research
    suggests that 82% of our profit shifting problem is with just 7 tax
    havens, the ones shown in Figure 5. And 98% of the profit shifting
    occurs with countries that have effective tax rates that are less than
    15%. These facts clearly show that lowering the corporate tax rate is
    not enough to stem this type of tax avoidance. Absent tough measures to
    combat tax base erosion, haven tax rates under 5% will remain big
    magnets for internationally mobile income, even if the U.S. corporate
    ---------------------------------------------------------------------------
    tax rate declines substantially.

    [GRAPHIC] [TIFF OMITTED] T0317.005

    More Base Erosion: The Problem of Favorable Pass-Through Taxation
        While multinational companies almost always operate in corporate
    form, in part due to the benefits of deferral of U.S. taxation on
    foreign income until income is repatriated, much domestic business
    activity has moved from corporate to pass-through form. Pass-through
    income is now over half of business income. For domestic companies, tax
    burdens are often far lower in pass-through form, and tax avoidance is
    a big problem. Pass-through businesses often feature opaque
    organizational forms that facilitate tax avoidance. The average Federal
    rate on pass-through income is 19%, a rate lower than the rate on
    corporate income, and the movement of business income into pass-through
    form has reduced corporate tax revenues by about $100 billion each
    year.\9\
    ---------------------------------------------------------------------------
        \9\ See Michael Cooper, et al., 2016, ``Business in the United
    States: Who Owns It and How Much Tax Do They Pay?'', Tax Policy and the
    Economy, 30(1), 91-128.

        Providing a tax preference for pass-through income risks more tax
    base erosion. Rates below the top personal rate will open up massive
    new opportunities for tax avoidance, as (typically high-income)
    individuals with discretion will be tempted to reorganize their income
    as business rather than personal income. This type of tax avoidance was
    endemic in Kansas after their experiment with lower pass-through rates,
    and in general, it is very difficult to combat without adding immense
    complexity to the tax system. While some small businesses are the sorts
    of endeavors that are easily romanticized in these types of committee
    hearings, pass-through organizational form is also popular among very
    wealthy individuals, including President Trump, who owns many pass-
    through businesses. According to estimates from the nonpartisan Tax
    Policy Center, an astonishing 85% of a pass-through tax cut would
    accrue to those in the top 1% of the income distribution.\10\
    ---------------------------------------------------------------------------
        \10\ See http://www.taxpolicycenter.org/sites/default/files/
    publication/141541/2001271-options
    -to-reduce-the-taxation-of-pass-through-income.pdf.
    ---------------------------------------------------------------------------
               why is it important to protect the corporate tax?
        1. Revenue. As demonstrated in Figure 3, U.S. corporate tax
    revenues are lower than those of peer nations, due to both profit
    shifting and the importance of the pass-through sector. In the wake of
    record high corporate profits in recent years, the low, flat trend of
    our corporate tax revenues is particularly noticeable. Protecting the
    corporate tax base would help ensure adequate government revenues in a
    time when the labor share of income is steadily shrinking.\11\ Revenues
    are particularly important to finance urgent priorities that are
    important for the competitiveness of our economy and the economic
    health of the middle class: priorities like infrastructure, education,
    and research and development.
    ---------------------------------------------------------------------------
        \11\ See Kimberly Clausing, ``Labor and Capital in the Global
    Economy,'' Democracy: A Journal of Ideas, 43, 2017, http://
    democracyjournal.org/magazine/43/labor-and-capital-in-the-global-
    economy/.

        Business tax reform that is not (at least) revenue neutral
    increases the government budget deficit. The deficit is already
    scheduled to increase by about 2% of GDP over the next decade due to
    our aging population and our important commitments to Social Security
    and Medicare. Debt held by the public is now about 75% of GDP. Further
    increasing our indebtedness at this moment in time is unwise. When
    another recession occurs, and unfortunately recessions do always come,
    we will need room for the natural increases in budget deficits that
    occur as the economy collects less tax revenue and spends more on
    unemployment. Our current levels of indebtedness already provide little
    wiggle room. Also, monetary policy will have limited ability to respond
    to the next recession since interest rates are already quite low. This
    ---------------------------------------------------------------------------
    is a bad time for tax cuts.

        Deficit-financed tax cuts increase tax burdens on our children and
    grandchildren. Also, government budget deficits reduce any growth-
    enhancing effects of tax cuts, since they either raise interest costs
    (due to greater government borrowing) or they pull in foreign sources
    of financial capital, which have the advantage of keeping interest
    rates lower, but result in future repayments of debts abroad, lowering
    standards of living at home during that period.

        The nonpartisan Tax Policy Center has calculated that base
    broadening can only finance a limited revenue-neutral corporate rate
    reduction. Ignoring deferral, if you eliminate every single business
    tax expenditure (some of which are very popular), it only pays for a
    rate reduction to 26%, a far higher rate than those in the news
    lately.\12\
    ---------------------------------------------------------------------------
        \12\ TPC Staff, ``The Tax Reform Tradeoff: Eliminating Tax
    Expenditures, Reducing Rates,'' September 13, 2017. Of course, ending
    deferral would enable further rate reduction; however, a move toward a
    territorial system is likely to worsen erosion.

        2. A Fair Tax System. Any proposed business tax plan follows
    several decades of dramatically increasing income inequality, sharply
    declining shares of GDP that go to labor, sharply increasing shares of
    GDP that go to corporate profits, and middle class wage stagnation. Tax
    ---------------------------------------------------------------------------
    policy should work to counter, not reinforce, such trends.

        Business taxation has an important role to play in the
    progressivity of the tax system. As already noted, 85% of pass-through
    tax rate cuts accrue to the top 1% of the income distribution. And,
    aside from the estate tax, the corporate tax is our most progressive
    tax. All conventional models of corporate tax incidence assign the vast
    majority of the burden of the corporate tax to capital or shareholders,
    including models used by the Joint Committee on Taxation, the
    Congressional Budget Office, the U.S. Treasury, and the nonpartisan Tax
    Policy Center.\13\ Given the strong advocacy by shareholders and the
    business community for corporate tax cuts, it should not be surprising
    that these groups are the ones who would benefit from the tax cuts.
    They understand their own economic interests.
    ---------------------------------------------------------------------------
        \13\ For JCT, see https://www.jct.gov/
    publications.html?func=startdown&id=4528. For CBO, see https://
    www.jct.gov/publications.html?func=startdown&id=4528. For Treasury, see
    https://www.ntanet.org/NTJ/66/1/ntj-v66n01p239-62-distributing-
    corporate-income-tax.html. (This was previously available at https://
    www.treasury.gov/resource-center/tax-policy/tax-analysis/Documents/TP-
    5.pdf, but it was mysteriously pulled from the Treasury website in
    recent weeks.) For the TPC, see http://www.taxpolicycenter.org/
    publications/how-tpc-distributes-corporate-income-tax.

        Those concerned about the well-being of workers might usefully
    advocate for tax cuts on taxes that workers pay: economists agree that
    workers bear the burden of the payroll tax and the labor income tax.
    For corporate tax cuts to benefit workers, the resulting increase in
    corporate after-tax profits needs to fuel new investments, those new
    investments need to increase the productivity of labor, and the higher
    productivity needs to boost wages. Why rely on such indirect mechanisms
    to help workers when we have far more direct tools? If the aim is to
    help workers, then policymakers should go straight to the taxes that
    ---------------------------------------------------------------------------
    fall on them.

        Further, much of the U.S. corporate tax base at present is excess
    profits, which are profits above the normal level accruing due to
    intangible sources of economic value and market power. U.S. Treasury
    economists now calculate that three quarters of the corporate tax base
    is excess profits, often in the hands of very few superstar
    companies.\14\ Giving a tax cut to this part of the tax base just makes
    excess profits even larger, without stimulating capital investment or
    wages.
    ---------------------------------------------------------------------------
        \14\ See http://www.ntanet.org/NTJ/69/4/ntj-v69n04p831-846-excess-
    corporate-returns-increasing.pdf for evidence on excess profits.

        Finally, if burgeoning corporate after-tax profits were the key to
    investment and wage growth, then the previous 15 years should have
    already been a paradise of wage growth, as after-tax profits in recent
    years have been about 50 percent higher than in decades prior (as a
    ---------------------------------------------------------------------------
    share of GDP), and higher than at any point in the past half-century.

        I would urge the committee to focus on the distribution tables when
    designing tax law changes, relying on the well-regarded, nonpartisan
    economists at the Joint Committee on Taxation and the Congressional
    Budget Office to estimate the effects of tax and budget changes. The
    ultimate test of whether tax legislation will help American workers is
    the distribution analyses. In these analyses, it is important to
    consider the tax system as a whole: business taxes, individual income
    taxes, and estate taxes should all be considered together.

        3. An Efficient Tax System. Taxing corporate income helps make the
    tax system function better. Without the corporate tax, individuals
    could use the corporate form itself as a tax shelter. The corporate tax
    is also our only effective tool for taxing capital income. In my recent
    research with Leonard Burman and Lydia Austin of the Tax Policy Center,
    we show that only about 30% of U.S. equity income is taxed at the
    individual level by the U.S. Government; the rest is earned in tax free
    accounts, in non-taxable endowments, or by foreign investors.\15\
    ---------------------------------------------------------------------------
        \15\ Leonard Burman, Kimberly Clausing, and Lydia Austin, ``Is U.S.
    Corporate Income Double-Taxed?'', National Tax Journal, September 2017.

        Taxing all types of income at the same rate of taxation is a good
    ideal for tax policy. After the last great tax reform (that emerged
    from this very body) in 1986, both capital and labor income were taxed
    at the same rate. This sort of uniformity is consistent with the latest
    research on the ideal efficient tax policy design.\16\ Taxing different
    types of income at the same rate also cuts down on the many gimmicks
    and shenanigans that litter our tax system when tax rates differ.
    ---------------------------------------------------------------------------
        \16\ As examples, see Peter Diamond and Emmanuel Saez, 2011, ``The
    Case for a Progressive Tax: From Basic Research to Policy
    Recommendations,'' Journal of Economic Perspectives 25: 165-90;
    Emmanuel Farhi, Christopher Sleet, Ivan Werning, and Sevin Yeltekin,
    2012, ``Non-
    Linear Capital Taxation Without Commitment,'' Review of Economic
    Studies forthcoming: 1-25; Thomas Piketty and Emmanuel Saez, 2012, ``A
    Theory of Optimal Capital Taxation,'' National Bureau of Economic
    Research Working Paper No. 17989, April; Thomas Piketty and Emmanuel
    Saez, 2013, ``A Theory of Optimal Inheritance Taxation,'' Econometrica
    81 (5): 1851-86.

        Finally, since the vast majority of the corporate tax base is
    excess profits, this also has efficiency implications. Taxing excess
    profits does not distort capital investment or hiring decisions, and
    excess profit taxes are far more efficient than taxes that target
    capital or labor.
                      implications for business tax reform
    1. First, Do No Harm: A Toothless Territorial System Heads in the Wrong
            Direction
        Many in the multinational community use the notion of
    ``competitiveness'' to suggest that that the United States should adopt
    a territorial system of taxation. Yet, as noted above, multinational
    firms already face low effective tax rates that are comparable to those
    of firms headquartered in other countries, and very little tax is
    presently collected on foreign income. Indeed, a well-designed
    territorial system could easily raise the tax burden on foreign income,
    as noted by many observers.\17\
    ---------------------------------------------------------------------------
        \17\ Leslie Robinson, 2014, testimony of Leslie Robinson before the
    United States Senate Committee on Finance, presented at the hearing on
    international corporate taxation, Washington, DC, July 22; Jane G.
    Gravelle, 2012, ``Moving to a Territorial Income Tax: Options and
    Challenges,'' Washington DC: Congressional Research Service.

        So, presumably, those that push for adoption of a territorial
    system under the guise of competitiveness concerns truly have in mind a
    ``toothless territorial'' system that would lower the tax burden on
    foreign income. A toothless territorial system, without serious and
    effective base erosion protection measures, risks worsening an already
    large corporate tax base erosion problem. Exempting foreign income from
    taxation would relax the remaining constraint on shifting income
    abroad, the potential tax due upon repatriation. This turbocharges the
    already large incentive to book profits in low-tax havens, likely
    generating large revenue losses.
    2. Cutting Business Rates Below Personal Tax Rates Risks More Tax Base
            Erosion
        Discrepancies between the top personal rate and the business rate
    will create new avoidance opportunities as wealthy individuals seek to
    earn their income in tax-
    preferred ways, reducing their labor compensation in favor of business
    income. Companies would be inclined to tilt executive compensation
    toward stock-options and away from salary income, and high-income
    earners would be inclined to earn income through their businesses in
    pass-through form. Thus, serious tax revenue leakage in the personal
    income tax system is also likely.
    3. Much Ado About Repatriation . . . Why Give Windfalls for Income
            Already Earned?
        U.S. multinational companies have accumulated over $2.6 trillion in
    offshore profits, sitting in countries with very low effective tax
    rates, typically less than 5%. Companies are able to borrow against
    these funds, and even invest these funds in U.S. financial markets, but
    they are not able to distribute the funds to shareholders in the form
    of dividends and share repurchases without triggering U.S. tax on the
    repatriated funds. As a consequence, companies have left funds piling
    up offshore, in the hope that Congress will give them a special holiday
    rate again (as in the 2004 American Jobs Creation Act), or even enact
    permanently favorable treatment of foreign income.

        Company decisions about when to pay dividends and repurchase shares
    are distorted by these tax incentives. However, it is unlikely that
    repatriation tax is reducing U.S. investment. The companies that have
    accumulated these earnings abroad are the most credit-worthy companies
    on the planet, and they can easily borrow to finance worthy new
    investments in the United States. In fact, borrowing achieves the
    equivalent of a tax-free repatriation, since the funds abroad
    accumulate interest income that offsets the interest deduction on funds
    borrowed at home, giving companies the same access to financial capital
    at no tax cost.

        Despite the hopeful title of the legislation, the 2004 American
    Jobs Creation Act's repatriation tax holiday did not create jobs or
    spur investment.\18\ Instead, it was effectively a tax windfall to
    shareholders based on companies' past tax avoidance. The only effect
    was a substantial increase in share repurchases and dividend issues.
    ---------------------------------------------------------------------------
        \18\ See Jane G. Gravelle and Donald J. Marples, 2011, ``Tax Cuts
    on Repatriation Earnings as Economic Stimulus: An Economic Analysis,''
    R40178, Congressional Research Service. This paper provides an
    extensive review of several papers, all of which show no jobs or
    investment stimulus resulting from the repatriation tax holiday.

        Further, preferential rates on income that has already been earned
    and that is stashed in tax havens makes no economic sense from either
    an efficiency or equity perspective. Giving shareholders a tax windfall
    on income they have already earned does not encourage job creation or
    investment. Instead, it merely enriches those at the very top of the
    income distribution. We have far more effective tools to encourage new
    investment, job creation, and the prosperity of the middle class.
    4. Tackling Base Erosion
        Congress should focus on a revenue-neutral (or revenue-increasing)
    business tax reform that reduces the statutory corporate tax rate and
    eliminates the major corporate tax expenditures including deferral,
    taxing accumulated offshore earnings in full. Eliminating deferral
    would eliminate the incentive to earn income in low-tax countries, by
    treating foreign and domestic income alike for tax purposes. Pairing
    that reform with a lower corporate tax rate need not raise tax burdens
    on average, although it would create winners and losers among corporate
    taxpayers. A more fundamental reform would require worldwide corporate
    tax consolidation; this would align the tax system with the reality of
    globally-integrated corporations.\19\ These reforms should be combined
    with anti-inversion measures such as better earnings stripping rules
    and an exit tax.
    ---------------------------------------------------------------------------
        \19\ One proposal for worldwide consolidation is within Kleinbard's
    proposal for a Dual BEIT: Edward D. Kleinbard, ``Business Taxes
    Reinvented: A Term Sheet'' (September 25, 2017), Tax Notes, Vol. 156,
    2017. Another fundamental reform worthy of long-run consideration is
    formulary apportionment. See Reuven S. Avi-Yonah and Kimberly A.
    Clausing, 2008, ``Reforming Corporate Taxation in a Global Economy: A
    Proposal to Adopt Formulary Apportionment.''

        Taxing foreign income currently also eliminates the incentive to
    build up large stocks of unrepatriated foreign income, now estimated at
    $2.6 trillion. Settling the future tax treatment of foreign income
    ---------------------------------------------------------------------------
    should be a key goal of reform efforts.

        In terms of more incremental reforms, even a per-country minimum
    tax would be a big step toward reducing profit shifting toward tax
    havens and protecting the corporate tax base. A minimum tax would
    currently tax income earned in the lowest tax countries. Ninety-eight
    percent of the profit shifting out of the United States is destined for
    countries with foreign tax rates below 15%.\20\ However, a ``global''
    minimum tax is a far less effective step. Since companies could use
    taxes paid in higher-tax countries to shield income booked in tax
    havens from the minimum tax, there would still be a very substantial
    incentive to earn income in tax havens. The playing field would be more
    tilted toward both haven income and other types of foreign income; the
    two streams of income would work together to reduce tax burdens.
    ---------------------------------------------------------------------------
        \20\ See Kimberly Clausing, ``The Effect of Profit Shifting on the
    Corporate Tax Base in the United States and Beyond,'' 69 National Tax
    Journal 905, 905-934 (2016).

        In general, making our tax system compatible with the global
    economy is an important goal. We need a simplified corporate tax system
    that actually collects the tax that is due. As it is, too many people
    waste their careers pursuing tax-related gimmicks and shenanigans.
    Profit shifting costs the U.S. Government over $100 billion each year.
    Simple reforms like a per-country minimum tax--or better yet, ending
    deferral--would address that problem and make our corporate tax system
    more compatible with the global operations of multinational firms.
    5. Paying Attention to the Middle Class
        The truth is in the distribution tables. Any tax law changes should
    not worsen income inequality. The tax plans of this committee follow
    decades of dramatically increasing income inequality, sharply declining
    shares of GDP that go to labor, sharply increasing shares of GDP that
    go to corporate profits, and middle class wage stagnation. Our tax
    policy should be working to counter these trends, making sure that all
    American workers benefit from the gains in national income that
    steadily increase our GDP.
    ---------------------------------------------------------------------------
        \21\ See Thomas Piketty, Emmanuel Saez, and Gabriel Zucman,
    ``Distributional National Accounts: Methods and Estimates for the
    United States,'' December 2016.

    [GRAPHIC] [TIFF OMITTED] T0317.006

        In earlier decades, the middle class did better. Figure 6 shows
    that pre-tax income growth over the period 1946 to 1980 exceeded 100%
    for the bottom 90% of the population, and income growth was actually
    lower for the top shares of the population. However, between 1980 and
    2014, the growth of the bottom 50% is literally invisible in the chart,
    at 1%. Growth in incomes for the middle 40% is 42 percent, and it
    accelerates from there. As a result, there has been an increasing
    concentration of national income at the top of the income distribution.
    The top 1% now have a fifth of national income, 50% more income than
    ---------------------------------------------------------------------------
    the bottom half of the income distribution. (See Figure 7.)

    [GRAPHIC] [TIFF OMITTED] T0317.007

        These figures help explain why typical American households are not
    content with the pace of economic progress. The standard expectation
    that every generation would be better off than the prior generation has
    been disappointed. Nearly 90% of children born in the 1940s out-earned
    their parents, but that share has fallen steadily. For children born in
    1970, only 60% out-earn their parents; for those born in the 1980s,
    only half do.\22\
    ---------------------------------------------------------------------------
        \22\ See Raj Chetty et al., ``The Fading American Dream: Trends in
    Absolute Income Mobility Since 1940,'' NBER Working Paper No. 22910,
    December 2016.

        Our tax system needs to reflect these changing realities by making
    sure that tax cuts are directed to those that are not in the top 1%,
    focusing instead on the bottom 80% of the population that has been
    frustrated by our prior record of economic progress. The tax system can
    better serve American workers by expanding the earned income tax
    credit, by providing wage insurance for workers who have lost their job
    due to technological disruption or due to competitive pressures, and by
    making sure that tax cuts are larger for the middle class than for the
    rich. We also need to work to solidify the economic fundamentals of our
    economy. This requires responsible tax legislation that gives us the
    revenue we need for vital investments in education, infrastructure,
    healthcare, and other urgent priorities.
    6. Fund the IRS; They Need More Resources to Do Their Job
        In order to administer the tax system in a way that is fair to
    taxpayers and that meets the needs of the country, the IRS needs
    adequate resources and technology.
    7. Finally, a New Revenue Source Can Make Tax Policy Trade-Offs Less
            Vexing
        Whatever happens with tax policy in the months and years ahead, we
    will likely aim for more ideal tax policy in the future. To do this,
    we'll need a planet that is fit for habitation. Climate change is a
    real and pressing problem, but it is also an opportunity for efficient
    taxation. Normally, taxes burden things we actually want to encourage,
    like work or savings. But carbon dioxide emissions are wreaking havoc
    on the world's climate, and a tax on carbon is an ideal way to counter
    them, without resorting to burdensome regulations. A carbon tax raises
    a lot of revenue; a tax of $25/per metric ton is estimated by the
    Congressional Budget Office to generate about a trillion dollars in
    revenue over 10 years.\23\ And, unlike most sources of revenue, a
    carbon tax makes the economy more efficient by discouraging something
    that the market, left to its own devices, over-produces.
    ---------------------------------------------------------------------------
        \23\ This tax rate is lower than many estimates of the tax rate
    that would truly cause market participants to find the ideal level of
    carbon dioxide emissions, but it would be a sizable step in the right
    direction, and the tax rate could be increased over time. Arguably, the
    rate should be about twice as high, eventually.

        A carbon tax can help keep other tax rates lower than would
    otherwise be necessary. Several very prominent Republican economists
    have recently suggested a novel way to tax carbon in their
    ``Conservative Case for Climate Action.'' \24\ They propose simply
    refunding the carbon tax to ordinary Americans in equal amounts. This
    is a masterful policy that will help workers in the bottom 70% of the
    income distribution (since they will receive more from the rebate than
    they pay in tax).\25\ The large revenue source keeps overall tax
    burdens much lighter for those Americans who have struggled the most in
    recent decades. It will lead to new investments and new jobs in cleaner
    technologies and a healthier planet. A very good idea indeed.
    ---------------------------------------------------------------------------
        \24\ See Martin Feldstein, Ted Halstein, and Greg Mankiw, ``A
    Conservative Case for Climate Action,'' New York Times, February 8,
    2017, https://nyti.ms/2kMKE4u.
        \25\ See https://www.treasury.gov/resource-center/tax-policy/tax-
    analysis/Documents/WP-115.
    pdf.

        Thank you again for inviting me to testify today. I look forward to
    your questions.

    Further Reading

        This testimony draws on several other works by the author,
    including those below. In some cases, sections of text are excerpted.
    Interested readers are referred to the following articles by the author
    for more detail on these arguments.

          ``Strengthening the Indispensible U.S. Corporate Tax,''
    Washington Center for Equitable Growth, August 2016, http://
    equitablegrowth.org/report/strengthening-the-indispensable-u-s-
    corporate-tax/.
          ``The Effect of Profit Shifting on the Corporate Tax Base in the
    United States and Beyond,'' 2016, National Tax Journal, December,
    69(4), 905-934, https://papers.ssrn.com/sol3/
    papers.cfm?abstract_id=2685442.
          ``Competitiveness, Tax Base Erosion, and the Essential Dilemma
    of Corporate Tax Reform,'' 2016, (6) BYU Law Review, 1649-1680, http://
    digital
    commons.law.byu.edu/cgi/viewcontent.cgi?article=3075&context=lawreview.
          ``Labor and Capital in the Global Economy,'' Democracy: A
    Journal of Ideas, 43, 2017, http://democracyjournal.org/magazine/43/
    labor-and-capital-in-the-global-economy/.
          ``Is U.S. Corporate Income Double-Taxed?'' (with Leonard Burman
    and Lydia Austin), September 2017, National Tax Journal, 70(3), 675-
    706.

                                     ______

            Prepared Statement of Itai Grinberg, Professor of Law,
                        Georgetown University Law Center
        Chairman Hatch, Ranking Member Wyden, and members of the committee,
    it is an honor to participate in these hearings on international tax
    reform. I am a professor of law at the Georgetown University Law
    Center. I served in the Office of International Tax Counsel in both the
    George W. Bush and Obama administrations. Before joining the Treasury
    Department I practiced international tax law at Skadden Arps in
    Washington, and in 2005 I served as counsel to the bipartisan
    President's Advisory Panel on Federal Tax Reform.

        The interconnectedness of today's global economy and the mobility
    of capital, intellectual property, and high-skilled labor make all
    attempts to impose high income tax rates on multinational corporations
    (MNCs) counterproductive. The global market for corporate control
    combined with the home-country bias for high-quality headquarters and
    R&D jobs means that lagging in this area will be increasingly costly in
    terms of employment and opportunity, especially for younger generations
    of Americans.

        Our singularly high corporate tax rate and worldwide system are
    severely out of line with international norms. The United States'
    statutory corporate income tax rate is the highest in the Organisation
    for Economic Cooperation and Development (OECD), and our effective
    corporate tax rate is also high.\1\ Every other G7 country and 29 of
    the other 34 OECD member countries allow their resident companies to
    repatriate active foreign business income to their home country without
    paying a significant additional domestic tax. This system of taxation
    is usually referred to as ``dividend exemption'' or a ``territorial tax
    system.''
    ---------------------------------------------------------------------------
        \1\ For instance, Philip Bazel and Jack Mintz find that the United
    States has a marginal effective tax rate on corporate investment that
    is more than 15 percentage points higher than the OECD average and
    represents the 3rd-highest marginal effective tax rate in the OECD,
    after only France and Japan. Philip Bazel and Jack Mintz, ``2015 Tax-
    Competitiveness Report: Canada is Losing its Attractiveness,'' 9:37 SPP
    Research Papers (Nov. 2016), https://www.
    policyschool.ca/wp-content/uploads/2016/12/Tax-Competitiveness-Bazel-
    Mintz.pdf.

        There is now a widespread consensus that the United States needs to
    reform its aberrant worldwide corporate tax system and that such reform
    should involve lowering the tax rate and adopting a territorial tax
    system. Other countries have been taking these steps for years, while
    also increasing their reliance on consumption taxes and decreasing
    their reliance on corporate income taxes. Indeed, since the 1986 Act,
    other OECD countries have reduced their collective average corporate
    tax rate by more than 19 percentage points.\2\
    ---------------------------------------------------------------------------
        \2\ See ``U.S. Tax Code: Love It, Leave It, or Reform It,'' hearing
    before the Senate Committee on Finance, 113th Congress 2 (2014)
    (statement of Peter R. Merrill, Director of the National Economics and
    Statistics Group at PricewaterhouseCoopers LLP), https://
    www.finance.senate.
    gov/download/merrill.

        The committee has examined these issues since at least 2010, and
    many hearings have focused on these matters.\3\ Substantially reducing
    the corporate income tax rate and moving to a territorial system are
    important steps the United States should take. But these steps are not
    enough.
    ---------------------------------------------------------------------------
        \3\ Indeed, at the committee's July 2017 hearing, John Talisman,
    who served as Assistant Secretary of the Treasury for Tax Policy in the
    Clinton administration, pointed out that he had testified at a hearing
    in front of the committee in 2011 entitled ``How Did We Get Here?'' and
    joked that he wondered why the July 2017 hearing wasn't titled ``Why
    Are We Still Here?'', ``Comprehensive Tax Reform: Prospects and
    Challenges,'' hearing before the Senate Committee on Finance, 115th
    Congress 1 (2017) (statement of John Talisman). Those of us who have
    been following these matters for years appreciated the humor, but I
    feel confident the country would appreciate the benefits of corporate
    tax reform a great deal more.

        Rather than restate the rationale for lowering the corporate rate
    and moving to a territorial system, which has been eloquently explained
    by many witnesses at earlier committee hearings over the course of this
    decade,\4\ my testimony will focus on one significant issue within
    international tax reform that has received much less attention in prior
    hearings and from U.S. policymakers generally. The issue involves
    rectifying the relative advantages that U.S. law gives to foreign MNCs
    investing in the United States that make foreign status more attractive
    than U.S. status.
    ---------------------------------------------------------------------------
        \4\ See, e.g., ``Comprehensive Tax Reform: Prospects and
    Challenges,'' hearing before the Senate Committee on Finance, 115th
    Congress (2017) (statement of Pamela F. Olson), https://
    www.finance.senate.gov/imo/media/doc/30827.pdf; ``The U.S. Tax Code:
    Love It, Leave It, or Reform It,'' hearing before the Senate Committee
    on Finance, 113th Congress 9 (2014) (statement of Mihir A. Desai);
    ``Navigating Business Tax Reform,'' hearing before the Senate Committee
    on Finance, 114th Congress 11 (2016) (statement of James Hines).

        The current U.S. international tax regime makes foreign ownership
    of almost any asset or business more attractive than U.S. ownership
    from a tax perspective, thereby creating tax-driven incentives for
    foreign takeovers of U.S. firms and foreign acquisition of business
    units previously owned by U.S. MNCs. It also creates substantial
    financial pressures that encourage U.S. MNCs to ``invert'' (move their
    headquarters abroad), produce abroad for the U.S. market, and shift
    business income to low-tax jurisdictions abroad. Finally, given a
    global business environment in which corporate tax residence is
    increasingly elective, new firms have significant incentives to
    incorporate their parent firm outside the United States at the moment
    of formation. The worldwide system and high rate that creates these tax
    ---------------------------------------------------------------------------
    incentives is not in America's interest.

        As is the case with our worldwide system and high rate, in failing
    to address the taxation of foreign direct investment into the United
    States (known as ``inbound taxation''), the United States is a global
    outlier. In the rest of the world, governments have been focusing their
    policy efforts in the last decade almost exclusively on inbound
    taxpayers that minimize their income in local jurisdictions. Especially
    given this global reality, U.S. corporate tax reform must also focus on
    how the U.S. tax system disfavors U.S. MNCs relative to the treatment
    of inbound taxpayers.

        In the past, the tax disadvantages of U.S. status were balanced
    against the non-tax advantages of being a U.S.-resident firm. However,
    foreign firms are increasingly able to replicate the non-tax benefits
    of being a U.S. tax-resident MNC. The globalization of securities
    markets has made it relatively easy to raise funds in foreign capital
    markets and to access U.S. capital markets as a foreign firm. The
    globalization of best practices in corporate governance has made U.S.
    corporate governance rules less of a factor in firm valuations.\5\ As a
    result, the tax disadvantage increasingly outweighs the non-tax
    advantages of U.S. residency.\6\ In our globalized economy, the result
    over time is a long-term trend towards foreign-resident MNCs and away
    from U.S.-resident MNCs. The inversion phenomenon is just one symptom
    of that trend.\7\ Since 2000, the number of U.S.-resident MNCs among
    the 500 largest public companies in the world as measured by Forbes has
    declined by over 25%, from 202 in 2000 to 147 in 2016.
    ---------------------------------------------------------------------------
        \5\ Julie A. Roin, ``Inversions, Related Party Expenditures, and
    Source Taxation: Changing the Paradigm for the Taxation of Foreign and
    Foreign-Owned Businesses,'' 2016 BYU Law Review 1837, 1852 (Apr. 2017);
    see also Daniel N. Shaviro, ``Fixing U.S. International Taxation''
    (2014).
        \6\ Indeed, corporations have also become increasingly
    ``decentered'' in recent years, such that corporate tax residence need
    not necessarily dictate the location of business functions. Mihir
    Desai, ``The Decentering of the Global Firm,'' 32 World Economics
    (Special Issue) 1271 (Sept. 2009). However, as discussed below, the
    BEPS project put a premium on shifting management and research and
    development jobs to the locations where an MNC wishes to be taxed.
        \7\ See, e.g., Eric Solomon, ``Corporate Inversions: A Symptom of
    Larger Tax System Problems,'' 67 Tax Notes 1203 (Sept. 24, 2012).
    ---------------------------------------------------------------------------
             the role of u.s. and foreign mncs in the u.s. economy
        Globally engaged MNCs, whether they be U.S. or foreign-parented
    firms, provide jobs for a large part of the American work force and
    higher wage employment than other parts of the American private sector.
    U.S.-headquartered MNCs employ 26.6 million workers in the United
    States.\8\ Majority-owned U.S. affiliates of foreign MNCs employ
    another 6.8 million workers in the United States.\9\ Together U.S. and
    foreign-headquartered MNCs represent more than 25% of total private
    sector payroll employment in the United States.\10\ Total compensation
    per American worker employed by both U.S. and foreign-headquartered
    MNCs averages about one-third more than the rest of the U.S. private
    sector.
    ---------------------------------------------------------------------------
        \8\ Sarah P. Scott, ``Activities of U.S. Multinational Enterprises
    in the United States: Preliminary Results From the 2014 Benchmark
    Survey,'' 96:12 Survey of Current Business, Dec. 2016, https://
    www.bea.gov/scb/pdf/2016/12%20December/
    1216_activities_of_us_multinational_enter
    prises.pdf.
        \9\ Sarah Stutzman, ``Activities of U.S. Affiliates of Foreign
    Multinational Enterprises in 2015,'' 97:8 Survey of Current Business,
    Aug. 2017, https://www.bea.gov/scb/pdf/2017/08-August/0817-activities-
    of-us-affiliates-of-foreign-multinational-enterprises.pdf.
        \10\ Moreover, both U.S. and foreign multinationals purchase
    trillions of dollars of intermediate inputs each year from other U.S.
    companies, helping sustain other private-sector employment in America.
    Kevin B. Barefoot, ``U.S. Multinational Companies: Operations of U.S.
    Parents and Their Foreign Affiliates in 2010,'' 92:11 Survey of Current
    Business 51, 52, Nov. 2012, https://www.bea.gov/scb/pdf/2012/
    11%20November/1112MNCs.pdf.

        There are various explanations for why MNCs generally offer better
    wages and jobs than most purely domestic firms. For instance,
    multinationals may require a higher-skilled labor force because of the
    technological requirements and competitive need to produce higher
    quality goods associated with competing globally. Given that MNCs
    require a higher-quality product, they may pay efficiency wages--as
    higher quality products require higher quality workers, MNCs pay more
    ---------------------------------------------------------------------------
    to induce more effort from workers.

        U.S. MNCs, however, are more closely tied to the United States than
    their foreign competitors. The domestic affiliates of U.S. MNCs perform
    84.3% of the worldwide research and development undertaken by U.S.
    MNCs.\11\ These domestic affiliates also represented more than two-
    thirds of worldwide U.S. MNC employment.
    ---------------------------------------------------------------------------
        \11\ Barefoot, supra note 10, at 54.
    ---------------------------------------------------------------------------
             the importance of encouraging mncs to remain american
        In order to maximize the opportunity for well-paid employment for
    future generations of Americans, we need to ensure that multinationals
    can be U.S.-headquartered and still compete effectively with their
    foreign MNC competitors. Expansion abroad by affiliates of U.S.
    multinationals tends to support their U.S.-
    parent jobs. Economic research shows that more affiliate investment and
    employment is generally associated with more investment and employment
    back in U.S. parents. For instance, Mihir Desai and James Hines find
    based on 1982-2004 U.S. Bureau of Economic Analysis data that on
    average, a 10% increase in foreign subsidiary sales is associated with
    a 6.5% increase in U.S. exports.\12\ They also find that a 10%
    expansion of foreign employment by U.S. MNCs is associated with a 3.7
    percent expansion of domestic employment by the same firms at the same
    time. As the Senate Finance Committee's bipartisan international tax
    working group report highlighted, the data suggests that for each
    dollar of additional wages paid in U.S. foreign affiliates, U.S. wages
    increase by $1.84.\13\ Relying on still other studies, Greg Mankiw and
    Phillip Swagel conclude that for U.S. MNCs, ``success overseas leads to
    job gains in the United States.'' \14\
    ---------------------------------------------------------------------------
        \12\ Mihir Desai, C. Fritz Foley, and James R. Hines, Jr.,
    ``Domestic Effects of the Foreign Activities of U.S. Multinationals,''
    American Economic Journal: Economic Policy, no. 1 (Feb. 2009).
        \13\ U.S. Senate Committee on Finance, ``The International Tax
    Bipartisan Tax Working Group Report'' (2015), https://
    www.finance.senate.gov/imo/media/doc/The%20International%20Tax%
    20Bipartisan%20Tax%20Working%20Group%20Report.pdf.
        \14\ N. Gregory Mankiw and Phillip Swagel, ``The Politics and
    Economics of Offshore Outsourcing'' (National Bureau of Economic
    Research, Working Paper No. 12398, 2006).

        No study reaches the same conclusion about foreign expansion by
    foreign MNCs. Indeed, the results of the studies described above
    regarding the effects of U.S. MNC growth abroad would suggest that when
    foreign companies expand outside the United States, related
    headquarters investment and employment would tend to accrue in their
    home country.\15\ Importantly--this turns out to be the case even with
    formerly U.S.-tax resident corporations that have substantial presence
    in the United States but change their country of tax residency.
    Nirupama Rao has shown that former U.S. MNCs that undertake inversions
    subsequently develop higher shares of their employees and capital
    expenditures abroad after inversion, relative to similar firms that
    remain U.S. tax resident.\16\ In effect, the data suggests that a tax-
    motivated inversion may subsequently create other incentives to
    offshore more jobs, just like being a historically foreign-
    headquartered MNC exerts a kind of gravitational force that keeps a
    higher percentage of the best jobs in the firm outside the United
    States.
    ---------------------------------------------------------------------------
        \15\ It is clear that policymakers in other major developed
    economies have this intuition. As with some other economic issues, U.S.
    data in this regard is often more robust than foreign data. Study of
    Japanese MNCs similarly shows that Japanese outbound investment is
    correlated with increased Japanese domestic employment. Mitsuyo Ando
    and Fukunari Kimura, ``International Production/Distribution Networks
    and Domestic Operations in Terms of Employment and Corporate
    Organization: Microdata Analysis of Japanese Firms,'' REITI Discussion
    Paper Series 07-E-063 (2007).
        \16\ Nirupama Rao, ``Corporate Inversions and Economic
    Performance,'' 68 National Tax Journal 1073 (2015). As Rao's paper
    highlights, the changes in hiring and investment resulting from
    inversion are not attributable to the onetime effects on the data due
    to the inclusion of the foreign acquiring firm's existing workforce and
    investments. Rather, foreign shares of employment and investment are
    systematically higher two and more years after inversion, relative to
    the first year after inversion.
    ---------------------------------------------------------------------------
              greenfield and brownfield foreign direct investment
        Foreign investment into the United States is broadly categorized
    into two buckets by the U.S. Department of Commerce: the establishment
    of new U.S. businesses or the expansion of existing U.S. businesses
    (referred to as ``greenfield investment''), and the acquisition of
    existing U.S. businesses (``brownfield investment''). Greenfield
    investment in the United States by foreign firms should unquestionably
    be welcomed by the United States. When a foreign MNC purchases a
    business unit from a U.S. MNC, or acquires a U.S. MNC, for the reason
    that the foreign MNC can use that business more productively, and
    therefore generate higher levels of output and employment from that
    business, we should also welcome that inbound investment.

        Importantly, however, the data suggests that the vast majority of
    inbound foreign direct investment represents the transfer of ownership
    of businesses rather than greenfield investment. In 2016, expenditures
    by foreign direct investors made to acquire U.S. firms totaled $365.7
    billion, whereas expenditures by foreign direct investors to establish
    new U.S. businesses totaled $5.6 billion and expenditures to expand
    existing foreign-owned U.S. businesses totaled $2.2 billion.\17\ In
    other words, less than 3% of 2016 foreign direct investments were
    greenfield investments. The Department of Commerce Bureau of Economic
    Analysis data for earlier years in this century also shows that the
    vast majority of foreign direct investment consists of acquisitions of
    existing U.S. businesses rather than the establishment of new U.S.
    businesses or the expansion of existing U.S. businesses.
    ---------------------------------------------------------------------------
        \17\ Bureau of Economic Analysis, U.S. Department of Commerce, 17-
    35, ``BEA Expenditures by Foreign Direct Investors for New Investment
    in the United States,'' 2014-2016 (2017), https://www.bea.gov/
    newsreleases/international/fdi/fdinewsrelease.htm.

        What drives foreign direct investor acquisitions is that the
    domestic business being acquired has greater financial value to a
    foreign firm than it does to the prior domestic owner. When that higher
    value is based on the ability of the foreign direct investor to make
    the domestic business more productive, the acquisition is likely to
    support American employment. In other cases, though--as shown in
    Senator Portman's Permanent Subcommittee on Investigations study
    entitled ``Impact of the U.S. Tax Code on the Market for Corporate
    Control and Jobs,'' ``foreign acquirers that hail from more favorable
    tax jurisdictions are able to create value simply by restructuring the
    affairs of the U.S. target companies to improve their tax profile.''
    \18\ In the subset of foreign acquisitions where that greater value in
    the hands of a foreign firm is driven by increased opportunities for
    tax minimization, the resulting increase in foreign direct investment
    (and the resulting apparent ``increase'' in employment of Americans by
    U.S. affiliates of foreign firms and ``decrease'' in employment of
    Americans by domestic firms) is simply not in the national interest of
    the United States. Indeed, a tax system that artificially encourages
    foreign ownership of originally U.S. assets that would otherwise be
    owned by more productive U.S. owners is not just disadvantageous for
    the United States--it will tend to reduce global well-being.\19\
    ---------------------------------------------------------------------------
        \18\ ``Impact of the U.S. Tax Code on the Market for Corporate
    Control and Jobs,'' Permanent Subcommittee on Investigations, Senate
    Committee on Homeland Security and Governmental Affairs, 114th Congress
    2 (2015) (Majority Staff Report).
        \19\ As Mihir Desai and James Hines have persuasively shown, ``if
    the productivity of capital depends on the identities of its owners
    (and there is considerable reason to think that it does), then the
    efficient allocation of capital is one that maximizes output given the
    stocks of capital in each country. It follows that tax systems promote
    efficiency if they encourage the most productive ownership of assets
    within the set of feasible investors.'' Mihir Desai and James R. Hines,
    Jr., ``Evaluating International Tax Reform,'' 56 National Tax Journal
    487, 494 (2003).
    ---------------------------------------------------------------------------
       favoring foreign mncs over u.s. mncs reduces economic opportunity
        While both U.S. MNCs and foreign MNCs support high-value jobs in
    the United States, U.S. MNCs tend to be more dedicated to U.S.
    employment. In those cases where a business asset would otherwise be
    equally productive under U.S. or foreign ownership, one should on
    average expect that business asset in the hands of a MNC with U.S. tax
    residence to produce more skilled jobs for Americans than the same
    business asset owned by a foreign MNC. For more than a generation, the
    labor market here and globally has been characterized by an increase in
    returns to skilled vs. semi-skilled and unskilled labor. Since there is
    no reason to believe this trend is likely to change, fewer skilled jobs
    located in the United States would reduce the opportunity set for
    younger Americans, and lead to both greater inequality and lower
    standards of living for our children and grandchildren.

        We may one day reach a point where multinational firms are totally
    ``decentered,'' such that national residence will have no effect on
    country of employment. But that day has not arrived. Moreover, there is
    no reason to believe it is likely to arrive during the probable
    lifetime of this round of corporate tax reform. Thus, in order to
    maximize opportunity for our kids, we must level the playing field and
    change the tax code to stop discouraging the formation, asset ownership
    by, and continued existence of U.S. MNCs relative to foreign MNCs. To
    do so, the United States must remove the incentives for tax-motivated
    foreign takeovers of U.S. firms, corporate ``inversions,'' and initial
    foreign tax domiciliation to avoid U.S. tax-resident status. To achieve
    that result it is necessary--but not sufficient--for the United States
    to lower its corporate rate and move to a territorial system. The
    United States also has to deal with the problem of under-taxation of
    foreign-owned U.S. corporations.\20\
    ---------------------------------------------------------------------------
        \20\ A recent article by Julie Roin addresses the technical
    questions associated with this problem in depth, and I recommend it to
    the committee. Roin, supra note 5.
    ---------------------------------------------------------------------------
                           our unlevel playing field
        Most debates on international tax reform have thus far focused on
    income earned abroad by U.S. MNCs. However, arguably the greatest
    structural tax disadvantage of being a U.S.-resident corporation
    relates to the taxation of income earned in the United States. U.S.
    MNCs are much more constrained than foreign MNCs from stripping income
    out of the U.S. tax base. A foreign MNC can reduce the amount it owes
    to the U.S. Government through deductible interest and royalty payments
    from its U.S. affiliates to its foreign affiliates, as well as by
    charging its U.S. affiliates prices for goods or services that include
    the value of foreign-owned intangibles in high-priced products for
    resale in the United States.\21\ A U.S. MNC cannot use deductible
    related party interest and royalty payments in the same way. U.S. MNCs
    are also somewhat more constrained in reducing their U.S. tax liability
    by embedding foreign-owned intellectual property in products sold into
    the United States.
    ---------------------------------------------------------------------------
        \21\ Other deductible payment streams, including rents, premiums,
    and management service fees made from foreign-controlled domestic
    affiliates to foreign affiliates can also be used by foreign MNCs to
    strip the U.S. tax base.

        The relative tax advantages that benefit foreign MNCs are in large
    measure the result of specific structural features of our tax law. Most
    notably, royalty and interest income earned by foreign affiliates of
    U.S. MNCs is generally subject to inclusion on a current basis as part
    of ``subpart F.'' The subpart F regime applies only to U.S. MNCs. It
    imposes U.S. tax on certain items of foreign income earned by the
    foreign affiliates of U.S. MNCs. Planning techniques exist to limit the
    impact of these rules with respect to income generated by foreign
    affiliates in sales made outside the United States, but these
    techniques generally do not work for payments made by U.S. affiliates
    of a U.S. MNC to its foreign affiliates. For example, the benefits of
    section 954(c)(6)--which can limit the impact of subpart F with respect
    to payments made between foreign affiliates--are not available for
    payments made by a U.S. affiliate of a U.S. MNC to a foreign affiliate
    of a U.S. MNC. As a result, U.S. MNCs can use section 954(c)(6) to
    reduce the tax burden on their foreign earnings but not on their
    ---------------------------------------------------------------------------
    domestic earnings.

        In contrast, foreign-resident MNCs can strip the U.S. tax base with
    very few limitations by structuring related party interest and royalty
    payments with their U.S. affiliates. They do not need to rely on
    subpart F planning techniques because subpart F does not apply to them.
    By statute, interest and royalty payments these foreign MNCs make to
    their foreign affiliates are theoretically subject to U.S. withholding
    taxes, but such taxes almost never apply under our tax treaties, which
    generally reduce these withholding taxes to zero.\22\
    ---------------------------------------------------------------------------
        \22\ 26 U.S.C. Sec. 871 (2012), U.S. Model Income Tax Convention
    Article 11-12 (Treasury Department, 2006); U.S. Model Income Tax
    Convention Article 11-12 (Treasury Department 2016).

        Another way to see the senselessness of focusing our international
    tax policy debate primarily on residence country taxation of U.S. MNCs
    is to consider the so-called ``round-tripping'' debate. Round-tripping
    is used in the international tax debate as a pejorative term meant to
    characterize a strategy employed by a limited group of U.S. MNCs to
    reduce their U.S. tax liability on U.S. sales by making deductible
    payments to foreign affiliates owning the U.S. rights to intellectual
    property incorporated into goods and services sold into the United
    States. ``Round-
    tripping'' by a subset of U.S. MNCs has been treated as a separate
    question deserving of special scrutiny in the international tax debate
    for at least the last 6 years. For example, concerns regarding round-
    tripping motivated the decision to limit the reduced U.S. tax rate on
    putatively foreign intangible income provided in former House Ways and
    Means Chairman Camp's tax reform proposal to income derived from
    foreign customers.\23\
    ---------------------------------------------------------------------------
        \23\ See H.R. 1, 113th Congress, Sec. 4211 (2nd Session, 2014).

        However, the same basic planning technique used by ``round-
    trippers''--owning abroad the U.S. rights to intellectual property
    associated with the sale of goods and services into the United States--
    is also routinely used by foreign MNCs. Yet when undertaken by foreign
    MNCs this same planning technique has received almost no attention, let
    alone criticism. The lack of attention is despite evidence showing that
    European MNCs (for example) very disproportionately hold their
    intellectual property in low- or no-tax jurisdictions.\24\ Given the
    malleability of corporate residence, as well as the evidence that in
    general U.S. MNCs tend to produce more high-
    quality jobs in the U.S. than foreign MNCs, why would the Congress
    attack a tax planning technique when undertaken by U.S. MNCs, but leave
    it untouched when employed by foreign MNCs?
    ---------------------------------------------------------------------------
        \24\ See Matthias Dischinger and Nadine Riedel, ``Corporate Taxes
    and the Location of Intangible Assets Within Multinational Firms,'' 95
    Journal of Public Economies 691 (2011) (examining a dataset of
    intangible holdings of the affiliates of EU-headquartered firms and
    finding ``a robust inverse relation between the subsidiary's corporate
    tax rate relative to other group affiliates and its intangible asset
    holdings'').

        Another perverse fact is that foreign MNCs can manufacture in the
    United States and still strip the U.S. tax base, whereas U.S. MNCs
    cannot. Under subpart F, a foreign affiliate of a U.S. multinational is
    able to earn IP income from embedded intangibles on both foreign and
    domestic sales without being subject to current taxation in the United
    States only if the foreign affiliate conducts the related manufacturing
    outside the United States. Thus, U.S. law in effect discourages U.S.
    MNCs from manufacturing in the United States.\25\
    ---------------------------------------------------------------------------
        \25\ See Paul Oosterhuis and Moshe Spinowitz, presentation at the
    Brookings Institute/Urban Institute Tax Policy Center/ITPF Conference
    on Tax Policy and U.S. Manufacturing in a Global Economy: ``Tax
    Incentives to Conduct Offshore Manufacturing Under Current Law'' (March
    15, 2013).

        Given the fungibility of tax residence for business units (which
    can be acquired), new businesses (which can incorporate initially
    abroad), and multinationals as a whole (which are now routinely
    acquired by foreign firms), differentiating tax burdens based on U.S.
    tax residence or foreign tax residence is simply untenable. Yet our law
    is heavily based on an antiquated residence principle, and penalizes
    U.S. tax residence relative to foreign tax residence. This legal regime
    may have been appropriate when it came into being more than half a
    century ago, when cross-border mergers and acquisitions were rare and,
    when cross-border acquisitions did happen, they overwhelmingly involved
    U.S. MNC acquisitions of foreign firms. Now, however, this legal regime
    makes no sense.
                               the global context
        The U.S. debate regarding corporate tax reform is happening in a
    broader international tax context: the international tax environment
    around the world is becoming both less stable and less favorable to
    American business. The Base Erosion and Profit Shifting (BEPS) project
    at the OECD was justified as an attempt to prevent the old framework
    for international taxation from falling apart and being replaced by
    unilateral actions, double taxation of cross-border business, and what
    the OECD termed ``global tax chaos.'' \26\ Unfortunately, the post-BEPS
    environment already shows signs of becoming characterized by much of
    the global tax chaos the BEPS project was supposed to prevent. In
    particular, countries around the world are moving away from residence
    country taxation and towards source country taxation in a variety of
    often uncoordinated ways.
    ---------------------------------------------------------------------------
        \26\ 11 Organisation for Economic Co-Operation and Development
    (OECD), ``Action Plan on Base Erosion and Profit Shifting,'' https://
    www.oecd.org/ctp/BEPSActionPlan.pdf.

        As a result of the BEPS project, transfer pricing norms globally
    were generally adjusted to, in the parlance of the OECD, ``align income
    taxation with value creation.'' The key practical consequence of this
    agreement is to require MNCs to move high-skilled jobs (rather than
    merely shifting income) if they wish to benefit from the lower
    corporate tax rates available from America's competitor countries.
    Thus, a key outcome of the agreements reached in the BEPS project was
    to increase the negative consequences to American workers if the United
    States failed to lower our corporate tax rate and adopt a territorial
    ---------------------------------------------------------------------------
    system.

        Since the BEPS project ended, countries as diverse as Australia,
    Chile, France, Germany, India, Israel, Italy, Japan, Mexico, New
    Zealand, Poland, Spain, and the United Kingdom have taken additional
    unilateral legislative or administrative actions. These unilateral
    actions are not limited by or consistent with the BEPS agreements and
    are designed to increase levels of inbound corporate income taxation.
    Moreover, a number of these actions have been designed so that, as a
    practical matter, they are targeted to primarily hit U.S. MNCs.

        For example, in the last few years the European Commission invented
    a new ``state aid'' theory to target U.S. MNCs.\27\ And last month the
    European Commission went further and considered a joint Franco-German-
    Italian-Spanish proposal to impose a so-called ``equalization levy'' on
    U.S. tech companies based on their gross turnover in EU countries,
    which is supposed to make up for their paying insufficient corporate
    income tax. At the September European Union Economic and Financial
    Affairs Council (``ECOFIN'') meeting, finance ministers expressed
    unanimous support for some form of action to tax ``enterprises that use
    digital technology.'' The ministers agreed to move forward swiftly and
    to reach a common understanding at the ECOFIN in December. Moreover,
    the current presidency of the ECOFIN asserted that ``[i]f we can agree
    on the approach inside the European Union, then we can also affect the
    global rules in a way that is favorable to us.'' \28\ Less than a week
    later the European Commission followed up with a statement that
    ``unilateral initiatives in the EU and internationally will continue to
    develop,'' and made proposals for various gross-basis taxes on revenues
    from digital business only.\29\ As a practical matter, this proposed
    tax is quite obviously targeted at U.S. companies.
    ---------------------------------------------------------------------------
        \27\ For more on this issue, see my 2016 testimony before the House
    Ways and Means Committee, ``Global Tax Environment in 2016 and
    Implications for International Tax Reform,'' hearing before the
    Committee on Ways and Means, 114th Congress 2 (2016) (statement of Itai
    Grinberg).
        \28\ European Commission press release, September 16, 2017,
    Economic and Financial Affairs Council, ``EU finance ministers agreed
    to develop new digital taxation rules'' (Sept. 16, 2017), https://
    www.eu2017.ee/news/press-releases/eu-finance-ministers-agreed-develop-
    new-digital-taxation-rules.
        \29\ Communication from the Commission to the European Parliament
    and the Council, ``A Fair and Efficient Tax System in the European
    Union for the Digital Single Market,'' COM (2017) 547 Final (Sept. 21,
    2017).

        The strategic questions implied by the unsettled state of
    international tax affairs should feature as an important consideration
    in the policy discussions surrounding U.S. international tax reform.
    Unfortunately, to date many analysts have maintained the historic
    American tendency to treat the diplomatic and competitive processes
    entailed in multilateral discussion of international tax rules as a
    second-order matter. In effect, some analysts pretend that if the
    United States takes decisive action the rest of the world will just
    follow, or behave in ways that will not fundamentally alter the policy
    ---------------------------------------------------------------------------
    consequence of U.S. policy.

        Despite being the world's largest economy, in the international tax
    diplomatic space the United States has been losing for a number of
    years. We have failed to successfully defend our national interests,
    and have been repeatedly out-negotiated. One underlying cause of these
    failures has been our inability to enact international tax reform that
    defines a corporate tax base that we can successfully defend.

        Historically the multilateral international tax architecture was
    heavily focused on residence country taxation. The international tax
    architecture around the world is shifting towards greater source-based
    taxation, but that transition is liable to be long and messy.

        If we continue to insist on the idea of worldwide residence country
    taxation of U.S. MNCs, we will simply make U.S. MNCs uncompetitive
    outliers subject to foreign revenue grabs. Moreover, with respect to
    inbound taxation, it is important to understand that we have no
    international status quo, and we are likely taking the first steps in a
    multistage, multi-country game.

        As a result, the inbound policy result the United States reaches in
    tax reform in this Congress will almost certainly be revisited
    repeatedly, spurred on by both unilateral actions by other countries
    and multinational negotiations. This time the inbound piece of
    international tax reform will not be a once in a generation event.
    Therefore, when addressing inbound corporate tax reform in this
    Congress, policymakers should seek to give the United States leverage.
    It is important to put the United States in a good position to bargain
    internationally about a future set of broadly accepted rules that will
    most likely be agreed to multilaterally at a later date.
              the u.s. response must be administrable unilaterally
        In crafting our inbound taxation policy we should keep in mind
    whether any given regime requires multilateral cooperation to be
    effective. For example, proposals that are only administrable with
    significant new information-sharing with foreign sovereigns require
    international agreement. In the short-term, such agreement seems
    unlikely.

        The difficult international tax diplomatic environment means that
    for the time being it may be more important that U.S. legal changes be
    administrable by the U.S. alone, rather than being as intellectually or
    technically robust as possible. At the same time, changes to our law
    should not involve technical innovations that we would strenuously
    oppose if used abroad. For example, it would be difficult for the
    United States to maintain that virtual permanent establishments are
    inappropriate abroad and simultaneously move forward with a deemed
    permanent establishment arrangement as part of income tax reform at
    home.

        To ensure that our policy reflects the principle that we are
    working to level the playing field, the primary inbound measures the
    United States adopts should affect all industries and treat domestic
    and foreign firms equivalently in theory and practice. That must be one
    of the principles for eventual international agreement, and--unlike
    Europe--the United States' Wilsonian tradition stands for being a
    beacon of principle in international relations. Treating U.S. and
    foreign MNCs equivalently also helps preserve international economic
    law rules that generally prohibit discrimination against foreigners on
    the basis of national origin.

        Nevertheless, within any inbound piece of tax reform, we also
    should consider including a punitive measure to discourage the
    imposition of particularly economically destructive taxes. For example,
    the gross basis turnover taxes on digital business proposed by the
    European Commission represent a mercantilist effort to target U.S.
    firms. The European Commission is proposing to revive a form of
    particularly inefficient taxation that was largely abandoned long ago.
    If actions like these are being proposed by our trading partners, we
    need U.S. legislation to make clear that attacks targeted at U.S. MNCs
    would have meaningful consequences. In that circumstance the balance of
    economic power would make it possible to reach a principled global
    settlement.

        In sum, despite the unsettled global environment, the United States
    needs to act on reforming its inbound rules. What we need for the time
    being on inbound is a pragmatic, administrable policy that helps level
    the playing field between U.S. and foreign MNCs. The policy should be
    based on a defensible principle--for instance an inbound corporate
    minimum tax.\30\
    ---------------------------------------------------------------------------
        \30\ Arguing that some part of income in part attributable to
    intellectual property should be taxed by the source state is not a new
    idea. See, e.g., Lawrence Lokken, ``The Sources of Income From
    International Uses and Dispositions of Intellectual Property,'' 36 Tax
    Law Review 233, 243 (1981). Some version of this point arguably dates
    all the way back to the work of the International Chamber of Commerce
    in the 1920s. See, e.g., Bret Wells and Cym Lowell, ``Income Tax Treaty
    Policy in the 21st Century: Residence vs. Source,'' 5 Columbia Journal
    of Tax Law 1 (2014).
    ---------------------------------------------------------------------------
      a minimum tax targeted at u.s. mncs should not be the focus of the
                            anti-base erosion regime
        One anti-base erosion proposal that has received prominent
    consideration in recent congresses is some form of minimum tax built
    onto the infrastructure of subpart F and used to reach intangible
    income. Unlike an inbound corporate minimum tax, such proposals target
    U.S. MNCs and only U.S. MNCs. In effect a minimum tax imposed on only
    U.S. MNCs is just a worldwide system with a lower rate for foreign
    source income than domestic source income. No other country on Earth
    has such a system. To the extent we impose such a tax at a significant
    rate we will continue to discourage U.S. tax residence and encourage
    foreign tax residence for all cross-border business.

        Subpart F-based minimum tax proposals target U.S. MNCs to pay more
    tax to the United States just as foreign sovereigns are targeting these
    same MNCs to pay more source country tax. However, because residence
    taxation is a residual obligation, the end result of enacting a high
    subpart F based minimum tax would not likely be that U.S. MNCs would
    pay more tax to the United States.

        Rather, because foreign taxes are generally creditable against U.S.
    tax liability, in a minimum tax system U.S. MNCs will tend to be
    indifferent to increased foreign taxes relative to MNCs resident in
    territorial countries. Why take the risk of planning to avoid a foreign
    tax, when under a minimum tax combined with a foreign tax credit, the
    ultimate cost of foreign source country income taxes (up to the level
    of the minimum tax) will generally be borne by the U.S. fisc rather
    than the company? Moreover, as other countries increase their source-
    based taxes, a residence-based minimum tax coupled with a foreign tax
    credit positively encourages other countries to specifically target
    U.S. MNCs with their own source-based taxes. Thus, the most likely
    consequence of enacting a significant minimum tax that applies only to
    U.S. MNCs is that business people and tax professionals will conclude
    that the best way to protect a business asset from attack by both the
    U.S. and foreign tax authorities is to take it out of the U.S. tax net,
    and make that asset tax resident somewhere else. The medium-term
    consequence of such decisions would be fewer jobs for U.S. workers.

        The recently released ``Unified Framework for Fixing Our Broken Tax
    Code'' makes two key commitments to protect the U.S. tax base. The
    framework suggests the committee will ``incorporate rules to level the
    playing field between U.S.-headquartered parent companies and foreign-
    headquartered parent companies.'' \31\ It also states that ``the
    framework includes rules to protect the U.S. tax base by taxing at a
    reduced rate and on a global basis the foreign profits of U.S.
    multinational corporations.'' To the extent this means that the
    committee may include a subpart F-based minimum tax proposal as part of
    tax reform, it should set the rate as low as possible, provide for
    foreign tax credit haircuts, and pair that idea with an inbound
    corporate minimum tax. In this way a subpart F-based minimum tax
    proposal could incentivize U.S. multinationals to risk tax disputes
    with foreign sovereigns rather than decreasing tax payments to the
    United States, while limiting the degree to which a subpart F-based
    minimum tax would make the playing field less level.\32\ Adopting a
    form of corporate integration that passes the benefit of only U.S.
    taxes paid by U.S. MNCs through to taxable U.S. shareholders could also
    help ameliorate the foreign tax payment incentive that could be created
    by even a low-rate subpart F-based minimum tax.\33\
    ---------------------------------------------------------------------------
        \31\ ``Unified Framework for Fixing Our Broken Tax Code'' (Sept.
    27, 2017), https://www.treasury.gov/press-center/press-releases/
    Documents/Tax-Framework.pdf.
        \32\ See Daniel Shaviro, ``The Case Against Foreign Tax Credits''
    (N.Y.U. Law and Economic Working Paper No. 208, March 2010).
        \33\ For further discussion, see ``Integrating the Corporate and
    Individual Tax Systems: The Dividends Paid Deduction Considered,''
    before the Senate Finance Committee, 114th Congress 2 (2016) (statement
    of Michael J. Graetz, Wilbur H. Friedman Professor of Tax Law and
    Columbia Alumni Professor of Tax Law at Columbia University), https://
    www.finance.senate.gov/imo/media/doc/16MAY2016Graetz.pdf; Bret Wells,
    ``International Tax Reform by Means of Corporate Integration,'' 20
    Florida Tax Review 70 (2016).

        The most effective anti-base erosion proposal, however, would be to
    find a way to lower the corporate tax rate even further, and not just
    meet, but beat our global competitors. When corporate income tax rates
    are significantly lower than those of competitor countries, other anti-
    base erosion measures become both less contentious and less important.
    The most plausible approach to accomplish such an achievement would be
    to adopt a value-added tax and use there venue to sharply lower both
    corporate and individual income tax rates. A number of highly esteemed
    witnesses appearing before the committee have made this point,\34\ and
    Senator Cardin has introduced a bill with some of these admirable
    features. While adding another tax base is likely outside the scope of
    the current tax reform effort--as a destination-based tax, the value-
    added tax naturally taxes an immobile factor and therefore is much less
    susceptible to base erosion. Moreover, the revenue generated by a
    value-added tax could be used to cut income taxes sharply across the
    board without raising concerns regarding fiscal sustainability.
    Finally, as a tax on consumption, the VAT is just more efficient and
    pro-growth than business income taxes. It also could be a fairer way to
    address the intergenerational consequences of our unfunded entitlement
    liabilities and help ensure greater prosperity and opportunity for our
    children.
    ---------------------------------------------------------------------------
        \34\ See, e.g., statement of Michael J. Graetz, id.,
    ``Comprehensive Tax Reform: Prospects and Challenges,'' hearing before
    the Senate Committee on Finance, 115th Congress (2017) (statement of
    Pamela F. Olson), https://www.finance.senate.gov/imo/media/doc/
    Pamela%20Olson
    %20Testimony.pdf.
    ---------------------------------------------------------------------------
                                   conclusion
        As both Chairman Hatch and Ranking Member Wyden have pointed out in
    the past, the United States corporate and international tax rules are
    an anticompetitive mess.\35\
    ---------------------------------------------------------------------------
        \35\ At the committee's 2014 international tax hearing, while
    Senator Wyden described our system as anti-competitive, Pascal St.
    Amans--a French socialist who testified in his role as Director of the
    OECD's Centre for Tax Policy and Administration--went further and chose
    to describe the U.S. corporate tax system as ``diseased.'' ``U.S. Tax
    Code: Love It, Leave It, or Reform It,'' hearing before the Senate
    Committee on Finance, 113th Congress 2 (2014).

        Among taxes currently in use by developed economies, the corporate
    income tax is (as the OECD has pointed out repeatedly) \36\ the tax
    that is the most harmful to economic growth. Unsurprisingly, then,
    governments around the world have come to view reducing corporate
    income tax rates and moving to a territorial system as tools to attract
    investment and jobs.
    ---------------------------------------------------------------------------
        \36\ See Organisation for Economic Co-Operation and Development
    (OECD), ``Tax Policy Reform and Economic Growth,'' OECD Tax Policy
    Studies, No. 20 (Nov. 3, 2010); see also, Asa Johnansson, Organisation
    for Economic Co-Operation and Development (OECD), ``Public Finance,
    Economic Growth, and Inequality: A Survey of the Evidence,'' ECO/WKP
    (2016) 70 (Nov. 22, 2016); Asa Johansson, Organisation for Economic Co-
    Operation and Development (OECD), ``Tax and Economic Growth,'' ECO/WKP
    (2008) 28 (July 11, 2008).

        Lowering the corporate income tax rate and moving to a territorial
    system are important to maintain U.S. prosperity and improve growth
    prospects for our economy. The United States cannot stand apart from
    corporate tax competition in a globalized economy and is falling
    ---------------------------------------------------------------------------
    further behind each year.

        To ensure that corporate income tax reform maximizes opportunity
    for well-paid employment for as many of our children and grandchildren
    as possible, the United States must also level the playing field
    between U.S. and foreign-headquartered MNCs. Leveling the playing field
    requires addressing the relative tax advantages available to foreign-
    owned U.S. corporations that represent one of the most senseless
    aspects of our current corporate tax code.

                                     ______

                  Prepared Statement of Hon. Orrin G. Hatch,
                            a U.S. Senator From Utah
    WASHINGTON--Senate Finance Committee Chairman Orrin Hatch (R-Utah)
    today delivered the following opening statement at a hearing on
    reforming the international code. The goal of the hearing is to examine
    how Congress can update the United States' system of taxing cross-
    border income to level the playing field for American companies and
    keep more jobs and investment here at home.

        Today's hearing will focus on another piece in the complex tax
    reform puzzle. But before I get to details of international tax reform,
    let me briefly address the elephant in the room.

        Last week, I joined with the Secretary of the Treasury, the
    National Economic Council director, the Senate Majority Leader, the
    House Speaker, and the Chairman of the Ways and Means Committee to put
    forward a broad unified framework for tax reform.

        As the document makes clear, this is just one step in the larger
    tax reform effort. But, let's not mince words: it is a big step.

        I would be hard-pressed to remember the last time the White House
    and House and Senate leadership were in agreement on an issue as
    complicated as tax reform. We began discussions earlier this year, and,
    at that time, there were a number of high-profile differences among us.
    I'm very pleased that we have been able to bridge so many divides and I
    am optimistic about our chances going forward.

        I want to express my gratitude to the others who worked on the
    framework and to the members of this committee who have helped us move
    the tax reform effort forward. I particularly want to acknowledge the
    work of Senator Grassley, who, as a former chairman and ranking member
    of the committee, laid much of the groundwork for the ideas we're
    discussing and for the progress we've made. It was under Senator
    Grassley's chairmanship that the Finance Committee, in 2003-2004,
    initiated the last package of international tax reforms.

        Now, as some have already pointed out, the framework released last
    week is not, by design, a complete plan. Of course, that hasn't stopped
    think tanks and analysts from speculating about its fiscal and
    distributional impact. We've already seen groups attempting to reverse-
    engineer a completed tax plan from the framework, generally filling in
    blanks with their own ideas and assumptions, and reaching conclusions
    about a plan they've essentially written themselves. Generally
    speaking, it seems that the blank-filling exercise is designed to cast
    the framework in the worst possible light.

        The framework does not include any specific information about
    things like the break points for the individual tax brackets, the value
    and indexing of the enhanced Child Tax Credit, or the precise rate for
    the top bracket. Without those and other key pieces of information,
    there is simply no way for any outside party to produce a credible
    analysis of the framework, let alone a detailed estimate of revenue and
    the distribution of tax burden.

        But, that didn't stop a certain think tank from issuing a
    ``preliminary analysis'' of the framework at the end of last week, nor
    did it stop any of the framework's critics from citing that analysis as
    authoritative. It's odd, however, that the analysis came with a
    disclaimer that it was expressing only the views of the authors, not
    the think tank itself. Even more unusual, no specific authors were
    listed on the analysis, probably because no respectable academic or
    researcher was willing to have their name associated with something so
    haphazardly cobbled together.

        But I digress.

        As the framework makes clear, this committee will be responsible
    for writing the Senate tax reform bill and I'm going to work with
    members of the committee to make sure we are successful. For now,
    everyone should take every estimate or analysis about the plan from
    outside groups with an exceptionally large grain of salt.

        Moving on, I also want to say that my preference has always been
    for this to be a bipartisan effort, and I think there are several
    elements in the framework where Democrats and Republicans can work
    together and hope we will be able to do so. The subject of today's
    hearing is a great example of an area where both parties are largely in
    agreement.

        Under our current system, U.S. multinationals that accrue overseas
    earnings can defer U.S. tax on those earnings until they are brought
    back to the United States. In 1962, due to concerns that businesses
    were moving passive and highly mobile
    income-producing assets offshore, Congress enacted subpart F of the
    Internal Revenue Code. Under subpart F, income from these sources is
    immediately subject to U.S. tax, while taxes on active and less-mobile
    offshore income remain deferred until the earnings are repatriated.

        This is a bit confusing in the abstract, so let me provide a
    hypothetical.

        Imagine that an American Company--headquartered in the United
    States and subject to our corporate tax rates--opens a factory in
    Germany, incorporating a subsidiary there. The income generated by the
    subsidiary--legally a German company--will be subject to German taxes
    paid to German authorities.

        So long as the American Company doesn't bring that income back to
    the United States, its income from the German subsidiary will not be
    subject to U.S. taxes. And, in fact, we are finding that many American
    companies have been keeping this type of income offshore in order to
    avoid our punitive corporate taxes.

        Now, imagine if the American Company parked its money in stocks,
    bonds, or other passive investments and moved the income generated from
    those assets to an offshore, low-tax jurisdiction. Under subpart F,
    that type of passive and highly mobile income is immediately subject to
    U.S. tax, without any deferral.

        Now, I know this is a bit arcane. And frankly, I'd be nodding off
    if I didn't know how this story ended.

        As a result of subpart F, American companies have engaged in a
    number of sophisticated and complex tax planning schemes to keep
    earnings offshore to avoid the U.S. corporate tax.

        According to the Joint Committee on Taxation, American companies
    are currently holding more than $2.6 trillion in earnings offshore,
    thanks, in large part, to our worldwide tax system--something often
    referred to as the ``lock-out'' effect.

        That's $2.6 trillion held by foreign subsidiaries of U.S.
    corporations that the parent companies are unable to invest here at
    home. That is income that could be used to create more American jobs
    and grow wages for American workers. And, that income has attracted the
    interests of foreign tax authorities, particularly in Europe, who wish
    to tap into what is, by all rights, part of the U.S. tax base.

        I know some of my colleagues have proposed to solve this problem of
    earnings being locked out of the United States by transitioning to a
    pure worldwide system with no deferral. And while that would rid us of
    the lock-out problem, it would significantly increase pressures for
    American multinationals to invert, or be acquired by foreign-based
    multinationals.

        Many of us have talked at length about inversions in recent years
    and the problems they pose for our economy and our tax base. Perhaps
    even worse than an inversion is when a larger foreign corporation
    simply acquires a smaller American corporation. Either way, the result
    is the same--a foreign corporation becomes the parent of the
    restructured multinational group.

        Companies take these routes for a number of reasons.

        First, they want to escape the high corporate tax rate in the
    United States, which, as we heard in our last hearing, is the highest
    in the industrialized world.

        Second, they want to minimize the damage caused by our worldwide
    tax system. If an American multinational can successfully move its tax
    situs out of the U.S., it will only owe taxes on the earnings accrued
    here. There is also the matter of earnings stripping, which is another
    complicated topic that I look forward to our witness panel discussing
    today.

        All of these problems are key for today's hearing because they
    highlight the shortcomings of our outdated worldwide tax system.

        The solution to these and other problems, to put it very simply, is
    to transition to a territorial-based system like virtually all of our
    foreign competitors. Under such a system, an American company would owe
    taxes only on income earned in the United States. Income earned in
    foreign jurisdictions would only be taxed by those jurisdictions, not
    here.

        This type of reform would have to be accompanied by enforceable
    anti-base-
    erosion rules to make sure companies--both domestic and foreign--do not
    exploit loopholes in order to unduly avoid paying taxes here. That
    approach is endorsed in the united framework.

        It was also suggested in the last Congress by our committee's
    bipartisan working group on international tax, which was co-chaired by
    Senator Portman and by current Senate Minority Leader Schumer. Other
    members of the committee have also made significant contributions in
    the area of international tax reform, including both Senator Wyden and
    Senator Enzi.

        Finally, as many of you know, I've been interested for some time in
    the idea of better integrating our individual and corporate tax
    systems. I continue to believe that corporate integration, by means of
    a dividends paid deduction, can significantly help with some of our
    existing problems and I look forward to talking more about that today
    as well.

        Once again, international tax reform is an area that is rife for
    bipartisanship, if we're willing to work together on goals that members
    from both parties share. I hope people will note that the international
    portion of the framework is particularly short on details. That's
    because these problems can't be solved in a nine-page framework
    document. That will require the work and effort of this committee.

                                     ______

        Prepared Statement of Stephen E. Shay,* Senior Lecturer on Law,
                     Harvard Law School, Harvard University
    ---------------------------------------------------------------------------
        * Senior lecturer on law, Harvard Law School. I thank Megan
    McCafferty for assistance with editing and visual aids and Lisa Brem,
    Kim Clausing, Cliff Fleming, and Steven Rosenthal for comments on
    earlier drafts. The views expressed in this testimony are my own, are
    in my personal capacity, and do not reflect those of any organization
    for which I render paid or pro bono services nor any client. I disclose
    certain activities not directly connected with my position at Harvard
    Law School at http://hls.harvard.edu/faculty/directory/10794/Shay/.
    ---------------------------------------------------------------------------
        Good morning, Chairman Hatch, Ranking Member Wyden, and members of
    the committee. My name is Stephen Shay. Thank you for the opportunity
    to testify before you today on international tax reform. It is a
    pleasure and honor to be with the committee once again. By way of
    background, I am a senior lecturer on law at Harvard Law School. I have
    served twice in the Treasury Department, the first time in the Reagan
    Administration \1\ and the second time as Deputy Assistant Secretary
    for International Tax Affairs in the first term of the Obama
    administration, and practiced international tax law for over 2 decades
    as a partner at Ropes and Gray LLP in Boston.
    ---------------------------------------------------------------------------
        \1\ I participated as Treasury Deputy International Tax Counsel and
    then as International Tax Counsel in each step of the process leading
    to the Tax Reform Act of 1986, starting with the initial 1984 Treasury
    international proposals that became President Reagan's proposals in
    1985, to House passage of the bill in 1985 and Senate passage in 1986,
    through conference committee to final legislation in November 1986. I
    resigned from the Treasury in 1987 after publication of an initial
    round of regulations interpreting international provisions of the Act.

        My topic today is international tax reform. I set out what I
    believe should be the objectives for tax reform and their implications
    for international tax reform in the next section. I next provide data
    on tax burdens on U.S. multinational corporations (MNCs) and their
    foreign subsidiaries. Based on conclusions I draw from this data and my
    decades of experience in international taxation, I set out my
    recommendations for the direction that the committee should take to
    reform U.S. international tax rules. Although I do not favor a
    territorial system, I offer suggestions on how to improve this
    approach, if that path is chosen.
                               executive summary
    Objectives for Tax Reform
        Tax reform should maintain or enhance our tax system's current
    level of progressivity in distributing tax burdens and benefits. The
    most significant social welfare fact today is that the income of
    middle- and lower-income workers has stagnated in recent decades and a
    disproportionate share of income growth has accrued to those with
    highest incomes--the top 1%. While we have recovered from the recession
    and middle- and lower-income workers have made some gains, the
    disparity between high-income and middle- and lower-income has grown
    substantially and income mobility is more constrained than for prior
    generations.\2\ The taxation of cross-border income of U.S. MNCs should
    be analyzed under the same fairness standards that apply to any other
    income.\3\ In particular, as I discuss later in this testimony, a
    reduced ``holiday'' tax rate on U.S. MNCs' pre-effective date offshore
    earnings will overwhelmingly benefit high-income Americans (and
    foreigners) and is not justified on any policy ground.\4\ Its sole
    purpose is to provide a one-time source of revenue that disguises the
    future revenue loss from shifting to a weak territorial system.
    ---------------------------------------------------------------------------
        \2\ Professor Lily Batchelder's September 13, 2017 testimony before
    this committee provides an excellent summary of the relevant data and
    references to literature. Lily L. Batchelder, Professor of Law, New
    York University, ``Opportunities and Risks in Individual Tax Reform,''
    testimony before the Senate Committee on Finance, hearing on
    ``Individual Tax Reform'' (Sept. 13, 2017).
        \3\ See J. Clifton Fleming, Jr., Robert J. Peroni, and Stephen E.
    Shay, ``Fairness in International Taxation: The Ability-to-Pay Case for
    Taxing Worldwide Income,'' 5 Florida Tax Review 299 (2001).
        \4\ J. Clifton Fleming, Jr., Robert J. Peroni, and Stephen E. Shay,
    ``Getting From Here to There: The Transition Tax Issue,'' 154 Tax Notes
    69 (2017).

        Tax reform should be revenue-neutral or increase net revenues. The
    central importance of our tax system to national competitiveness and
    growth is to fund public goods, such as education, basic research,
    infrastructure, health-care and income security transfers, and national
    defense. These government services and capital expenditures support a
    high standard of living, income security, and physical security for all
    Americans. It is the job of the tax system to raise the necessary
    revenue to fund needed public expenditure and not add trillions to the
    national debt as proposed in the Senate Budget proposal and the GOP Tax
    Reform Plan.
    Objectives for International Tax Reform
        International tax reform should maintain or increase, not reduce,
    the aggregate tax on U.S. MNCs' foreign income. There is no policy
    justification to advantage international business income of
    multinational corporations (MNCs) beyond allowing a credit for foreign
    income taxes. Moreover, evidence does not support claims that U.S. MNCs
    are overtaxed or are non-competitive as a consequence of U.S. tax
    rules. The U.S. Treasury Department found that the average tax paid by
    U.S. companies from 2007-2011 on their book earnings plus foreign
    dividends was 22%.\5\ The most recent publicly available Statistics of
    Income data for 2012 shows that foreign subsidiaries of U.S. MNCs in
    the aggregate paid an average foreign tax rate of 12%. Foreign income
    should be taxed currently or, if that is not politically feasible,
    under a per-country minimum tax regime that is effective in
    discouraging tax avoidance through transfer pricing and related
    techniques that shift income to low tax countries and directly and
    indirectly erode the U.S. tax base.
    ---------------------------------------------------------------------------
        \5\ U.S. Treasury, Office of Tax Analysis, ``Average Effective
    Federal Corporate Tax Rates,'' Table 1 (April 1, 2016).

        International tax reform should assure that the tax rules for
    foreign multinational companies on U.S. business activity do not
    provide them an advantage in relation to U.S. companies. Tax reform
    should undertake a fundamental review of U.S. source taxation of cross-
    border activity having a U.S. destination including remote digital
    sales into the United States. In addition, tax reform should strengthen
    ---------------------------------------------------------------------------
    U.S. corporate residence and earnings stripping rules.

        Taxation of international portfolio income should be fundamentally
    re-examined. Under current rules, there are U.S. tax advantages for
    portfolio investment by U.S. investors in foreign stock over domestic
    stock. Similarly, foreign pension funds that benefit principally
    foreign workers receive exemptions and relief from U.S. tax that are
    not reciprocated by foreign countries on U.S. pension funds benefitting
    U.S. workers. A fundamental tax reform effort should re-examine from
    scratch the U.S. rules for taxing cross-border portfolio income,
    however, the treatment of portfolio income is a subject for development
    on another occasion.
                            background to tax reform
        I draw on the testimony of Professor Lily Batchelder from last
    month's hearing for three background facts that are critical to
    sensible tax reform. First, real median after-tax and after-transfer
    income for a working-class household of three has only grown 3% from
    1997 to 2015--even with the expansion of the earned income tax credit.
    Second, generational advantages and disadvantages are passed on more
    here than in peer countries, leading to less intergenerational mobility
    here. This is not the result of government regulation, but of a failure
    of government to foster genuinely equal opportunity and assure that we
    contribute to society according to our ability to pay. Third, we face a
    shortfall in revenues to pay for the services we demand. The CBO
    estimates of revenues and expenditures under current law project
    unprecedented levels of national debt as a share of GDP.

        In the face of the pressing needs for public investment in human
    capital and infrastructure, and demographic trends that cannot be
    reversed, we will be forced to spend more in the future. It would be
    foolhardy to adopt a revenue-losing tax reform, particularly one that
    would benefit those with high incomes, in the unsupported hope, based
    on tooth fairy economics, that short-term growth will outweigh longer
    term effects on interest rates and inflation.\6\ When spending exceeds
    revenues, the debt issued to pay the difference simply represents
    future taxes. What is needed is to re-build the income tax base so that
    it can raise revenues necessary to fund expenditures while honoring
    ability to pay principles. If the income tax base proves over time to
    be unable to support U.S. needs, then it would be necessary to employ
    additional revenue instruments.
    ---------------------------------------------------------------------------
        \6\ As Milton Friedman was said to explain, ``Who do you suppose
    pays for the difference? The tooth fairy? Hardly. You do.'' Gene
    Epstein, ``Tooth-Fairy Economics Triumphs in GOP Tax-Cut Plan,''
    Barron's (Sept. 25, 2017).

        U.S. companies are not over-taxed, domestically or abroad. The U.S.
    Treasury estimated the average effective ``actual'' tax rate on U.S.
    companies, excluding foreign subsidiaries, for 2007 to 2011 to be 22%.
    The Treasury's measure of the average effective ``actual'' tax rate is
    corporate-level tax actually remitted (after credits for foreign taxes
    paid on foreign income earned directly and credits for foreign taxes
    deemed paid on actual foreign dividends) as shown on tax filings
    divided by book or financial statement income (rather than taxable
    income). The average rate of tax is appropriate for measuring cash
    flows (used in valuations) and distributional burdens.\7\ It also is
    the most appropriate measure for evaluating whether to make a new
    direct investment in one country or another country--a discrete choice
    between two mutually exclusive locations.\8\
    ---------------------------------------------------------------------------
        \7\ U.S. Department of the Treasury, Office of Tax Analysis, ``The
    Case for Responsible Business Tax Reform,'' 21 (Jan. 2017)
    (hereinafter, Treasury, ``Responsible Business Tax Reform''); Don
    Fullerton, ``Which Effective Tax Rate?'', 37 National Tax Journal 23,
    30 (1984).
        \8\ Michael P. Devereux and Rachel Griffith, ``Evaluating Tax
    Policy for Location Decisions,'' 10 International Tax and Public
    Finance 107 (2003). The ATR measure may be contrasted with the
    effective marginal tax rate (EMTR), a metric used to make a decision
    whether to make a new investment or not by evaluating the impact of tax
    on the cost of capital. Treasury, ``Responsible Business Tax Reform,''
    supra note *, at 5-7; Devereux and Griffith, at 107.

    [GRAPHIC] [TIFF OMITTED] T0317.008

        When examined on an industry basis, the disparity in effective
    average actual taxation between different industries becomes clear with
    ---------------------------------------------------------------------------
    rates ranging from 28% for services to 10% for utilities.

        These differences justify reducing tax incentives that treat
    investments in separate sectors differently and insert the government
    unnecessarily into economic decision making.\9\ The ATR data, however,
    do not support a claim that U.S. companies are over-taxed.
    ---------------------------------------------------------------------------
        \9\ For differences in EMTRs by asset groupings and form of
    financing, see Treasury, ``Responsible Business Tax Reform,'' supra
    note 7, at 7.

    [GRAPHIC] [TIFF OMITTED] T0317.009

        But what about foreign subsidiaries of U.S. companies? Are they
    unable to compete in the countries in which they operate? The preceding
    corporate average actual effective tax rates do not reflect the even
    lower average effective foreign tax rates that controlled foreign
    corporation (CFC) subsidiaries of U.S. MNCs pay on their foreign
    income. In 2012, the most recent year for which IRS CFC data is
    publicly available, 52% of all U.S. CFCs' earnings and profits before
    tax was generated by companies in five tax haven or low-tax
    countries.\10\ Moreover, the ratio of these CFCs' foreign taxes paid
    (as reflected on IRS tax filings) to earnings and profits before taxes
    (under U.S. tax principles) was 12.10% in 2012.\11\
    ---------------------------------------------------------------------------
        \10\ IRS, Statistics of Income Division, September 2015, U.S.
    Corporations and CFCs, Table 2 and author's calculations.
        \11\ IRS, Statistics of Income Division, September 2015, U.S.
    Corporations and CFCs, Table 2 and author's calculations.

    [GRAPHIC] [TIFF OMITTED] T0317.010

        The CFC data undercut the claim that U.S. MNCs' foreign
    subsidiaries are over-taxed on their foreign income. The low effective
    tax rates on the earnings of foreign subsidiaries contradicts the claim
    ---------------------------------------------------------------------------
    that the subsidiaries cannot compete globally because of taxes.

        The very low average taxes paid on foreign subsidiary income are a
    major factor for retaining the low-taxed earnings to maximize after-tax
    profits reported on financial statements by relying on the claim to
    auditors that these amounts are ``indefinitely reinvested'' in
    investments that do not trigger deemed repatriation under U.S. tax
    rules.\12\ This position is maintained even though large amounts
    (approximately 40%) of these retained earnings are held offshore in
    U.S. dollar cash or marketable securities.\13\ Bloomberg assembled
    these amounts for public companies with the 50 largest reported cash
    holdings.\14\ The amounts and ratios of offshore to total cash for the
    10 companies with the highest cash holdings (totaling US$702 billion
    for these companies alone) are shown in the next chart.
    ---------------------------------------------------------------------------
        \12\ See letter from Tom Barthold to Kevin Brady and Richard Neal
    (Aug. 31, 2016) (estimating $2.6 trillion in post-1986 not previously
    taxed CFC earnings for 2015). For a description of the relevant
    investment in U.S. property rules, see Stephen E. Shay, ``The
    Truthiness of `Lockout': A Review of What We Know,'' 146 Tax Notes 1393
    (2015).
        \13\ The Financial Times has run a series of articles examining the
    investment strategies employed with respect to these cash and
    securities holdings and implications for financial markets. See, e.g.,
    Eric Platt, ``Corporate America's patchy disclosure on cash piles
    raises risks,'' Financial Times (Sept. 27, 2017) (30 companies studied
    have a portfolio of more than $400bn of U.S. corporate bonds,
    representing nearly 5 percent of the outstanding market).
        \14\ Laurie Meisler, ``The 50 Largest Stashes of Cash Companies
    Keep Overseas'' (June 13, 2017).

    [GRAPHIC] [TIFF OMITTED] T0317.011

        It bears repeating the Treasury Department's assessment from
    January of this year of the economic effect of the unrepatriated
    ---------------------------------------------------------------------------
    earnings (held in cash or marketable securities):

            The broader economic effects of the unrepatriated income are
            likely to be small, however, because that income is generally
            held in dollar-denominated assets, deposited at U.S. banks, and
            actively invested in productive uses by the financial system. A
            common misconception is that income reported as ``permanently
            reinvested abroad'' must be physically held or invested outside
            of the United States. Instead, that is a tax reporting
            convention intended to differentiate income that is immediately
            subject to U.S. tax from that which is deferred from tax; while
            there are limitations on how those funds may be used by the
            corporation, in general those assets are held for investment at
            U.S. financial institutions, and thus contribute to investment
            and capital formation in the United States, even if the
            earnings are not ``repatriated'' by the MNC.\15\
    ---------------------------------------------------------------------------
        \15\ Treasury, ``Responsible Business Tax Reform,'' supra note 7,
    at 38.

        Looking at filings for Fortune 500 companies, the Institute on
    Taxation and Economic Policy found that in 2016 10 companies alone
    reported over $1 trillion of the Fortune 500's estimated $2.6 trillion
    ---------------------------------------------------------------------------
    (or 38%) of ``indefinitely reinvested'' offshore earnings.

    [GRAPHIC] [TIFF OMITTED] T0317.012

        The primary businesses of these 10 companies rest on one or more
    of: (i) technology patents, copyrights, and trademarks created under
    the protection of U.S. laws; (ii) U.S. food and drug approvals
    authorizing access to and assurance to U.S. healthcare consumers; (iii)
    the internet developed by the U.S. government and transitioned to
    private hands; or (iv) leases of valuable rights to U.S. oil and gas
    natural resources. All of these are fruits of U.S. public goods and
    legal infrastructure developed and maintained with U.S. taxpayer
    dollars. Yet, these companies have been permitted to routinely use
    transfer pricing and stateless income planning techniques to pay
    extraordinarily low rates of tax on vast swathes of their income--and
    now the plan is to give them an amnesty rate on pre-effective date
    earnings?

        My co-authors Cliff Fleming and Bob Peroni and I have explained why
    a low rate on pre-effective date earnings is unjustified on policy
    grounds.\16\ In addition to the observations we made in that article, I
    want to emphasize that the benefit of a low tax rate on pre-effective
    date earnings will go to the highest income Americans (and foreigners)
    that are shareholders of these largest MNCs.\17\
    ---------------------------------------------------------------------------
        \16\ See J. Clifton Fleming, Jr., Robert J. Peroni, and Stephen E.
    Shay, ``Getting From Here to There: The Transition Tax Issue,'' Tax
    Notes, Apr. 3, 2017, p. 69 (proposing immediate taxation of accumulated
    offshore earnings at regular corporate rates with an option to pay the
    tax in interest-bearing installments). An important practical
    implication of our analysis is that it would be normatively justifiable
    to dial up the tax rate on pre-effective date earnings, indeed to the
    full pre-effective date tax rate of 35%, if necessary to meet the
    revenue objectives of a tax reform.
        \17\ See Steven M. Rosenthal, ``A Tax Break on Repatriated Earnings
    Will Not Trickle Down to U.S. Workers,'' TaxVox: Individual Taxes
    (Sept. 25, 2017), available at http://www.
    taxpolicycenter.org/taxvox/tax-break-repatriated-earnings-will-not-
    trickle-down-us-workers (last viewed Sept. 27, 2017).

        On this point, Donald Marron's testimony before this committee on
    September 19th was crystal clear: ``Retroactive tax cuts do not help
    workers; the benefits would go solely to shareholders.'' \18\ The most
    recent data show that companies publicly traded on U.S. securities
    markets are approximately 75% owned by U.S. shareholders, including
    principally individuals (directly and through mutual funds) and tax-
    favored retirement accounts.\19\ The Tax Policy Center finds that 76%
    of a retroactive corporate tax change would go to the highest quintile
    of income earners, 40% goes to the top 1% and 27% of the benefit goes
    to the top 0.1% of taxpayers.\20\ The remaining shares are owned by
    foreign shareholders.
    ---------------------------------------------------------------------------
        \18\ Donald B. Marron, institute fellow, Urban Institute and Urban-
    Brookings Tax Policy Center, testimony before the Senate Committee on
    Finance, hearing on ``Business Tax Reform'' 3 (Sept. 19, 2017).
        \19\ See Leonard E. Burman, Kimberly A. Clausing, and Lydia Austin,
    ``Is U.S. Corporate Income Double Taxed?'' (May 4, 2017) (building on
    work of Rosenthal and Austin); Steven M. Rosenthal and Lydia S. Austin,
    ``The Dwindling Taxable Share of U.S. Corporate Stock,'' 151 Tax Notes
    923 (2016).
        \20\ Tax Policy Center, ``Share of Change to Corporate Income Tax
    Burden by Expanded Cash Income Percentile,'' T17-0180 preliminary
    results (June 6, 2017), available at http://www.
    taxpolicycenter.org/model-estimates/distribution-change-corporate-tax-
    burden-june-2017/t17-0180-share-change-corporate, last viewed Sept. 27,
    2017.

    [GRAPHIC] [TIFF OMITTED] T0317.013

                           directions for tax reform
        The preceding discussion leads me to recommend that the committee
    consider the following proposals or areas for reform.
    Improve Taxation of Foreign Business Income
        My first recommendation would be to follow the Wyden-Coats and
    Trump campaign proposals to tax U.S. MNCs' foreign subsidiary earnings
    currently and allow deductions allocable to foreign subsidiary earnings
    in full.\21\ This would address U.S. multinational base erosion and
    profit shifting that is pervasive under current law and would be
    exacerbated under a final global minimum tax. The claim that U.S. MNCs
    would not be able to compete if the corporate rate is reduced to 20%
    (or 24% under the Wyden-Coats proposal) is unsupported and a claim for
    special treatment for foreign income that should be justified with
    evidence.
    ---------------------------------------------------------------------------
        \21\ See S. 727, Bipartisan Tax Fairness and Simplification Act of
    2011, 112th Congress, 1st Session, Sec. 204(c) (2011). The GOP Tax
    Reform Plan of September 27th appears to describe a minimum tax
    combined with a form of dividend exemption. An important element from a
    revenue perspective is how deductions are allocable to foreign
    subsidiary earnings eligible for a reduced rate of tax. The effects of
    the minimum tax are not easy to discern without a specific proposal,
    including a specific tax rate.

        A second best approach would be adopt an advance minimum tax on
    foreign business income under the current law deferral regime and to
    defer U.S. deductions allocable to deferred foreign income until the
    foreign income is taxed. This is described in my 2015 Senate Finance
    Committee testimony and is developed in greater detail in a co-authored
    Florida Tax Review article.\22\
    ---------------------------------------------------------------------------
        \22\ See Stephen E. Shay, J. Clifton Fleming, Jr., and Robert J.
    Peroni, ``Designing a 21st Century Corporate Tax--An Advance U.S.
    Minimum Tax on Foreign Income and Other Measures to Protect the Base,''
    17 Florida Tax Review 669 (2015) (proposing a minimum tax that would
    partially end deferral by effectively serving as an advance withholding
    tax with respect to the ultimate U.S. levy on repatriated foreign-
    source active-business income). Under an advance minimum tax, a United
    States shareholder in a controlled foreign corporation (CFC) would be
    required to include in income (under the code's subpart F rules) the
    portion of the CFC's earnings that would result in a residual U.S. tax
    sufficient to achieve the target minimum effective tax rate on the
    CFC's current year earnings. The target minimum effective tax rate
    would be based on a percentage of the of the U.S. corporate rate, so
    that it would adapt to changes in the U.S. corporate tax rate.
    Deductions incurred by U.S. affiliates allocable to the CFC's earnings
    only would be allowed to the extent the CFC's earnings were actually or
    deemed distributed. For example, if the actual and deemed distributions
    caused 35% of the CFC's earnings to be distributed, then 35% of the
    deductions allocable to the CFC's income would be allowed and the
    remaining 65% would be suspended until the remaining earnings were
    distributed. The earnings deemed distributed would be treated as
    previously taxed as under current law and would be available for
    distribution without a further U.S. tax (which would reduce pressure on
    earnings held abroad).

        A territorial system such as one referred to but not specified in
    the GOP Tax Reform Plan of September 27 is a least good proposal and
    indeed can, if not designed properly, leave the tax system materially
    worse off than under current law. My co-authors and I detailed design
    features that should characterize a principled territorial system in a
    2012 article.\23\ In a new Tax Notes article we describe how to
    incorporate a principled minimum tax in a territorial regime.\24\ Key
    design features of such a minimum tax that are critical to protecting
    the tax base include the following:
    ---------------------------------------------------------------------------
        \23\ See J. Clifton Fleming, Jr., Robert J. Peroni, and Stephen E.
    Shay, ``Designing a U.S. Exemption System for Foreign Income When the
    Treasury Is Empty,'' 13 Florida Tax Review 397 (2012) (hereinafter
    Fleming, Peroni, and Shay, ``Designing Exemption'').
        \24\ J. Clifton Fleming, Jr., Robert J. Peroni, and Stephen E.
    Shay, ``Incorporating a Minimum Tax in a Territorial System,'' 156 Tax
    Notes 54 (Oct. 2, 2017).

        1.  To avoid gaming, a U.S. territorial system should apply to both
    ---------------------------------------------------------------------------
    foreign branch income and dividends received from foreign subsidiaries.

        2.  There should be no deferral; the minimum tax should apply to
    the foreign-source income of U.S. MNCs as the income is earned either
    directly or by foreign affiliates.

        3.  The minimum tax should be a relatively high percentage of the
    regular U.S. tax rate (no less than 60% and preferably 80%).\25\ The
    minimum tax should be applied on a country-by-country and not a global
    basis as is suggested in the GOP framework. Allowing blending of high
    and low foreign taxes will in some cases incentivize high-taxed foreign
    investments and shifting of U.S. income to be low-taxed foreign income
    in other cases.
    ---------------------------------------------------------------------------
        \25\ For example, if the corporate rate were 20%, the minimum tax
    should be at least 12% and preferably 16%.

        4.  A foreign tax credit should be allowed against the minimum tax
    but only in the ratio that the U.S. minimum tax rate bears to the
    regular U.S. corporate tax rate.\26\ Only the pro-rated amount of
    foreign taxes allocable to minimum taxed income on a country-by-country
    basis should be creditable against the U.S. tax on that income. Cross-
    crediting should be severely limited or there again will be incentives
    to mix and match investment by the level of tax on the return from the
    investment.
    ---------------------------------------------------------------------------
        \26\ The foreign income taxes eligible for the credit would be
    limited to the ratio that the minimum tax rate bears to the regular
    U.S. rate. This is the same approach taken in the section 965 temporary
    tax holiday provision. See IRS Notice 2005-64, Sec. 4.03, 2005-36 IRB
    471, 476-478.

        5.  A U.S. territorial system should exempt only dividends paid out
    of foreign-source active business income that has borne a meaningful
    tax and only
    foreign-source branch income that has the same characteristic. No sound
    policy objective is achieved by going further and exempting other
    income. An exemption should not apply to foreign-source income that was
    treated as a deductible payment in the foreign country--royalties,
    rents, and interest should be fully taxed and only withholding taxes on
    that income allowed as a credit against the U.S. tax on that income.
    Consistent with practice in other developed countries, current taxation
    of passive income (under subpart F) should be retained so that the
    exemption does not encourage tax avoidance on passive income.\27\
    ---------------------------------------------------------------------------
        \27\ With respect to private equity and other investment funds,
    subpart F should be modified so that it applies at the level of the
    fund (whether the fund is a domestic or a foreign partnership) and U.S.
    investors can no longer escape current taxation of subpart F income by
    being less than 10 percent owners of the fund.

        6.  Corporate overhead, interest, and research and development
    deductions should be properly and fully allocated to exempt income and
    disallowed. Limiting the exemption to 95% (or some other percentage) of
    otherwise qualifying income as a substitute for properly allocating
    deductions between exempt income and non-exempt income inappropriately
    expands the exemption subsidy to domestic income. Foreign losses should
    be prorated between exempt foreign income and taxable income. The
    portion allocable to exempt foreign income should be disallowed; only
    ---------------------------------------------------------------------------
    losses allocable to taxable income should be deductible.

        If these design principles are followed, it is possible for such a
    regime to improve current taxation of international operations over
    current law.
    Honor 2004 Congressional Commitment to One-Time-Only Amnesty; If Not,
    Use the Highest Possible Single Rate

        The committee should resist taxing pre-effective date earnings of
    the largest U.S. MNCs at a low amnesty rate that will overwhelmingly
    benefit high income American and foreign shareholders. This is
    unjustified on policy and distributional grounds. Moreover, the
    additional revenue will be sorely needed to reduce the massive deficits
    that would result from the GOP Tax Reform Plan of September 27th.

        There should not be a higher rate on cash and cash equivalents and
    certainly not one announced in advance without an immediate effective
    date. A dual rate structure will require a definition of cash and cash
    equivalent and a measurement on a set date that, if prospective, will
    be subject to planning and manipulation. At a minimum, it would create
    an incentive for pre-effective date investment in ``illiquid assets''
    which could have unintended effects on markets in which U.S. MNCs hold
    large portions of outstanding securities. If experience with the
    manufacturing deduction is any guide (where Starbucks coffee roasting
    can obtain a tax benefit for manufacturing), definitions will be
    stretched with the well-paid assistance of K Street denizens. If any
    relief is given, which is poor policy, use a single rate as close to
    the historic rate as possible (and certainly not below the new regular
    corporate tax rate).
    Strengthen U.S. Corporate Residence Rules
        If taxation of foreign income is reformed along the lines described
    above, or with most plausible anti-base erosion provisions in a further
    development of the tax reform legislation, there will be continued
    pressure on U.S. corporations to change corporate residence. The United
    States should broaden its definition of a resident corporation to
    provide that a foreign corporation would be a U.S. tax resident if it
    satisfied either a shareholder residency test or the presently
    controlling place of incorporation test. Importantly, linking corporate
    residence to greater than 50% control by U.S. tax residents would align
    corporate residence with the primary reason the U.S. seeks to impose a
    corporate tax, which is to tax resident shareholders. There are
    important details to be worked out in designing a shareholder residence
    test, but my colleagues and I have explored many of the relevant issues
    and I strongly encourage the committee to pursue this avenue.
    Strengthen U.S. Source Taxation Rules
        The first and most direct way to generally strengthen U.S. source
    taxation is through improved earnings stripping rules that should not
    be limited to interest.\28\ If the committee does not adopt a general
    limitation on deductions for net interest expense, which would subsume
    earnings stripping, then it is important to adopt a limitation on
    deduction for excess related party interest. There have been robust
    proposals by Representative Camp and the Obama administration so I do
    not address details here except to emphasize that, unless addressed,
    U.S. MNCs will continue to attempt to shift corporate residence to take
    advantage of the U.S. tax reduction opportunities from earnings
    stripping. It would be a significant mistake for the administration to
    undo the substance of the recently finalized section 385 regulations
    before a replacement of equal strength is firmly in place.\29\
    ---------------------------------------------------------------------------
        \28\ See J. Clifton Fleming, Jr., Robert J. Peroni, and Stephen E.
    Shay, ``Getting Serious About Cross-Border Earnings Stripping:
    Establishing an Analytical Framework,'' 93 North Carolina Law Review
    673 (2015).
        \29\ This committee should discourage any such steps. For various
    reasons, including inducing inversions in any interim period, it would
    be especially foolish to encourage repeal of the regulations in hopes
    of improving a revenue score for a legislative change.

        It is foolish to believe that the U.S. tax base is immune from the
    same source tax avoidance, base erosion, and profit shifting that has
    afflicted other developed countries and given rise to the G20/OECD BEPS
    project. Structural advantages for foreign-controlled domestic
    companies constitutes an integral part of the current international tax
    architecture and is found in almost every country's tax system. The
    sources of advantage include remote sellers using digital commerce and
    foreign businesses using treaties and information technology advances
    to avoid direct local activity. In addition to adopting robust anti-
    earnings stripping rules that extend beyond interest to other
    deductible payments, it is time to engage in a more fundamental review
    of U.S. source taxation interests and legal rules. It is striking that
    a so-called fundamental tax reform effort over many years has
    disregarded this area that badly needs re-thinking and updated rules.
                                   conclusion
        International business income is but a part of the larger mosaic
    that comprises the U.S. economy. In no area of business are tax
    planning skills more acute and heavily deployed to take advantage of
    exceptions, special deductions, and lower effective rates than in
    relation to earning cross-border business income.

        There is no normative reason to privilege foreign business income
    beyond allowing a credit for foreign income taxes. My recommendation is
    to tax foreign business income broadly and allow a credit for foreign
    income taxes. I encourage you not to gamble with a territorial system
    with weak protections and not to give away tax benefits to the
    undeserving rich and foreigners. If any group of taxpayers does not
    bear its share of tax, others must make up the difference sooner or, if
    the deficit is debt-financed, later. Neither the tooth fairy nor
    dynamic scoring will alter this fundamental reality.

        I would be pleased to answer any questions the committee might
    have.

                                     ______

    Prepared Statement of Bret Wells, Professor of Law and George R. Butler
          Research Professor of Law, Law Center, University of Houston
        My name is Bret Wells, and I am the George R. Butler professor of
    law at the University of Houston Law Center. I would like to thank
    Chairman Hatch, Ranking Member Wyden, and the other members of the
    committee for inviting me to testify. I am testifying in my individual
    capacity, and so my testimony does not necessarily represent the views
    of the University of Houston Law Center or the University of Houston. I
    request that my full written testimony be included in the record.

        Before addressing international taxation, I want to make a
    preliminary statement about the related topic of business tax reform.
    As to business tax reform, Chairman Hatch is to be commended for his
    work on corporate integration as part of tax reform--specifically, his
    partial dividends paid deduction proposal. A partial dividends paid
    deduction regime provides a corporate tax deduction that can
    approximate the stock ownership held by U.S. taxable investors.\1\ The
    existing scholarship makes a compelling case that significant
    efficiencies can be achieved through corporate integration.\2\ By
    limiting the dividend deductibility to the amount of equity held by
    U.S. taxable shareholders, the partial dividends paid deduction regime
    preserves corporate level taxation for earnings in an amount broadly
    equal to the equity ownership of nontaxable shareholders. A partial
    dividends paid deduction regime narrows the distinction between the tax
    treatment of debt and equity. A partial dividends paid deduction
    regime, in combination with a dividends and capital gains preference,
    in tandem can result in a combined tax rate on corporate business
    profits that approximates the individual tax rate, thus eliminating the
    disparity in tax rates between C corporations and pass-through
    entities. Thus, a partial dividends paid deduction regime is a critical
    step in the right direction and should be part of the final business
    tax reform legislation.
    ---------------------------------------------------------------------------
        \1\ For a more detailed analysis of my views on an earlier
    iteration of a dividends paid deduction proposal, see Bret Wells,
    ``International Tax Reform By Means of Corporate Integration,'' 19
    Florida Tax Review 71 (2016); see also testimony of Bret Wells at the
    hearing on ``Integrating the Corporate and Individual Tax Systems: The
    Dividends Paid Deduction Considered'' before the Senate Finance
    Committee (May 17, 2016).
        \2\ See, e.g., Michael J. Graetz and Alvin C. Warren, ``Integration
    of the U.S. Corporate and Individual Income Taxes: The Treasury
    Department and the American Law Institute Reports'' (1998); see also
    staff of the Joint Committee on Taxation, ``Overview of Approaches to
    Corporate Integration,'' JCX-44-66 (May 13, 2016); Republican staff of
    the Senate Finance Committee, ``Comprehensive Tax Reform for 2015 and
    Beyond'' at 122-237, 113th Congress, S. Prt. No. 113-31 (Dec. 2014).

        Now, I want to address outbound international taxation. This
    committee is well aware that our major trading partners have all opted
    for some variant of a territorial tax regime and that the divergent
    approach taken by the United States poses competitiveness concerns.\3\
    This reality creates an urgent need for this Congress to consider how
    to structure a territorial tax regime that provides parity with the tax
    systems of our major trading partners but at the same time protects the
    U.S. tax base from inappropriate profit shifting strategies. Under
    current law, the U.S. subpart F regime provides a fairly narrow set of
    exceptions to the deferral privilege, and these anti-deferral
    provisions serve as an important backstop to prevent tax avoidance of
    U.S. origin profits by U.S.-based multinational enterprises. Another
    means to address the tax avoidance concerns that underlie the U.S.
    subpart F regime would be to adopt greater source taxation measures to
    protect the U.S. tax base. Relying on a source taxation solution to
    address the profit shifting problem is consistent with a territorial
    tax regime and has the favorable benefit of implementing base
    protection measures that apply across-the-board to both U.S.-based
    multinational enterprises and foreign-based multinational enterprises.
    In contrast, solutions that rely on residency taxation principles (such
    as the U.S. subpart F regime) only protects against the profit shifting
    strategies of U.S.-based multinational enterprises. Thus, I favor
    source taxation measures over an expanded subpart F regime exactly
    because subpart F measures create divergent and discriminatory tax
    results for U.S.-based multinational enterprises and leaves in place
    the inbound earning stripping advantages for foreign-based
    multinational enterprises. Thus, for competitiveness reasons, this
    Congress must consider a territorial tax regime, and as part of that
    consideration Congress must utilize tax base protection measures that
    are even-handed.\4\ Expanding residency-based solutions via an
    expansion of the U.S. Subpart F regime creates artificial winners and
    losers based on the ultimate place of residence of the global parent
    company. The United States needs an international tax system that
    protects U.S. taxation over U.S. origin profits and is consistent with
    the tax regimes of our major trading partners.
    ---------------------------------------------------------------------------
        \3\ See Republican staff of the Senate Finance Committee,
    ``Comprehensive Tax Reform for 2015 and Beyond'' at 249-293, 113th
    Congress, S. Prt. No. 113-31 (Dec. 2014); see also staff of the Joint
    Committee on Taxation, ``Background and Selected Issues Related to the
    U.S. International Tax System and Systems That Exempt Foreign Business
    Income,'' JCX-33-11 (2011) (analyzing nine major trading partners of
    the United States that provide for an exemption system); staff of the
    Joint Committee on Taxation, ``Present Law and Issues in U.S. Cross-
    Border Income,'' JCX-42-11 (2011) (reviewing policy considerations
    between a territorial and worldwide tax system).
        \4\ For a more detailed analysis of my views on a territorial tax
    regime and the earning stripping issues inherent in such a regime, see
    Bret Wells, ``Territorial Taxation: Homeless Income is the Achilles
    Heel,'' 12 Houston Business and Tax Law Journal 1 (2012).

        For the balance of my time, I want to highlight three key issues
    with respect to inbound international tax reform.
       1. earning stripping is multifaceted and requires a comprehensive
                                    solution
        For corporate tax reform to be sustainable in a global environment,
    the United States tax system must be designed to ensure that business
    profits earned within the United States are subject to U.S. taxation
    regardless of where a multinational corporation is incorporated.
    Today's tax system does not achieve this objective, and its failure to
    do so creates earning stripping opportunities for foreign-based
    multinational enterprises that allow them to achieve a lower tax burden
    with respect to their U.S. operations than can be achieved by U.S.-
    based multinational enterprises conducting those same operations.\5\
    Thus, U.S.-based multinational enterprises are competitively
    disadvantaged by our own tax system.
    ---------------------------------------------------------------------------
        \5\ Earning stripping has been identified as a systemic challenge
    that requires a further legislative policy response. See, e.g., staff
    of the Joint Committee on Taxation, ``Present Law and Background
    Related to Possible Income Shifting and Transfer Pricing,'' JCX-37-10
    (2010). For a more detailed analysis of my views on how U.S.-based
    multinational enterprises are competitively disadvantaged because of
    the extra earning stripping opportunities that exist for foreign-based
    multinational enterprises that do not exist for U.S.-based
    multinational enterprises, see Bret Wells, ``Territorial Taxation:
    Homeless Income is the Achilles Heel,'' 12 Houston Business and Tax Law
    Journal 1 (2012).

        How does this inbound earning stripping problem arise? When a U.S.
    subsidiary makes a cross-border tax deductible payment to a low-taxed
    offshore affiliate, the overall income of the multinational enterprise
    has not changed. The multinational enterprise has simply moved assets
    from one affiliate entity's pocket to another affiliate's pocket. But,
    from a U.S. tax perspective, this related party (intercompany)
    transaction is quite lucrative. This intercompany transaction affords
    the U.S. affiliate with a U.S. tax deduction that reduces the U.S.
    corporate tax liability of the U.S. affiliate. The intercompany payment
    creates income in the hands of the low-taxed offshore affiliate that
    often escapes U.S. taxation and often avoids any meaningful taxation in
    the offshore jurisdiction. There are five intercompany techniques that
    can be utilized to strip out this U.S. origin ``homeless income'' \6\
    from the hands of the U.S. affiliate: (1) related party Interest
    Stripping Transactions; (2) related party Royalty Stripping
    Transactions;\7\ (3) related party Lease Stripping Transactions; (4)
    Supply Chain restructuring exercises; and (5) related party Service
    Stripping Transactions.
    ---------------------------------------------------------------------------
        \6\ By Homeless Income, I mean to refer to that category of a
    multinational corporation's consolidated income that has been removed
    from the tax base of the country of origin via a related-party tax
    deductible payment and relocated to an offshore affiliate's country of
    residence that chooses not to tax this extra-territorial income or
    provides concessionary taxation to this category of income. Thus, the
    income is ``homeless'' in the sense that it lost its tax home in the
    country of source. The origins of the homeless income mistake is dealt
    with extensively in my earlier writings in Bret Wells and Cym Lowell,
    ``Tax Base Erosion and Homeless Income: Collection at Source is the
    Linchpin,'' 65 Tax Law Review 535 (2012); Bret Wells and Cym Lowell,
    ``Income Tax Treaty Policy in the 21st Century: Residence vs. Source,''
    5 Columbia Tax Journal 1 (2013).
        \7\ The outbound migration of foreign-use intangibles is another
    systemic challenge to the current U.S. international taxation regime
    that does not involve an inbound Royalty Stripping Transaction and thus
    would not be prevented by a Base Protecting Surtax. But, the Treasury
    Department can and should amend its existing cost sharing regulations
    to disregard a funding party's tax ownership of an intangible above its
    actual functional contribution toward the intangible's creation apart
    from funding. For a further detailed analysis of this issue, see Bret
    Wells, ``Revisiting Sec. 367(d): How Treasury Took the Bite Out of
    Section 367(d) and What Should Be Done About It,'' 16 Florida Tax
    Review 519 (2014).

        Multinational enterprises come to every jurisdiction, including the
    United States, with a toolbox of tax planning techniques that utilize
    all five of the above earning stripping categories. So, to have a
    sustainable system of business taxation, the United States simply must
    address earnings stripping by addressing each of the categories of
    earning stripping transactions. Foreclosing one, but not all, of the
    earning stripping categories simply motivates a foreign-based
    multinational enterprise to use other tax planning tools.
       2. corporate inversions are not a stand-alone problem but merely
             the alter ego of the inbound earning stripping problem
        Corporate inversions are a telltale symptom of the larger inbound
    earning stripping cancer. Thus, corporate inversions cannot be handled
    as a stand-alone problem. Again, my first key point bears repeating:
    the current tax system provides significant earning stripping
    advantages that afford a better tax result for the U.S. activities of
    foreign-based multinational enterprises than exist for U.S.-based
    multinational enterprises that conduct similar U.S. activities.\8\ This
    reality causes U.S.-based multinational enterprises to want to become
    foreign-based multinational enterprises, or in other words to enter
    into a corporate inversion transaction so that the post-inversion
    company can avail itself of the same earning stripping opportunities as
    its foreign-based competitors without the impediment of the U.S.
    subpart F regime.
    ---------------------------------------------------------------------------
        \8\ The U.S. subpart F rules serve as a backstop to prevent a U.S.-
    based multinational enterprise from stripping U.S. source profits via
    inbound Interest Stripping, Royalty Stripping, and Lease Stripping
    transactions. For a more detailed analysis of my views on how the U.S.
    subpart F regime serves as a backstop to prevent U.S.-based
    multinational enterprises from benefitting from these earnings
    stripping techniques and how this subpart F backstop regime does not
    apply to foreign-based multinational enterprises, see Bret Wells and
    Cym Lowell, ``Tax Base Erosion and Homeless Income: Collection at
    Source is the Linchpin,'' 65 Tax Law Review 535 (2012); see also Bret
    Wells, ``Territorial Taxation: Homeless Income is the Achilles Heel,''
    12 Houston Business and Tax Law Journal 1 (2012).

        This is the point to be learned from the corporate inversion
    phenomenon: \9\ corporate inversions are an effort by U.S.-based
    multinational enterprises to become foreign-based enterprises exactly
    because the inbound earning stripping advantages available to foreign-
    based multinational enterprises are coveted by U.S.-based
    companies.\10\ Thus, instead of attacking the corporate inversion
    messenger in isolation, Congress should focus its attention on the
    inversion message, namely that the earning stripping techniques
    available to foreign-based multinational enterprises, if left
    unchecked, create an unlevel playing field that motivates U.S.-based
    multinational corporations to find pathways to successfully engage in
    corporate inversions. Said differently, corporate inversions tell
    Congress that it must solve the inbound earning stripping problem on a
    holistic basis if it wants to eliminate the tax incentives for these
    transactions. Corporate inversions are simply the alter ego of the
    inbound earning stripping problem and should not be viewed as a
    separate policy problem.
    ---------------------------------------------------------------------------
        \9\ Corporate inversions cause significant revenue losses and
    ongoing policy concerns. See Congressional Budget Office, ``An Analysis
    of Corporate Inversions'' (September 2017), available at https://
    www.cbo.gov/system/files/115th-congress-2017-2018/reports/53093-
    inversions.pdf. In the past, Congress has attacked the corporate
    inversion phenomenon as a stand-alone problem. In my view, Congress
    will not eliminate the corporate inversion phenomenon until Congress
    eliminates the inbound earning stripping advantages that motivate these
    transactions.
        \10\ For a more in-depth discussion of my views on why the
    corporate inversion phenomenon is best understood as a commentary on
    the broader inbound earning stripping problem and should not be viewed
    as a stand-alone problem, see Bret Wells, ``Corporate Inversions and
    Whack-a-Mole Tax Policy,'' 143 Tax Notes 1429 (June 23, 2014); Bret
    Wells, ``Cant and the Inconvenient Truth About Corporate Inversions,''
    136 Tax Notes 429 (July 23, 2012); Bret Wells, ``What Corporate
    Inversions Teach Us About International Tax Reform,'' 127 Tax Notes
    1345 (June 21, 2010).
    ---------------------------------------------------------------------------
                 3. a base protecting surtax should be part of
                        inbound international tax reform
        Congress needs a new approach to address the earning stripping
    problem, and it should address this problem in a comprehensive manner.
    I believe that a base protecting surtax is a solution that
    comprehensively addresses the inbound earnings stripping problem, and
    so I urge this committee to seriously consider it as part of
    international tax reform.\11\ By imposing a base protecting surtax on
    all five categories of earning stripping transactions, a surtax would
    be collected upfront in an amount equal to the amount of tax that would
    have been collected had the intercompany payment instead been paid as
    an intercompany dividend distribution. A base protecting surtax is
    essential even if Congress were to enact a partial dividends paid
    deduction regime because a foreign-based multinational enterprise can
    strip ``homeless income'' out of the U.S. tax base in a manner that
    achieves a better result than can be achieved via a partial dividends
    paid deduction. Thus, Congress needs to level the playing field with a
    base protecting surtax.
    ---------------------------------------------------------------------------
        \11\ Although adoption of a Base Protecting Surtax is my preferred
    policy response, the committee should consider this proposal alongside
    other thoughtful reform proposals that have been offered by other
    scholars. See, e.g., J. Clifton Fleming, Jr., Robert J. Peroni, and
    Stephen E. Shay, ``Getting Serious About Cross-Border Earnings
    Stripping: Establishing an Analytical Framework,'' 93 North Carolina
    Law Review 673 (2015) (provides a comprehensive expense disallowance
    approach to earning stripping transactions); Michael C. Durst,
    ``Statutory Protection for Developing Countries,'' 69 Tax Notes
    International 465 (Feb. 4, 2013) (endorses disallowance of related
    party payments made to tax haven affiliates); Reuven S. Avi-Yonah, ``A
    Coordinated Withholding Tax on Deductible Payments,'' 119 Tax Notes
    993, 995-96 (June 2, 2008) (endorses a withholding tax on earning
    stripping payments that is refundable if subjected to meaningful
    taxation in the offshore jurisdiction).

        If appropriately designed, a base protecting surtax would be
    applied on the payer in each of the five types of earning stripping
    transactions. As such, it is not a withholding tax on the payee. The
    base protecting surtax collects a surtax upfront on the payer's share
    (not the payee's share) of the residual profits that are earned by the
    multinational enterprises from within the United States and remitted as
    a tax deductible payment to a jurisdiction outside of the U.S. tax
    base. Thus, the surtax protects the U.S. tax base from being reduced by
    reason of earning stripping transactions and as such would provide tax
    revenue for tax reform. Moreover, by eliminating the tax benefits
    associated with earning stripping transactions, Congress will eliminate
    the fuel that drives the corporate inversion phenomenon. And finally, a
    comprehensively applied base protecting surtax levels the playing field
    between U.S.-based multinational enterprises and foreign-based
    multinational enterprises.
                                   conclusion
        Let me conclude my testimony by stating that this committee is to
    be commended for considering fundamental business tax reform. Business
    tax reform requires a careful consideration of international tax
    reform, and in my view any resulting legislation must be structured to
    withstand the systemic inbound earning stripping challenges that face
    the United States. Thank you for allowing me to speak at today's
    hearing. I would be happy to answer any of your questions.

                                     ______

                                   Appendix A

        The base protecting surtax that I and a co-author originally
    proposed \12\ in 2012 is updated in this testimony to mesh with a
    corporate integration proposal that would utilize a partial dividends
    paid deduction with the following elements:
    ---------------------------------------------------------------------------
        \12\ For a more detailed analysis of the original formulation of
    the Base Protecting Surtax set forth in this testimony, see Bret Wells
    and Cym Lowell, ``Tax Base Erosion and Homeless Income: Collection at
    Source is the Linchpin,'' 65 Tax Law Review 535 (2012).

        1.  Base Protecting Surtax on Base Erosion Payments. A related-
    party U.S. payer of a base erosion payment would be subjected to a Base
    Protecting Surtax on the earnings that are transferred to a foreign
    affiliate in an amount equal to the amount that would have been
    collected had those earnings instead been distributed as a partially
    deductible dividend. The purpose of the Base Protecting Surtax is to
    collect, as a surtax, a tax calculated on the gross amount of the
    earning stripping payment so that an equivalent tax is collected for
    what would have been due if the base erosion payment instead had been
    remitted as a tax deductible dividend to the foreign affiliate. The
    rebuttable presumption is that the base erosion payment represents, in
    ---------------------------------------------------------------------------
    its entirety, a transfer of residual profits.

        2.  Refund Process. If the U.S. payer believes that the amount of
    the Base Protecting Surtax is in excess of the amount needed to protect
    the U.S. tax base because, in fact, a portion of the base erosion
    payment represents a reimbursement of actual third-party costs and does
    not represent, in its entirety, a transfer of U.S. origin profits
    between affiliates, then the U.S. payer could request a redetermination
    by the Internal Revenue Service (Service) through a ``Base Clearance
    Certificate'' process. However, the burden is on the U.S. payer to
    demonstrate that the Base Protecting Surtax was assessed on an amount
    that exceeded the amount of residual profits that were actually
    transferred by the U.S. affiliate to a foreign affiliate, and this
    burden would only be satisfied if the taxpayer demonstrated that a
    correct application of a profit split methodology \13\ confirmed the
    taxpayer's assertion. Until the taxpayer meets this burden of proof,
    the surtax would not be refunded. So, the audit incentives for
    transparency in this posture are reversed as the government has
    collected the tax upfront and it falls to the taxpayer to develop the
    case for a refund, and so the taxpayer now has every incentive for
    transparency and expeditious handling of the audit proceeding.
    ---------------------------------------------------------------------------
        \13\ For further detail on why I believe transactional transfer
    pricing methodologies are inadequate to address the transfer pricing
    issues of multinational enterprises and why I believe all transfer
    pricing results in the multinational enterprise context should utilize
    a profit split methodology as the primary transfer pricing methodology
    or alternatively should be used as a mandatory confirmatory check to
    all other transactional transfer pricing methodologies, see Bret Wells
    and Cym Lowell, ``Tax Base Erosion: Reformation of Section 482's Arm's
    Length Standard,'' 15 Florida Tax Review 737 (2014).

        The purpose of the base protecting surtax is to serve as a backstop
    to prevent elimination of the residual U.S. taxation on any of the five
    categories of inbound earning stripping transactions that create
    ``homeless income'' out of U.S. origin business profits. By imposing a
    base protecting surtax on all five of the enumerated inbound Homeless
    Income strategies, the base protecting surtax collects an upfront tax
    in an amount equal to the amount that would have been collected had
    those earnings instead been distributed as a dividend subject to the
    applicable withholding tax on the grossed-up dividend. A Base
    Protecting Surtax is essential in a dividends paid deduction regime
    because without it the foreign-based multinational enterprise has
    inbound earning stripping strategies at its disposal that affords it
    the opportunity to strip profits from its U.S. subsidiary in a manner
    that circumvents U.S. taxation over U.S. origin profits that are
    ---------------------------------------------------------------------------
    unavailable to U.S.-based multinational enterprises.

        The proposed Base Protecting Surtax is a surtax on the payer and is
    not a withholding tax on the payee. The Base Protecting Surtax seeks to
    collect the tax that is due on the payer's share (not the payee's
    share) of the residual profits that are earned by the multinational
    enterprises from the United States. The surtax makes the following two
    assumptions about inbound earning stripping strategies: (1) base
    erosion payments represent, in their entirety, a transfer of residual
    profits to the offshore recipient, and (2) the onshore payer should
    have reported and paid source country taxes on those residual profits
    that arose from the U.S. affiliate's activities within the United
    States. The transfer pricing penalty and documentation provisions do a
    fine job of ensuring that routine profits are reported by the onshore
    U.S. subsidiary, but these provisions have not been successful at
    ensuring the self-reporting of residual profits by the U.S. affiliate.

        If the U.S. multinational enterprise discloses its overall books
    and proves that the combined profits of the multinational enterprise
    are less than the full gross amount of the base erosion payment, then a
    refund of the surtax (in whole or in part) could be made, but in this
    refund determination the taxpayer would be required to utilize a profit
    split methodology, not one of the transactional transfer pricing
    methodologies. The proposed Base Protecting Surtax relies on a profit
    split methodology (which is one of the accepted transfer pricing
    methods) and the surtax is refundable if it overtaxes the combined
    income. Moreover, the technical taxpayer for the surtax is the U.S.
    affiliate payer. Thus, because the surtax can be reconciled with the
    arm's length standard and because the surtax is not a withholding tax
    on the recipient, the proposal is consistent with existing treaty
    obligations.

                                     ______

                     Prepared Statement of Hon. Ron Wyden,
                           a U.S. Senator From Oregon
        The Trump team says their international tax framework is about
    creating jobs and firing up the country's economic engine, but the
    details show that's just part of the con job being pulled on the middle
    class. Behind the scenes, the administration recently scrubbed from the
    Treasury website a 2012 paper showing that workers do not primarily
    benefit from a corporate rate cut--that trickle down economics are a
    fantasy. Apparently that mainstream economic analysis had to be purged
    since it didn't jibe with the Trump Team's patter.

        They claimed the study was out of date, but they didn't find reason
    to take down any of the other papers that date back as far as the
    1970s. This sure makes it look like the Trump team is afraid of a well-
    informed public. And the con job isn't just about hiding inconvenient
    facts. The administration is currently working to pick apart the rules
    that were designed to combat the inversion virus and the decimation of
    our tax base.

        People at town halls tell me they want tough policies in place to
    stop companies from shipping jobs overseas. Especially in towns where
    mills and factories are shuttered and Main Street is vacant, Americans
    are desperate for more red, white, and blue jobs with good wages. And
    they want corporations to pay their fair share. What's on offer in the
    Trump plan is likely to disappoint.

        The Republican tax framework okayed the entire corporate wish list.
    A massive rate cut. A pure territorial system. But there was barely a
    nod to tough rules to prevent companies from sending jobs abroad or
    running away to set up HQ on some zero-tax island. Base erosion, a
    minimum tax--these vital parts of the international tax debate appear
    to be an afterthought. This is an invitation for corporations to game
    the system, and the tax lobby must be licking its chops.

        Bottom line, the President is giving multinationals a green light
    to pay no taxes. Then for the benefit of people reading the news,
    there's a lot of happy talk about jobs, economic growth, and the
    biggest tax cut ever.

        It's not hard to predict what will happen if this multi-trillion
    dollar tax giveaway to the wealthy and corporations is enacted, our tax
    base continues to erode, and the deficit skyrockets. Lawmakers will
    come after Social Security, Medicare and Medicaid yet again. And this
    isn't without precedent--privatizing Social Security was the first
    priority of the Bush administration's second term after its big,
    unpaid-for tax cuts. Let's remember that every percentage point
    decrease in the corporate tax rate results in a loss of $100 billion in
    revenue. Perhaps that's the kind of issue that caused Senator Corker to
    say that he's got big concerns over the deficit.

        Democrats have reached out to the majority with our principles for
    tax reform. There are a lot of members on this side with big ideas of
    how to help the middle class, create jobs, and bring some fairness to
    the tax code through bipartisan reform. That's the kind of reform that
    Ronald Reagan signed into law back in 1986, but the framework that was
    released last week is nowhere near what Reagan accomplished. And it's
    nowhere near the reforms built on fairness and fiscal responsibility
    that my colleagues Dan Coats, Judd Gregg, and I worked to write into
    our bipartisan plans more recently.

        As I wrap up, international taxation is going to be a key part of
    the tax reform debate, and it involves a lot of extraordinarily complex
    questions. The committee has an excellent panel of witnesses here today
    who can address international tax much more thoughtfully than the Trump
    framework does. So I look forward to the discussion.

                                     ______

                                 Communications

                                  ----------

                    American Council of Life Insurers (ACLI)

                          101 Constitution Avenue, NW

                           Washington, DC 20001-2133

                                  www.acli.com

    The American Council of Life Insurers (ACLI) is pleased to submit this
    statement for the record for the October 3, 2017 Senate Finance
    Committee hearing regarding international tax reform. We thank Chairman
    Hatch and Ranking Member Wyden for holding this hearing.

    The American Council of Life Insurers (ACLI) is a Washington, DC-based
    trade association with approximately 290 member companies operating in
    the United States and abroad. ACLI advocates in state, federal, and
    international forums for public policy that supports the industry
    marketplace and the 75 million American families that rely on life
    insurers' products for financial and retirement security. ACLI members
    offer life insurance, annuities, retirement plans, long-term care and
    disability income insurance, and reinsurance, representing 95 percent
    of industry assets in the United States.

    As the Committee considers updating the United States' international
    tax system in order to make our nation more competitive in the global
    economy and preserve our tax base, there are industry-specific matters
    to consider for life insurance companies with global interests that
    relate directly to our growth and competitiveness overseas. Our hope is
    that international tax reform reflects policies that treat our active
    business income on par with the income of non-financial services
    companies, though such income would likely be treated as ``passive
    income'' if earned by a non-financial services company. Our bricks and
    mortar and working capital ``assets'' are unique to this industry, thus
    meriting attentive consideration.

    Locally Regulated Business With Existing Robust Anti-Base Erosion Rules

    U.S.-based global life insurance companies operate where our customers
    are. U.S.-based global life insurance companies are highly regulated in
    the countries in which we do business and by federal and state
    regulators in the United States, and our local investments are heavily
    regulated and used to support our long-term product guarantees. The
    industry has long been subject to robust anti-base erosion rules--the
    active financing exceptions to Subpart F, or ``AFE'' rules. These rules
    apply at the entity level to ensure that each company is a properly
    regulated insurance company and that a substantial portion of our
    business is with local customers. The rules also apply similarly to
    test that our investments and related income are qualifying insurance
    investments and income. For the most part, these rules have reflected
    the way we do business.

    As the committee contemplates shifting from our current complex
    international tax rules to a territorial system, the industry applauds
    the stated goals of lower corporate tax rates, the ability to be more
    competitive globally and, of course, future tax structure simplicity.
    Additionally, we ask that several sector-specific issues be considered.

    Transition Tax Should Apply Lower Rate to Reserves Required to Stay
    Local

    First, under the recently released ``United Framework For Fixing Our
    Broken Tax Code'' (9/27/17) (the ``Tax Framework proposal''), the
    transition to a new territorial tax system includes a one-time deemed
    repatriation tax with bifurcated taxes for foreign earnings held in
    illiquid versus cash or cash equivalent foreign earnings. Earnings and
    profits (``E&P'') invested in cash deposits and marketable investment
    assets of insurance companies that support their regulatory required
    reserves are, as a practical matter, invested in assets that are
    similarly illiquid. The transition tax should be so applied and a
    practical method for doing so can be found under the current AFE rules.

    Transition Tax Should Apply on One-CFC Basis

    Second, the amount of E&P and foreign tax credits subject to the deemed
    repatriation tax should be calculated on a ``one-CFC basis,'' so that
    all of the foreign entities owned by members of a U.S. group are
    treated as a single foreign corporation. Under such a proposal, the
    aggregate amount of foreign earnings subject to the tax would be
    reduced by any earnings deficits. In addition, the pool of foreign
    taxes deemed to have been paid in respect of those earnings would
    reflect all taxes paid by companies whose earnings deficits were taken
    into account in determining the amount deemed to have been repatriated.

    Pro-Competitive Reforms to Active Finance Rules Advisable

    Third, as noted previously, the current international tax system
    applies the anti-base erosion Subpart F AFE rules to insurance
    companies. To the extent this set of rules remains intact in a new
    territorial system, three improvements should be considered. First, the
    AFE rules should be reformed to allow related-party reinsurance
    premiums to qualify as exempt from Subpart F as long as the related
    insurance company paying the reinsurance premium qualified under the
    AFE rules, and the insurance contract being reinsured was treated as
    qualifying and thus an exempt contract under the AFE. This would
    correct the current fact that U.S. tax law discourages the ability of
    U.S.-based global insurance companies to pool and diversify risks of
    their foreign affiliates by reinsuring risks to affiliated companies,
    which restriction runs counter to international norms, sound business
    practice, the way in which our global competitors operate their global
    insurance businesses and the expectation of regulators.

    The second AFE-specific proposal is that the rules for calculating
    reserves of qualifying foreign insurance companies should be modernized
    and simplified. Under the AFE rules, foreign subsidiaries of U.S. life
    insurance companies must use U.S. tax principles to calculate reserves
    for purposes of determining the amount of investment income that
    qualifies under the AFE, rather than using the actual amount of local
    country reserves. This recalculation requirement was originally
    designed as an anti-abuse rule, but this requirement is too restrictive
    and overly complex, failing to take account of the capital requirements
    that insurance companies must satisfy in order to operate a business
    competitively in a local jurisdiction. Congress should further
    encourage the IRS to provide more generally applicable guidance that
    would apply on a country-by-country basis to allow local country
    reserves or capital requirements to be utilized for purposes of
    calculating the investment income that would be exempt from Subpart F.

    Minimum Tax Application

    We understand the need for anti-base erosion measures as part of a
    reformed international tax system. As the AFE rules serve that purpose
    for our industry, it would be unnecessary and overly complicated to
    apply another layer of restrictive rules to income that is already
    qualifying under the AFE, such as a minimum tax. If a minimum tax were
    to apply to our industry, such a tax would create tremendous anomalies
    unless it was computed on a global basis, as is suggested by the Tax
    Framework proposal, rather than on a CFC-by-CFC basis.

    The American Council of Life Insurers appreciates the opportunity to
    file this statement for the record, along with an attached, more
    detailed, description of the issues outlined here. The life insurance
    industry stands ready to work with you in the interest of international
    tax reform whose goals--producing economic growth and ensuring
    competitiveness--are worthy.

                                     ______

              INTERNATIONAL TAX REFORM PRIORITIES FOR U.S.-BASED
                        GLOBAL LIFE INSURANCE COMPANIES

                                October 3, 2017

    The following proposals reflect the fact that U.S.-based global life
    insurance companies operate through local companies where our customers
    are, that we are highly regulated in the countries in which we do
    business and by federal and state regulators in the United States, and
    that our local investment income is heavily regulated and used to
    support our long-term product promises, or ``guarantees.''

    In addition, it is important to note the industry is already subject to
    robust anti-base erosion rules--the active financing exceptions to
    Subpart F, or AFE rules--that have existed in their current form since
    1998, and that are now permanent. These rules apply at the entity level
    to ensure that each company is a properly regulated insurance company
    and that a substantial portion of our business is with local customers.
    The rules also apply similarly to test our income as qualifying
    insurance income. For the most part, these rules reflect the way we do
    business. However, one proposed exception is described below, and
    relates to our ability to reinsure and get coordinated capital and
    investment efficiencies for our local country businesses.

    As tax reform turns to the priorities of anti-base erosion, growth and
    global competitiveness, our priorities reflect a desire to make the
    technical rules workable and fair for our industry. The following
    recommendations reflect policies that treat our active business income
    on par with the income of non-financial services companies, though such
    income would likely be treated as passive income if earned by a non-
    financial services company.

        a.  Application of lower split-rate transition tax to insurance
    company earnings that can't be repatriated

    The Unified Framework for Fixing Our Broken Tax Code (the
    ``Framework'') released by President Trump and Congressional Republican
    leaders on September 17, 2017, recommends that Congress include a
    territorial tax system as part of a comprehensive tax reform bill. The
    Framework proposes a transition rule from the current worldwide system
    that would treat foreign earnings accumulated under the existing system
    as being repatriated, and that foreign earnings held in ``illiquid
    assets'' would be taxed at a lower rate than earnings held as cash or
    cash equivalents. Under the Tax Reform Act of 2014 (H.R. 1) introduced
    by House Ways and Means Committee Chairman Dave Camp (R-MI),
    accumulated post-1986 \1\ undistributed earnings and profits (E&P) of
    CFCs would be subject to a similar one-time transitional tax. The tax
    rate would be 8.75% for E&P held in cash or cash equivalents, and 3.5%
    for the remainder. The purpose of the lower rate for non-cash and cash
    equivalents is to ``moderate the tax burden on illiquid accumulated E&P
    that has been reinvested in the foreign subsidiary's business,''
    according to the section-by-
    section summary of the bill provided by committee staff. The House
    Republican Blueprint included a similar proposal. While E&P invested in
    cash deposits and marketable investment assets of insurance companies
    that support their regulatory required reserves is, as a practical
    matter, invested in assets that are similarly illiquid, the bill did
    not apply the lower rate to such E&P. We believe it should apply to
    such cash and investments that support regulatory required insurance
    reserves. A practical method for doing so can be found under the AFE
    rules.
    ---------------------------------------------------------------------------
        \1\ The Camp proposal literally referred to E&P earned after
    December 31, 1986 as being subject to the one-time transitional tax.
    Post-1986 undistributed earnings as defined in section 902(c)(3) only
    includes earnings in the first taxable year that a foreign corporation
    has a 10 percent U.S. shareholder. The one-time tax should only apply
    to post-1986 undistributed earnings. The U.S. shareholder paid for the
    E&P earned prior to a U.S. shareholder owning the foreign company,
    which should not be subject to the one-time tax.

    Proposal: A method to identify these earnings for insurance groups can
    be found within the AFE rules that exempt certain insurance income from
    inclusion under the subpart F rules. Specifically, an insurance
    company's non-cash items could be defined in H.R. 1's section
    965(c)(2)(B) by limiting the ``liquid item'' to the extent that the
    insurance company has cash and investments in excess of the amount of
    reserves determined in section 954(i) with modifications. Thus, the
    amount that would be subject to the higher split-rate is an amount in
    excess of 110% of reserves for a life insurance company, which is as
    ---------------------------------------------------------------------------
    defined in sections 954(i)(2)(A) and 954(i)(2)(B)(i) and (ii).

    The term ``qualified insurance company'' would be made by reference to
    section 953(e)(3) without regard to section 953(e)(3)(B) (imposing a
    50% limitation focused on home country risk) and the term ``exempt
    contract'' would be made by reference to section 953(e)(2) without
    regard to section 953(e)(2)(B) (imposing a 30% limitation focused on
    home country income).

    While the higher split-rate might apply to the amount of a CFC's E&P
    held in cash or cash equivalents, that amount, in the case of a
    regulated insurance company, should exclude an amount attributable to
    assets that are necessary for any regulated insurance company to
    support its insurance obligations. Such an amount, like a
    manufacturer's plant and equipment, is recognized as being required to
    operate the local business and regulatory restrictions govern when a
    distribution of such amount is permissible.

    By removing the home country limitations of section 953(e), section 965
    is able to focus on the amount of cash and cash-like items that
    insurance companies must maintain to satisfy their regulatory capital
    reserves and risk profiles. These home country limitations are
    important for determining whether an insurance company's income should
    be excluded from subpart F income because the income is active and
    maintained in the local home country, but section 965 has a different
    focus. Section 965 seeks to determine, in part, the amount of aggregate
    earnings that are not freely distributable (and thus illiquid) so that
    an appropriate lower split-rate can apply to those illiquid earnings.
    Maintaining these home country limitations in section 965 would exclude
    earnings of insurance companies that are not freely distributable
    because of local regulatory requirements.

    Revisions to H.R. 1's language under section 965(c)(2)(B) for
    determining the cash portion have been provided to Senate Finance
    Committee staff.

        b.  Netting entities with positive and negative E&P pools as part
    of the transition to a new territorial tax system

    Since foreign insurance companies are per se corporations for U.S. tax
    purposes, and are subject to local regulatory requirements, we cannot
    avail ourselves of the ability to create larger or combined entities
    via check the box elections, and we face regulatory restrictions on
    whether and how we can organize or restructure our regulated entities
    to similarly combine companies having positive accumulated E&P with
    others having E&P deficits. This is important for purposes of the
    transition tax on previously untaxed foreign earnings.

    The Camp bill appropriately allowed for the netting of positive and
    negative earnings so that the one-time tax is applied to net E&P. In so
    doing, however, the Camp bill effectively put a limit on the amount of
    foreign tax credits that could be utilized as part of this process,
    potentially imposing double tax on some of the earnings subject to the
    transition tax simply because positive and negative E&P pools are
    allowed to be netted. Groups with no foreign subsidiaries having
    negative E&P would not face this haircut on their foreign tax credits,
    and those that are able to combine foreign CFCs through self-help would
    also not be subject to the haircut. In addition, the Camp bill failed
    to take account of so-called trapped foreign tax credits relating to
    CFCs that paid foreign taxes in years when they had positive earnings
    but happen to have a negative E&P pool at the time of the effective
    date of the transition tax. These trapped credits should also be
    allowed to be utilized; otherwise, they would never be allowed to be
    utilized going forward in the new territorial system.

    Another oversight in the Camp bill is that the netting of positive and
    negative E&P was at the first-tier U.S. parent level and not at the
    consolidated U.S. parent level. Therefore, a U.S. consolidated group
    with two U.S. subsidiaries that have CFCs cannot net the E&P of all
    CFCs. The insurance industry is subject to foreign regulations that
    restrict the ability of the U.S. group to own all CFCs by the same U.S.
    entity.

    Proposal: The amount of E&P and foreign tax credits subject to the
    deemed repatriation tax should be calculated on a ``one-CFC basis,'' so
    that all of the foreign entities owned by members of a U.S. group are
    treated as a single foreign corporation. Under such a proposal, the
    aggregate amount of foreign earnings subject to the tax would be
    reduced by any earnings deficits. In addition, the pool of foreign
    taxes deemed to have been paid in respect of those earnings would be
    all taxes paid by companies whose earnings deficits were taken into
    account in determining the amount deemed to have been repatriated.

        c.  The AFE rules should be reformed to allow related-party
    reinsurance premiums to qualify

    An insurer's business is to accept others' risks and manage, under the
    supervision of regulators, the cost of maintaining sufficient capital
    to bear those risks. Insurers manage exposure to these risks by pooling
    and diversifying risks (often through reinsurance), and by aligning
    investment strategies with potential insurance liabilities. While
    reinsurance is a key function for an insurance company, U.S. tax law
    discourages the ability of U.S.-based global insurance companies to
    pool and diversify risks of their foreign affiliates by reinsuring
    risks to affiliated companies. It does so by treating premiums paid
    between affiliates in order to reinsure contracts as premium income
    that is taxed currently by the United States; the income is not
    eligible for deferral under the AFE rules. This restriction runs
    counter to international norms, sound business practice, the way in
    which our global competitors operate their global insurance businesses
    and the expectation of regulators. Pooling risk allows an insurance
    company to hold less capital as a result of the diversification of risk
    and manage investments in a more efficient manner.

    Proposal: As part of the reform of the U.S. international tax rules,
    this restriction in the AFE rules should be fixed. Specifically,
    reinsurance premiums should be exempt from Subpart F as long as the
    reinsurer is a regulated insurance company, the related insurance
    company paying the reinsurance premium qualified under the AFE rules,
    and the insurance contract being reinsured was treated as qualifying
    and thus an exempt contract under the AFE. By limiting this rule to
    exempt contracts, the reinsurance of U.S. risks will continue to be
    subject to Subpart F. The Framework includes rules to protect the U.S.
    tax base by including a minimum tax on the foreign profits of U.S.
    multinational companies. To the extent the change in the AFE rules that
    we are suggesting in regards to related party reinsurance transactions
    outside the United States, it may be appropriate to apply such a
    minimum tax to premium income related to reinsurance that qualifies for
    this modified AFE treatment.

        d.  Modernize and simplify rules for calculating reserves of
    qualifying foreign insurance companies

    Under the AFE rules, foreign subsidiaries of U.S. life insurance
    companies must use U.S. tax principles to calculate reserves for
    purposes of determining the amount of investment income that qualifies
    under the AFE, rather than using the actual amount of local country
    reserves. This recalculation requirement was originally designed as an
    anti-abuse rule, to prevent companies from aggressively overstating
    local country reserves in order to maximize the amount of investment
    income that could be subject to deferral from U.S. tax. However, in
    significant foreign markets subject to developed and modern insurance
    regulation and oversight, this requirement is too restrictive and
    overly complex. It fails to take account of the capital requirements
    that insurance companies must satisfy in order to operate a business
    competitively in a local jurisdiction. Moreover, since the financial
    crisis of 2008, foreign regulators are using or moving towards a risk-
    based capital approach, wherein an insurance company's required capital
    is evaluated and measured taking into account the types of risks it has
    assumed (by looking at net premiums written--total premiums less
    reinsurance that has been ceded--in the local country and loss
    reserves). Then, the overall capital of the local company, including
    reserves and policyholder surplus, is taken into account to determine
    the company's risk-based capital position.

    Thus, the level of regulatory capital that is required to be retained
    in a country, and that cannot be repatriated, is different from the
    level based on a calculation of reserves utilizing U.S. tax principles.

    Present law does provide some relief for U.S. life insurance companies,
    by authorizing the Secretary to permit U.S. life insurance companies to
    request a ruling from the IRS to use foreign statement reserves.
    However, the ruling process is limited and is tremendously time
    consuming for both the IRS and taxpayers.

    Proposal: Congress should further encourage the IRS to provide more
    generally applicable guidance that would apply on a country-by-country
    basis to allow local country reserves or capital requirements to be
    utilized for purposes of calculating the investment income that would
    be exempt from subpart F. Alternatively, the guidance could approve
    common reserving methods that the IRS has already reviewed and approved
    via the ruling process. The guidance would be issued only after the
    industry demonstrates to the satisfaction of the Secretary that
    adequate evidence exists that the local country regulator and
    regulation is robust and meaningful or that the reserving method is
    commonly accepted.

        e.  Anti-base erosion proposals and the AFE rules

    The AFE rules define an active foreign insurance company for U.S. tax
    purposes and would define insurance income qualifying for a new
    dividend exemption system if the Subpart F rules were retained. The AFE
    rules are robust and restrictive, requiring qualifying income to have a
    significant nexus to the country where the CFC is organized or does
    business. We understand the need for anti-base erosion measures as part
    of a reformed international tax system. For our industry, the AFE rules
    serve that purpose; it would be unnecessary and overly complicated to
    apply another layer of restrictive rules to income that is already
    qualifying under the AFE, such as a minimum tax (except in the case of
    premiums related to reinsurance between affiliates, as noted in the AFE
    reform proposal related to reinsurance, suggested above).

    Proposal 1: Any minimum tax that is imposed on earnings of a CFC that
    would otherwise qualify for the territorial system should exclude from
    its base earnings that already qualify under the AFE rules.

    Proposal 2: If a minimum tax were to apply to our industry, such a tax
    would create tremendous anomalies unless it was computed on a global
    basis, as is suggested by the Framework, rather than on a CFC-by-CFC
    basis, as was the case with ``Option C'' in the final 2014 Camp bill.
    That bill raised the following issues:

          The tax base for determining Option C was earnings that exceed
    10% of the basis in the entity's tangible property. In an attempt to
    capture more mobile income including intangibles related income, this
    definition also captured the earnings of an entity with little or no
    tangible assets, including financial services companies. Option C
    failed to recognize that an insurance company's tangible asset and
    brick and mortar is its cash and investments that support its
    regulatory required reserves and capital.

          The CFC-by-CFC effective tax rate calculation requiring the use
    of U.S. tax concepts to compute the effective tax rate for the entity
    was never fleshed out in detail. For insurance companies, however, it
    is clear that there would be cases in which companies that pay a high
    effective tax rate in a local country would still suffer a minimum tax.
    This is because of significant differences in the calculation of
    taxable income between U.S. tax rules and local country tax rules, with
    the most likely differentiator being the calculation of insurance
    reserves and the timing of recognition of gains and losses on
    investments.

                                     ______

                      A. Philip Randolph Institute et al.

      100 GROUPS OPPOSING A TERRITORIAL TAX SYSTEM PROPOSED BY PRESIDENT
                          TRUMP AND REPUBLICAN LEADERS

    October 2, 2017

    Dear Member of Congress:

    We urge you to reject a proposal to give U.S. multinational
    corporations a huge tax break for sending jobs offshore and a huge
    loophole to help them avoid paying taxes.

    President Trump and Republican leaders in Congress want to allow
    multinational corporations to pay no U.S. taxes on their offshore
    profits. This is called a ``territorial tax system.''

    It is an incredibly bad idea. Ending taxation of offshore profits would
    give multinational corporations an incentive to send jobs offshore,
    thereby lowering U.S. wages. It would also be a giant loophole for
    corporations to use accounting gimmicks to move their profits to tax
    havens, resulting in the loss of billions of dollars in tax revenue for
    the United States.

    Ending taxation of offshore profits would rig the rules in favor of
    multinational corporations, give them a competitive advantage over
    domestic businesses, and make our tax system more complicated.

    We cannot afford to give multinational corporations a giant loophole to
    avoid paying their fair share of taxes at a time when we need more
    revenue to create jobs rebuilding infrastructure, educating our
    children, expanding healthcare coverage, researching new medical cures,
    and ensuring a secure retirement.

    Voters are unalterably opposed to a territorial tax system. Three-
    quarters of Americans say they would oppose a tax system that does not
    tax offshore profits. A June 2017 Hart Research poll found that 32
    percent of respondents believe that foreign profits of U.S.-based
    companies should be taxed at a higher rate than their U.S. profits
    while another 40 percent believe they should be taxed at the same rate.
    Only 8 percent believe foreign profits should be taxed at a lower rate,
    and only 4 percent said they should not be taxed at all--which is what
    a territorial tax system would do.

    Please see this fact sheet (http://bit.ly/2hCiVn9) from the Institute
    on Taxation and Economic Policy for a more detailed explanation of why
    a ``territorial tax system'' would rig the rules for multinational
    corporations and against American businesses and working people.

    We urge you to reject this terrible idea.

    Sincerely,

    A. Philip Randolph Institute
    ActionAid USA
    Agenda Project
    Alliance for Retired Americans
    Amalgamated Transit Union
    American Family Voices
    American Federation of Government Employees (AFGE)
    American Federation of Labor and Congress of Industrial Organizations
    (AFL-CIO)
    American Federation of Musicians of the United States and Canada
    American Federation of State, County, and Municipal Employees (AFSCME)
    American Federation of Teachers
    Americans for Democratic Action (ADA)
    Americans for Tax Fairness
    Asia Initiatives
    Asian Pacific American Labor Alliance
    As You Sow
    Brotherhood of Railroad Signalmen
    Campaign for America's Future
    Center for Biological Diversity
    Center for Community Change
    Center for Popular Democracy
    Center of Concern
    Citizens' Environmental Coalition
    Coalition of Black Trade Unionists
    Coalition of Labor Union Women
    Coalition on Human Needs
    Communications Workers of America
    Congregation of Our Lady of Charity of the Good Shepherd, U.S.
    Provinces
    Demand Progress
    Earth Action, Inc.
    EG Justice
    Economic Policy Institute Policy Center
    Fair Share
    Financial Accountability and Corporate Transparency (FACT) Coalition
    Financial Transparency Coalition (FTC)
    Fix Democracy First
    Food and Water Watch
    Franciscan Action Network
    Friends of the Earth
    Global Financial Integrity
    Health Care for America NOW!
    Hip Hop Caucus
    I.A.T.S.E., International Alliance of Theatrical Stage Employees
    Institute for Agriculture and Trade Policy
    Institute for Policy Studies--Inequality Program
    Institute on Taxation and Economic Policy
    International Association of Machinists and Aerospace Workers
    In ternational Association of SMART, Sheet Metal, Air, Rail, and
    Transportation Workers
    International Brotherhood of Boilermakers
    International Brotherhood of Teamsters
    International Corporate Accountability Roundtable (ICAR)
    International Federation of Professional and Technical Engineers
    (IFPTE)
    International Labor Rights Forum (ILRF)
    International Longshoremen's Association
    In ternational Union, United Automobile, Aerospace, and Agricultural
    Implement Workers of America, UAW
    Islamic Society of North America
    Jobs with Justice
    Jubilee USA Network
    Main Street Alliance
    MomsRising
    National Advocacy Center of the Sisters of the Good Shepherd
    National Education Association
    National Employment Law Project
    National Federation of Federal Employees
    National Organization for Women
    National Priorities Project
    National Women's Law Center
    NETWORK Lobby for Catholic Social Justice
    New Rules for Global Finance
    Other98
    Our Revolution
    Oxfam America
    Patriotic Millionaires
    Pax Advisory
    People Demanding Action
    People's Action
    Power Shift Network
    Pride at Work
    Progressive Change Campaign Committee
    Progressive Congress Action Fund
    Public Citizen
    Responsible Wealth
    Revolving Door Project
    Rights and Accountability in Development (RAID)
    RootsAction.org
    Service Employees International Union
    Social Security Works
    Tax Justice Network USA
    Tax March
    The Hedge Clippers
    The Language of Connection
    The Leadership Conference on Civil and Human Rights
    Unitarian Universalist Legislative Action Network
    United Food and Commercial Workers International Labor Union
    United for a Fair Economy
    United Steelworkers (USW)
    UNITE HERE
    Wall-of-Us
    Woodstock Institute
    Working America
    Worksafe

                                     ______

               Association of Americans Resident Overseas (AARO)

                               4 rue de Chevreuse

                              75006 Paris, France

                            Tel: +33 (0)1 4720 2415

                             Website: www.aaro.org

                             Email: contact@aaro.org

    14 October 2017

    Senate Committee of Finance
    Dirksen Senate Office Bldg.
    Washington, DC 20510-6200
    U.S.A.

    Re: 3 October 2017 Full Committee Hearing on ``International Tax
    Reform''

    Dear Chairman Hatch and other Committee Members,

    On behalf of the Association of Americans Resident Overseas (AARO), I
    wish to make the following statement for the record with regard to the
    3 October 2017 full committee hearing on ``International Tax Reform.''

    The full committee hearing on tax reform was an important step in the
    on-going effort to carry out reform of the United States' international
    tax system. The focus of this hearing was on taxation of corporations.
    In his opening statement, Chairman Hatch touched on a number of
    problems with the existing system. He then said this:

            All of these problems are key for today's hearing because they
            highlight the shortcoming of our outdated worldwide tax system.

            The solution to these and other problems, to put it very
            simply, is to transition to a territorial-based system like
            virtually all of our foreign competitors. Under such a system,
            an American company would owe taxes only on income earned in
            the United States. Income earned in foreign jurisdictions would
            only be taxed by those jurisdictions, not here.

    Chairman Hatch then added:

            Finally, as many of you know, I've been interested for some
            time in the idea of better integrating our individual and
            corporate tax systems.

    AARO agrees with Chairman Hatch that international tax reform should
    include individual taxation. AARO's position on individual
    international tax reform, as stated on our website, is this:

    TAXATION: We believe that the United States puts itself at a
    competitive disadvantage by taxing its citizens abroad on the basis of
    their nationality. The ability to send an employee abroad to manage,
    direct, instructor train the employees of a foreign subsidiary is
    crucial to successful competition in today's global economy. The U.S.
    should put U.S. persons on a par with citizens of other countries and
    adopt Residence-Based Taxation (RBT). The current system of
    Citizenship-Based Taxation (CBT) imposes the risk of double taxation on
    people already taxed in the countries where they live and work. In
    addition, the compliance costs for U.S. persons abroad are as daunting
    as the enforcement costs for the IRS.

    The Trump administration's interest in reforming taxation so as to
    create more jobs for Americans is best served by creating more jobs for
    Americans not only within the United States but also overseas.
    Switching from citizenship-based taxation of U.S. citizens to
    territorial-based taxation would put Americans interested in working
    overseas on an ``even playing field'' and would encourage U.S.
    companies operating overseas to hire more Americans.

    It is a shame when Americans qualified for overseas executive
    positions, special skills positions or other good jobs are passed over
    by U.S. companies in order to avoid the cost of grossing up salaries
    and/or making double declarations. Had Americans been hired for these
    jobs rather than foreigners, a good deal of their earnings would sooner
    or later flow back to America; a large proportion of Americans overseas
    have close relatives Stateside and plan to retire back in their
    homeland.

    As Chairman Hatch concluded in his opening statement, ``International
    tax reform is an area that is rife for bipartisanship.'' As a non-
    partisan group of U.S. citizens living and working around the world,
    AARO urges all members of the Committee to include territorial-based
    taxation of American individuals as an essential part of the reform.

    I thank you for your attention and would be most happy to discuss this
    with the Committee staff if there are any questions or concerns.

    Sincerely yours,

    Neil Kearney
    President, Association of Americans Resident Overseas

                                     ______

                            Center for Fiscal Equity

                        Statement of Michael G. Bindner

    Chairman Hatch and Ranking Member Wyden, thank you for the opportunity
    to submit these comments for the record to the Committee on Finance. As
    usual, we will preface our comments with our comprehensive four-part
    approach, which will provide context for our comments.

          A Value-Added Tax (VAT) to fund domestic military spending and
    domestic discretionary spending with a rate between 10% and 13%, which
    makes sure very American pays something.
          Personal income surtaxes on joint and widowed filers with net
    annual incomes of $100,000 and single filers earning $50,000 per year
    to fund net interest payments, debt retirement and overseas and
    strategic military spending and other international spending, with
    graduated rates between 5% and 25%.
          Employee contributions to Old-Age and Survivors Insurance (OASI)
    with a lower income cap, which allows for lower payment levels to
    wealthier retirees without making bend points more progressive.
          A VAT-like Net Business Receipts Tax (NBRT), which is
    essentially a subtraction VAT with additional tax expenditures for
    family support, health care and the private delivery of governmental
    services, to fund entitlement spending and replace income tax filing
    for most people (including people who file without paying), the
    corporate income tax, business tax filing through individual income
    taxes and the employer contribution to OASI, all payroll taxes for
    hospital insurance, disability insurance, unemployment insurance and
    survivors under age 60.

    Attacking unions for the past 30 years has taken its toll on the
    American worker in both immigration and trade. That has been
    facilitated by decreasing the top marginal income tax rates so that
    when savings are made to labor costs, the CEOs and stockholders
    actually benefit. When tax rates are high, the government gets the cash
    so wages are not kept low nor unions busted. It is a bit late in the
    day for the Majority to show real concern for the American worker
    rather than the American capitalist or consumer. The current plan will
    make things worse.

    Reversing the plight of the American worker will involve more than
    trade, but we doubt that the Majority has the will to break from the
    last 30 years of tax policy to make worker wages safe again from their
    bosses. Sorry for being such a scold, but the times require it.

    The main international impact in our plan is the first point, the
    value-added tax (VAT). This is because (exported) products would shed
    the tax, i.e., the tax would be zero rated, at export. Whatever VAT
    congress sets is an export subsidy. Seen another way, to not put as
    much taxation into VAT as possible is to enact an unconstitutional
    export tax.

    The second point, the income and inheritance surtax, has no impact on
    exports. It is what people pay when they have successfully exported
    goods and their costs have been otherwise covered by the VAT and the
    Net Business Receipts Tax/Subtraction VAT. This VAT will fund U.S.
    military deployments abroad, so it helps make exports safe but is not
    involved in trade policy other than in protecting the seas.

    The third point is about individual retirement savings. As long as such
    savings are funded through a payroll tax and linked to income, rather
    than funded by a consumption tax and paid as an average, they will add
    a small amount to the export cost of products.

    The fourth bullet point is tricky. The NBRT/Subtraction VAT could be
    made either border adjustable, like the VAT, or be included in the
    price. This tax is designed to benefit the families of workers, either
    through government services or services provided by employers in lieu
    of tax. As such, it is really part of compensation. While we could run
    all compensation through the public sector and make it all border
    adjustable, that would be a mockery of the concept. The tax is designed
    to pay for needed services. Not including the tax at the border means
    that services provided to employees, such as a much-needed expanded
    child tax credit--would be forgone. To this we respond, absolutely
    not--Heaven forbid--over our dead bodies. Just no.

    The NBRT will have a huge impact on international tax policy, probably
    much more than trade treaties, if one of the deductions from the tax is
    purchase of employer voting stock (in equal dollar amounts for each
    worker). Over a fairly short period of time, much of American industry,
    if not employee-owned outright (and there are other policies to
    accelerate this, like ESOP conversion) will give workers enough of a
    share to greatly impact wages, management hiring and compensation and
    dealing with overseas subsidiaries and the supply chain--as well as
    impacting certain legal provisions that limit the fiduciary impact of
    management decision to improving short-term profitability (at least
    that is the excuse managers give for not privileging job retention).

    Employee-owners will find it in their own interest to give their
    overseas subsidiaries and their supply chain's employees the same deal
    that they get as far as employee-ownership plus an equivalent standard
    of living. The same pay is not necessary, currency markets will adjust
    once worker standards of living rise.

    Over time, this will change the economies of the nations' we trade
    with, as working in employee owned companies will become the market
    preference and force other firms to adopt similar policies (in much the
    same way that, even without a tax benefit for purchasing stock,
    employee-owned companies that become more democratic or even more
    socialistic, will force all other employers to adopt similar measures
    to compete for the best workers and professionals).

    In the long run, trade will no longer be an issue. Internal company
    dynamics will replace the need for trade agreements as capitalists lose
    the ability to pit the interest of one nation's workers against the
    others. This approach is also the most effective way to deal with the
    advance of robotics. If the workers own the robots, wages are swapped
    for profits with the profits going where they will enhance consumption
    without such devices as a guaranteed income.

    If Senator Sanders had been nominated and elected, this is the type of
    trade policy you might be talking about today. Although the staff at
    the Center supported the Senator, you can imagine some of us thought
    him too conservative in his approach to these issues, although we did
    agree with him on the $15 minimum wage. Economically, this would have
    had little impact on trade, as workers at this price point often
    generate much more in productivity than their wage returns to them.
    This is why the economy is slow, even with low wage foreign imports.
    Such labor markets are what Welfare Economics call monopsonistic
    (either full monopsony, oligopsony or monopsonistic competition--which
    high wage workers mostly face). Foreign wages are often less than the
    current minimum wage, however many jobs cannot be moved overseas.

    As we stated at the outset, the best protection for American workers
    and American consumer are higher marginal tax rates for the wealthy.
    This will also end the possibility of a future crisis where the U.S.
    Treasury cannot continue to roll over its debt into new borrowing.
    Japan sells its debt to its rich and under-taxes them. They have a huge
    Debt to GDP ratio, however they are a small nation. We cannot expect
    the same treatment from our world-wide network of creditors, an issue
    which is also very important for trade. Currently, we trade the
    security of our debt for consumer products. Theoretically, some of
    these funds should make workers who lose their jobs whole--so far it
    has not. This is another way that higher tax rates and collection (and
    we are nowhere near the top of the semi-fictitious Laffer Curve) hurt
    the American workforce. Raising taxes solves both problems, even though
    it is the last thing I would expect of the Majority.

    We make these comments because majorities change--either by deciding to
    do the right thing or losing to those who will, so we will keep
    providing comments, at least until invited to testify.

    Thank you for the opportunity to address the committee. We are, of
    course, available for direct testimony or to answer questions by
    members and staff.

                                     ______

                                Democrats Abroad

                                 P.O. Box 15130

                              Washington, DC 20003

                                      USA

                            www.democratsabroad.org

                             www.votefromabroad.org

    U.S. Senate
    Committee on Finance
    Dirksen Senate Office Building
    Washington, DC 20510-6200

    October 3, 2017

    Re: Senate Finance Committee hearing on ``International Tax Reform''

    Dear Chairman Hatch, Ranking Member Wyden, and all Members of the
    Committee, Democrats Abroad greatly appreciates you holding this
    important hearing on international tax reform and allowing for
    stakeholders to submit testimony into the record. Like you, Democrats
    Abroad believes that comprehensive tax reform is long overdue for
    middle-class Americans, working-class families, small businesses, job
    creators, and especially so for American taxpayers living and working
    abroad.

    As you know, millions of U.S. citizens reside overseas, normally for
    family reasons, but also for work, education or adventure. As
    Americans, we are all subject to tax-filing requirements in both our
    country of residence and to the U.S. even though our use of the
    services provided by our federal taxes is comparably negligible.
    Furthermore, the U.S. is only one of two countries in the world still
    taxing non-resident citizens based on the outdated system of
    citizenship-based taxation.

    Fortunately, with Congress and the Administration ready to move forward
    together on the most significant tax reform in three decades, we
    believe that lawmakers are presented with an ideal opportunity to
    correct this injustice to Americans abroad and restore fairness to the
    taxation playing field.

    Democrats Abroad joins the rest of the Americans abroad community in
    our strong support for a tax reform package which includes:

      Reforms to the U.S. tax code which reduce inequality, boosts
    opportunity, and raises revenue to meet public demands primarily from
    those with the greatest ability to pay;
      Residency-based taxation as a replacement for the current system of
    citizenship-based taxation;
      Safeguards to prevent tax abuse by those seeking to hide offshore
    income;
      Relief from foreign financial account reporting for Americans abroad
    genuinely residing in their country of residence;
      Simplified and improved tax filing for Americans living abroad; and
      Deficit-neutrality and revenue-neutrality to ensure tax cuts are
    fully paid for and Congress does not add to our nation's existing debt.

    Itai Grinberg, your witness in today's hearing, previously wrote a
    paper on international taxation in which he stated, ``It is
    inappropriate for regulatory rules to make it difficult for [Americans
    living abroad] to maintain residence country financial accounts.'' \1\
    We strongly agree with Mr. Grinberg's assessment in that everyday
    Americans abroad experience financial hardship which results in not
    being able to save for retirement or utilize financial services in the
    same manner as Americans living within U.S. borders.
    ---------------------------------------------------------------------------
        \1\  Grinberg, Itai, 2012, ``Beyond FATCA: an evolutionary moment
    for the international tax system,'' 27 January, Georgetown University
    Law Center, p. 59. http://scholarship.law.
    georgetown.edu/cgi/viewcontent.cgi?article=1162&context=fwps_ papers.

    Although we are disappointed that the Senate has decided to advance the
    FY18 budget resolution with reconciliation instructions on tax reform,
    we are encouraged by this hearing that all perspectives will be
    ---------------------------------------------------------------------------
    considered by the Senate in crafting tax legislation.

    Thank you for your consideration of this submission for inclusion into
    the hearing record. If you or your staff have any questions regarding
    this letter or if you would like to discuss an expanded outline of our
    tax reform recommendations, please feel free to contact me or Ms
    Carmelan Polce, Chair of the Democrats Abroad Taxation Task Force, at
    cpolce@tpg.com.au.

    Respectfully submitted,

    Julia Bryan
    International Chair, Democrats Abroad
    E-mail: chair@democratsabroad.org
    Phone: (843) 628-2280

                                     ______

                                 FACT Coalition

                          1225 Eye St., NW, Suite 600

                              Washington, DC 20005

                               +1 (202) 827-6401

                                 @FACTCoalition

                            www.thefactcoalition.org

    October 3, 2017

    The Honorable Orrin Hatch
    Chairman
    U.S. Senate
    Committee on Finance
    219 Dirksen Senate Office Building
    Washington, DC 20510-6200

    The Honorable Ron Wyden
    Ranking Member
    U.S. Senate
    Committee on Finance
    219 Dirksen Senate Office Building
    Washington, DC 20510-6200

    RE: October 3rd hearing on ``International Tax Reform''

    Dear Chairman Hatch and Ranking Member Wyden, we are writing on behalf
    of the Financial Accountability and Corporate Transparency (FACT)
    Coalition to thank you for holding a public hearing on the
    international aspects of tax reform and to offer our recommendations on
    how to improve the American tax system.

    The FACT Coalition is a non-partisan alliance of more than 100 state,
    national, and international organizations working toward a fair tax
    system that addresses the challenges of a global economy and promoting
    policies to combat the harmful impacts of corrupt financial
    practices.\1\
    ---------------------------------------------------------------------------
        \1\ For a full list of FACT Coalition members, visit https://
    thefactcoalition.org/about/coalition-members-and-supporters/.

    While the problems with the tax code span across many areas, we
    especially appreciate this hearing's focus on updating our
    international tax system and reforming the tax code so that it
    strengthens American business. The tax treatment of multinational
    corporations is one of the areas of the tax code most in need of
    substantial reform. In fact, a prominent tax economist estimates that
    up to $135 billion is lost each year to offshore corporate tax
    avoidance.\2\ The ability of companies to defer paying taxes on their
    offshore earnings has allowed them to accumulate a stunning $2.6
    trillion in earnings ``offshore'' on which they are avoiding $750
    billion in taxes.\3\
    ---------------------------------------------------------------------------
        \2\ Kimberly A. Clausing, ``Profit shifting and U.S. corporate tax
    policy reform,'' Washington Center for Equitable Growth, May 2016,
    http://equitablegrowth.org/report/profit-shifting-and-u-s-corporate-
    tax-policy-reform/.
        \3\ Institute on Taxation and Economic Policy, ``Fortune 500
    Companies Hold a Record $2.6 Trillion Offshore,'' March 28, 2017,
    https://itep.org/fortune-500-companies-hold-a-record-26-trillion-
    offshore/.

    Allowing multinational corporations to continue to engage in large-
    scale offshore tax avoidance hurts small and wholly domestic
    businesses. Every dollar companies avoid in taxes must be paid in one
    form or another. On the one hand, offshore tax avoidance means that we
    are short on the revenue to make needed public investments in things
    like infrastructure, education, and health care that make our economy
    competitive over the long term. On the other hand, small and domestic
    businesses are disadvantaged because they are the ones left picking up
    the tab for all the tax avoidance by their multinational competitors.
    In fact, one study found that the total potential burden on small
    businesses for the cost of federal tax avoidance could be as high as
    $4,481 per company on average.\4\
    ---------------------------------------------------------------------------
        \4\ Alexandria Robins and Michelle Surka, ``Picking Up the Tax
    2016,'' U.S. PIRG, November 29, 2016, http://www.uspirg.org/reports/
    usp/picking-tab-2016.

    We, as a coalition, believe that any tax reform effort should take four
    critical steps to dramatically cut back on the gaming by
    ---------------------------------------------------------------------------
    multinationals.

    1. Stop Giving Multinationals an Advantage over Wholly Domestic and
    Small Businesses

    We should immediately close the loophole that allows companies to defer
    paying taxes by moving their profits offshore. As U.S. citizens, you
    and I--and every domestic company--pay taxes on what we earn,
    regardless of where we earn it. None of us can defer our tax
    obligations. But multinational companies can create foreign
    subsidiaries, divide themselves in ways that game the system, and defer
    paying all or most of the taxes due on their foreign earnings. It's not
    fair, and it's anti-
    competitive. They use our roads and bridges to ship their goods,
    recruit from our colleges and universities, and are protected by our
    laws and our military. They should not, through loopholes and
    accounting gimmicks, defer paying their share and leave the rest of us
    to pick up the tab.

    Also, we should not favor multinationals over wholly domestic and small
    businesses by giving them a special rate. Shockingly, some--including
    the so-called ``Big Six''--have proposed a lower tax rate for those
    companies that shift jobs and money overseas.\5\ That makes no sense.
    ---------------------------------------------------------------------------
        \5\ Speaker Ryan Press Office, ``Unified Framework for Fixing our
    Broken Tax Code,'' Office of the Speaker of the House, September 27,
    2017, https://www.speaker.gov/sites/speaker.
    house.gov/files/Tax%20Framework.pdf.

    2. Stop U.S. Companies From Claiming Foreign Residence Simply to Dodge
    ---------------------------------------------------------------------------
    Taxes

    Some large U.S. companies buy up smaller, foreign companies, move their
    legal residence to one of the tax haven countries (a paper transaction,
    no moving van required) and claim they are no longer U.S. residents to
    avoid paying taxes. They still have access to our markets and many of
    the privileges they enjoyed as U.S. companies, but stop paying the
    taxes needed to support that access. That means you and I are left
    paying their share. We should strengthen ``anti-inversion'' and
    earnings stripping rules to prevent that type of gaming.

    3. Ensure Multinationals Play by the Rules by Publicly Reporting Their
    Profits and Taxes Paid

    Multinational companies do not publicly report on where they are making
    their money or what taxes they are paying to whom. We have no idea
    exactly how they are gaming the system--what they tell us versus what
    they tell other countries. They should have to write it down in one
    place and report it on a country-by-country basis, so that the public
    can see what they are really paying.\6\
    ---------------------------------------------------------------------------
        \6\ The FACT Coalition, ``FACT Sheet: Public Country-by-Country
    Reporting,'' September 27, 2017, http://thefact.co/aldnl.
    ---------------------------------------------------------------------------

    4. Don't Make Things Worse

    Our current system allows U.S. companies to delay paying taxes on U.S.
    profits they shift overseas. That's bad enough. Some in Congress have
    proposed allowing the profit-shifting without ever having to pay what
    they owe. That's the ultimate loophole. If we move toward what's called
    a ``territorial tax system,'' which really means giving multinational
    corporations a zero tax on profits they shift abroad, the only
    companies left paying U.S. corporate income taxes would be those too
    small to game the system. It also means that multinational companies
    would face an incentive to offshore jobs to countries with lower tax
    rates than the U.S. That is why more than 100 organizations sent a
    letter to Congress on Monday urging legislators to reject a
    ``territorial tax system.'' \7\
    ---------------------------------------------------------------------------
        \7\ Clark Gascoigne, ``Over 100 Organizations Urge Congress to
    Reject Giant Tax Loophole for Offshoring and Tax Avoidance,'' The FACT
    Coalition, October 2, 2017, http://thefact.co/3Kzko.

    If there is one thing that policymakers, the media, and the public can
    agree on, it is that the tax code is long overdue for a substantial
    overhaul. We appreciate the diligent work you and committee staff have
    put into exploring these issues and hope to work with you moving
    ---------------------------------------------------------------------------
    forward on tax reform.

    For additional information, please contact Clark Gascoigne at
    cgascoigne@
    thefactcoalition.org or Richard Phillips at rphillips@itep.org.

    Sincerely,
    Gary Kalman
    Executive Director

    Clark Gascoigne
    Deputy Director

    Richard Phillips
    Policy and Communications Co-Chair

                                     ______

                        Letter Submitted by Gina M. Hunt
    October 1, 2017

    U.S. Senate
    Committee on Finance
    Dirksen Senate Office Bldg.
    Washington, DC 20510-6200

    RE:  Full committee hearing, ``International Tax Reform,'' October 3,
    2017

    Dear Sirs and Madams,

    I am writing you today to request that you consider changing
    international tax laws governing American citizens living abroad, not
    just those governing American businesses and corporations abroad. I
    don't imagine that you have any idea what it is like for the 9,000,000
    of us, so I respectfully request that you read and consider every
    communication sent to you from one of us.

    I earned a salary of just over =50,000 last year and paid 40% of that
    in French taxes. That means that I netted somewhere around $35,000
    USD--way, way, way under your salary, I am certain. I point this fact
    out because I need you to realize that I am not a rich person living
    abroad but a middle-class one. I own no home anywhere and have very
    little in total assets. And yet, I am required to file taxes in the
    U.S. every year because of citizen-based taxation. I also have my
    meager French bank accounts reported to the U.S. Government every year
    because of FATCA.

    I never owe anything in U.S. taxes, but the paperwork is complicated
    nonetheless. It is costly to have it completed correctly, and that's
    the least of the problems with these issues. If I were to make twice as
    much as I make now, I still would not be rich, and yet, I would have to
    pay income taxes on some of that income in both France and in the U.S.
    How can that be justified? It can't. And citizens who are unaware of
    the requirement to file or citizens who don't file for any reason can
    be fined outrageous fines even though they owe nothing in U.S. taxes.
    That is simply abusive.

    As for FATCA, this is a clear violation of our 4th amendment rights,
    plain and simple. It is also the reason that 1 in 10 Americans living
    abroad cannot get a bank account, and that number is growing daily.
    Think about that for a minute. Could you function in your daily life
    without a bank account? Of course you couldn't.

    You see, the rich can get around these things. They can pay accountants
    and lawyers and find a way around anything they want to find a way
    around. The banks find a way around steep fines charged by the U.S.
    Government for reporting mistakes that they may make and the like by
    refusing to open bank accounts for Americans.

    But some Americans, those of us who are middle-class and who are the
    vast majority of Americans living abroad cannot afford to pay our way
    out of this noose that the U.S. Government has put around our necks and
    is tightening every day. So for the past several years, more and more
    Americans have renounced their American citizenship. In 2016, a record
    number of Americans renounced. Think about that for a minute. Record
    numbers of Americans renouncing citizenship. I never thought I'd see
    that day, and I am heartbroken that it is here. They aren't the rich,
    as some might have you believe. Again, the rich can get around
    oppressive regulations. These people are the backbone of America--the
    middle class, and they are renouncing citizenship because they feel
    that they have no other choice. This is nothing short of tragic.

    You have the opportunity to fix this nightmare imposed on us by the
    Obama administration. Repeal FATCA. It is not catching fat-cats; it is
    pushing middle-class Americans over the edge. Change the U.S., the only
    country in the world other than Eritrea to impose citizen-based
    taxation, to a system of residency-based taxation. We should pay taxes
    where we live, and believe me, we do, but citizen-based taxation and
    FATCA are cruel and unusual tax regulations that are punishing law-
    abiding, middle-class Americans just because they live outside of the
    U.S. We are the 9,000,000 unpaid ambassadors of the U.S. We are hard-
    working Americans. And we deserve a government that does not treat us
    as criminals and ignore our constitutional rights.

    Thank you.

    Regards,

    Gina M. Hunt

                                     ______

                       Investment Company Institute (ICI)

                               1401 H Street, NW

                           Washington, DC 20005-2148

                                  202-326-5800

                                  www.ici.org

    The Investment Company Institute (``ICI'') \1\ appreciates the
    opportunity to provide the Committee its comments regarding
    international tax reform. ICI applauds the Committee for its efforts to
    improve and simplify the tax code in a manner that spurs U.S. economic
    growth and job creation.
    ---------------------------------------------------------------------------
        \1\ The Investment Company Institute (ICI) is the leading
    association representing regulated funds globally, including mutual
    funds, exchange-traded funds (ETFs), closed-end funds, and unit
    investment trusts (UITs) in the United States, and similar funds
    offered to investors in jurisdictions worldwide. ICI seeks to encourage
    adherence to high ethical standards, promote public understanding, and
    otherwise advance the interests of funds, their shareholders,
    directors, and advisers. ICI's members manage total assets of US$20.5
    trillion in the United States, serving more than 100 million U.S.
    shareholders, and US$6.7 trillion in assets in other jurisdictions. ICI
    carries out its international work through ICI Global, with offices in
    London, Hong Kong, and Washington, DC.

    As the Committee is aware, an important component of any comprehensive
    tax reform initiative is updating our international tax system to make
    our nation more competitive in the global economy and to encourage
    ---------------------------------------------------------------------------
    foreign investment in the United States.

    ICI supports changes to the Internal Revenue Code (``Code'') that would
    increase foreign investment in U.S. regulated investment companies
    (``RICs''), more commonly known as mutual funds. Specifically, ICI
    proposes an investment vehicle that would encourage foreign investment
    in RICs by reducing the disparate tax treatment between U.S. and
    foreign funds and thereby allow RICs to compete more effectively with
    foreign funds for foreign investors.

    Foreign Investment in U.S. RICs Should Be Encouraged

    ICI strongly supports increasing the international competitiveness of
    U.S. mutual funds. Almost 47 percent of all mutual fund assets are held
    by U.S.-domiciled funds.\2\ The percentage of global fund industry
    assets held by U.S. funds, however, has declined as investment markets
    have globalized.
    ---------------------------------------------------------------------------
        \2\ https://www.ici.org/pdf/2017_ factbook.pdf, Table 65.

    Changes taking place in Asia, Europe, and elsewhere are providing many
    significant opportunities for growth in the asset management industry.
    ``Cross-border mutual funds'' (i.e., mutual funds that are domiciled in
    one country but offered for sale in other countries) have enjoyed
    explosive growth. At the end of 2016, there were more than 100,000
    foreign mutual funds and ETFs in existence, compared to fewer than
    10,000 mutual funds and ETFs domiciled in the United States.\3\ Today
    virtually no U.S. mutual fund is marketed or offered on a cross-border
    basis, even though many cross-border mutual funds invest in U.S.
    assets.
    ---------------------------------------------------------------------------
        \3\ Id., Table 66.

    The U.S. tax laws require U.S. mutual funds to distribute essentially
    all their income and gains on an annual basis to avoid double taxation.
    This distribution requirement creates a substantial barrier to
    marketing U.S. funds abroad because foreign investors incur a home-
    country tax when such income and gain is distributed to them. Foreign
    investors may also be subject to higher tax rates if their home country
    treats capital gain dividends paid by RICs as dividends that are not
    eligible for preferential capital gains tax rates. Many foreign funds,
    in contrast, are permitted to retain (or ``roll up'') their income
    without either current taxation of the fund or any obligation to
    ---------------------------------------------------------------------------
    distribute the income to investors.

    U.S. mutual funds could compete effectively against foreign mutual
    funds if they were not required to distribute their income currently to
    their foreign investors. U.S. products would offer several advantages
    to foreign investors. First, the size and sophistication of U.S. funds
    allow them to invest more efficiently and operate at lower cost than
    their smaller foreign counterparts. Second, the protection afforded by
    U.S. securities regulation is considered state of the art, including in
    particular the protections afforded by the Investment Company Act of
    1940. Third, the U.S. has a deep pool of highly skilled workers to run
    its investment products. Fourth, the U.S. already has underlying retail
    investment products in place for all major asset classes that would
    make the IRIC attractive to foreign investors.

    Investment Vehicle to Encourage Foreign Investment in U.S. RICs

    ICI proposes an investment product called an International Regulated
    Investment Company (``IRIC'') that is designed to reduce U.S. tax
    disadvantages that prevent U.S. mutual funds from competing effectively
    against foreign mutual funds. Prompt enactment of legislation creating
    IRICs is critical if U.S. mutual funds are to compete in the rapidly
    globalizing investment markets. If the IRIC proposal is not enacted,
    U.S. funds (particularly at small and medium sized fund companies) will
    continue to cede ground to foreign funds.

    The IRIC provides foreign investors with a feeder vehicle through which
    they can access a U.S. mutual fund without triggering certain negative
    tax consequences in their home countries. An IRIC would be a U.S.
    mutual fund that could be acquired only by foreign shareholders (only
    nonresident alien individuals and their foreign estates, and qualified
    foreign pension funds) and that would invest only in the shares of a
    single U.S. mutual fund that qualifies as a RIC under Subchapter M of
    the Internal Revenue Code. The IRIC would register with the Securities
    and Exchange Commission under the Investment Company Act of 1940.

    The IRIC would not be required to distribute its income or capital gain
    annually. IRIC investors, however, would effectively pay the same
    annual U.S. income tax as if they had invested directly in the RIC
    shares held by the IRIC. Instead of tax being collected on
    distributions by the RIC to the foreign investor, however, the tax
    would be paid by the IRIC on the distributions it receives from the
    underlying RIC. The tax rate applied to the IRIC's taxable income would
    be 30 percent (the current rate applied to taxable distributions, such
    as dividends, paid to foreign persons) or 15 percent (if all the IRIC's
    shareholders were entitled under applicable tax treaties with the U.S.
    to a rate of 15 percent or less) and the IRIC made a ``treaty IRIC''
    election to pay tax at that rate.

    Thus, the same U.S. tax revenue would be collected, but the foreign
    investor would not be subject to tax in his or her home country until
    the IRIC shares were sold (absent a current inclusion tax regime
    comparable to the PFIC regime in the U.S.). The RIC in which the IRIC
    invests would remain subject to the Internal Revenue Code's
    distribution requirements, as under present law.

    Conclusion

    ICI commends the Committee for its goal of modifying the international
    provisions of the Code in a manner that will improve U.S.
    competitiveness abroad and thereby enhance foreign investment in the
    U.S. The proposal that ICI advances is consistent with this goal and,
    if adopted, will increase foreign investment in U.S. RICs.

    ICI would be pleased to work with the Committee on the IRIC proposal or
    other legislation that would level the playing field so U.S. mutual
    funds are able to better compete in the rapidly globalizing investment
    markets.

                                     ______

                      Letter Submitted by Jeffery M. Kadet
    October 13, 2017

    U.S. Senate
    Committee on Finance
    Dirksen Senate Office Bldg.
    Washington, DC 20510-6200

    Dear Sirs:

    I respectively submit the attached memorandums. I would be please to
    respond to any questions that you might have.

    Yours very truly,

    Jeffery M. Kadet

                                     ______

                                 MEMORANDUM 1
                      CONCERNING INTERNATIONAL TAX REFORM

    Public discussion and what one sees in the press imply that some form
    of territorial tax system, perhaps with some safeguards to hold back
    profit shifting, is the only tax reform option to replace our present
    dysfunctional ``deferral'' system for taxing U.S. based multinational
    corporations. Maybe that's because 99% of the few persons who
    understand what ``deferral'' and ``territorial'' really mean work for
    either the multinationals (MNCs) that would benefit from adopting
    territoriality or the law, accounting and lobbying firms that are well
    paid to service the MNCs.

    As for the other 1%, those are mostly law school professors without
    lobbyists. (Full disclosure: The writer provided international tax
    advice for more than 30 years to MNCs and is now an adjunct faculty
    member teaching lawyers how to do likewise within a graduate Tax LLM
    program within a law school.)

    Some of the 1% strongly believe that a residence-based system for
    active business income is far far superior to the territorial system,
    even with safeguards built in.

    There are various terms that are used for residence-based systems. They
    include worldwide consolidation and worldwide full-inclusion. In short,
    the idea is to tax any U.S. headquartered group on all of its income
    currently at the home country tax rate, no matter in which country or
    in which subsidiary that income is earned. There are a few different
    approaches regarding how such a system could be implemented (e.g.,
    through subpart F income inclusions or through a consolidation
    computation), but that is not the purpose of this letter. Rather, the
    purpose of this letter is to set out in brief and concise terms why a
    residence-based system is vastly superior to a territorial system.\1\
    ---------------------------------------------------------------------------
        \1\ This memorandum is intentionally short and concise. For more
    detailed discussion, please see ``U.S. Tax Reform: Full-Inclusion Over
    Territorial System Compelling,'' 139 Tax Notes 295 (April 15, 2013),
    available at SSRN: http://ssrn.com/abstract=2275488.

    The chart below summarizes the content of this letter.

               Contrasting Territorial and Residence-Based Systems
    ------------------------------------------------------------------------
                                                             System Best
     Policy Issue      Territorial      Residence-Based     Accomplishing
                          System            System         Policy Objective
    ------------------------------------------------------------------------
    Competitivenes  A more level       Competitive       Territorial Psystem
     s: U.S. MNCs    playing field      disadvantage
     vs. foreign     but differences    for a few U.S.
     MNCs            will persist due   MNCs versus
                     to varying CFC     foreign MNCs
                     rules among
                     countries
    Competitivenes  Advantages of      More level        Residence-based
     s: U.S. MNCs    U.S. MNCs over     playing field     Psystem
     vs. pure U.S.   domestic
     domestic        corporations
     corporations    increase further
    Neutrality      Strong             Neutrality        Residence-based
     (including      encouragement to   achieved          Psystem
     the export of   move jobs,
     jobs)           activities, and
                     ownership of IP
                     from the U.S. to
                     overseas
    Simplification  CFC rules and      Real              Residence-based
                     subjective areas   simplification    Psystem
                     like transfer      through
                     pricing critical   elimination of
                     due to exemption   some
                     of foreign         problematic
                     earnings           subjective
                                        areas (e.g., no
                                        subpart F and
                                        TP less
                                        important)
    Broadening the  Narrowing the tax  True broadening   Residence-based
     tax base        base by            of the tax base   system
     (ability to     exempting          by making        This base
     generate tax    foreign earnings   currently         broadening can pay
     revenues)       from any federal   taxable all       for corporate rate
                     tax                foreign           reduction
                                        earnings
                                        whether
                                        repatriated or
                                        not
    Encouragement   Even stronger      Eliminated or     Residence-based
     of ``game       encouragement      significantly     system
     playing'' to    than presently     curtailed
     shift profits   exists under our
     from U.S. to    deferral system
     low-tax
     countries
    Lock-out        Not fully solved   Totally solved    Residence-based
     effect          if 95% dividend-                     system
                     received
                     deduction
                     mechanism used
    ------------------------------------------------------------------------

    What will a residence-based system accomplish?

    It promotes fair competition--``We need a level playing field with our
    foreign competitors.'' This is the rallying cry of the 99% as they
    argue for not only a lower corporate rate but also a territorial tax
    system. Yet an even more important competition issue is seldom
    mentioned. That is the present non-level playing field between U.S.
    corporations that operate solely within the U.S. and those that operate
    internationally.

    Say two U.S. companies manufacture a widget. One does it in
    Poughkeepsie while the other does it through a subsidiary in Singapore.
    The first has its profits taxed at 35% (or in the future some lower
    rate) plus NY State tax, while the second is taxed by Singapore at a
    much lower rate . . . maybe even zero. This unfairness will be much
    worse under a territorial system. A residence-based system would
    eliminate it. And frankly, this domestic-international fairness issue
    is the tax policy issue that is more important to make sure we get
    right.

    But what about the competition issue with foreign-based MNCs? Without
    meaning to be unkind, the continued whining of MNCs that competition
    justifies their paying little or no tax is simply a red herring. The
    roughly $3 trillion of accumulated overseas profits is powerful proof
    of this. And after the U.S. corporate tax rate is reduced to something
    within G20 norms, the competition issue will be completely put to rest.

    It broadens the tax base, allowing for a reduced rate--This is a ``no
    brainer.'' A territorial tax system eliminates billions from the tax
    base and puts more pressure on the remaining U.S. taxpayers. Sure, take
    away more depreciation and other benefits from domestic U.S. taxpayers
    to give tax-free treatment to MNCs that conduct substantial activities
    outside the U.S.

    A residence-based system broadens the base since foreign income now
    going untaxed becomes currently taxable. A broadened tax base supports
    the lower corporate tax rate that both political parties say they want.
    And, as noted above, this lower rate would make clear that there is no
    disadvantage faced by our MNCs from their foreign competitors.

    It reduces the incentive to export jobs--Remember those widgets
    manufactured in Poughkeepsie? The tax incentive to move those jobs to
    Singapore under our current deferral system would become even stronger
    under a territorial system. Under a residence-based system, this
    incentive to move operations and jobs overseas virtually disappears.

    It is neutral as to physical location and legal ownership--A tax system
    should not affect business decisions regarding the physical location of
    assets, personnel, and operations. Business factors such as being close
    to raw materials and/or customers, labor, and transportation costs,
    etc. should govern such decisions. The same can be said for the legal
    ownership of business operations and assets, importantly including high
    value intangibles (intellectual property).

    The deferral system we have now strongly encourages companies to
    transfer actual or economic ownership of valuable intangible property
    created in the U.S. to tax havens. It also encourages supply chain and
    other structures that allow MNCs to move the bulk of their operating
    profits out of the U.S. to foreign subsidiaries in zero or low tax
    locations that assume business risk and hold rights to the MNC's
    intellectual property. ``Transfer pricing'' concepts and rules are
    aggressively used to maximize profits in these tax haven locations and
    minimize profits in the countries where actual R&D, manufacturing, and
    sales activities take place.

    A territorial system will simply increase the motivation for the game
    playing that creates these convoluted legal and tax structures. A
    residence-based system, on the other hand, really approaches true
    neutrality. Under most circumstances, it should eliminate U.S. tax as a
    factor and allow business decisions to be made solely on the basis of
    relevant business factors.

    It can promote simplification--Simplification is a mixed bag. Depending
    on how a residence-based system is implemented, it could eliminate some
    very troublesome areas of the tax law (e.g., fewer transfer pricing
    issues and elimination of subpart F). A territorial system, for the
    most part, will leave in place the current complications and likely
    make them much worse. These complications are necessary to counteract
    the increased game playing that the territorial system incentivizes.

    It should be added here that the efforts of lobbyists to gut any
    safeguards against future profit shifting (e.g., stronger subpart F
    rules, a minimum tax, etc.) and the creativity of MNCs and their legal,
    accounting, and tax advisors to come up with new schemes mean that game
    playing under a territorial system will reach new heights. This will
    result in the exact opposite of any tax policy simplification goals.

    It completely solves the ``trapped cash'' problem--Under the deferral
    system, returning foreign earnings to the U.S. via dividends triggers
    the up to 35% U.S. tax (and sometimes foreign withholding taxes as
    well). As is well known, many MNCs have stockpiled billions of such
    low- or zero-taxed foreign earnings outside the U.S. and often maintain
    that those earnings are permanently invested outside the U.S. to
    provide higher earnings-per-share, higher stock prices, and higher
    equity-based compensation for CEOs and other executives.

    A territorial system should eliminate the trapped cash issue. However,
    a territorial system such as those presented in prior years \2\
    unbelievably fails to do this. The mechanism that was chosen (a 95%
    dividend-received deduction) would continue to cause actual dividends
    to trigger tax to the extent of the 5% taxable portion.\3\ This may
    seem small. It will, though, impede dividend payments and continue the
    trapped cash problem. This issue is fixable if Congress decides on a
    100% dividend received deduction. If it does so, though, it must at the
    same time put in strong rules to deny any tax deduction for interest
    costs and all other expenses that are directly or indirectly
    attributable to foreign investment or foreign business, the profits of
    which would be exempt under the territorial system. Getting back to
    simplification, such expense disallowance rules and the need to
    counteract the accounting games that MNCs will play to minimize the
    disallowed expenses means more complication and less simplification.
    ---------------------------------------------------------------------------
        \2\ E.g., the October 2011 Discussion Draft from House Ways and
    Means Committee Chairman Dave Camp (R-MI) and the February 2012
    proposal from Senator Mike Enzi (R-WY).
        \3\ See suggested approach to fix this issue in ``Territorial W&M
    Discussion Draft: Change Required,'' 134 Tax Notes 461 (January 23,
    2012), available at SSRN: http://ssrn.com/abstract=1997515.

    A residence-based system totally eliminates the trapped cash problem.

    Conclusion

    Territorial system vs residence-based system . . . it is not a toss-up.
    Without doubt, for the benefit of our country and from virtually all
    tax policy perspectives, a
    residence-based system is vastly superior.

    The 99% downplay the above concerns (export of jobs, etc.) and explain
    that strong anti-avoidance rules will of course accompany any
    territorial system. Such rules, it is argued, would prevent many of
    these terrible results.

    Yes, truly strong anti-avoidance rules could prevent some of the worst
    excesses. But, frankly, it is naive to think that such strong rules
    would be put in place. First, the rules under consideration within
    Congress would be understood by few and attacked viciously by corporate
    lobbyists. So, whatever gets enacted will be very weak. Second, even if
    something halfway strong were to be enacted, our high-powered tax
    consulting community has a century-long tradition of working around
    anti-avoidance rules. So, I have little faith that any strong or
    effective anti-avoidance rules will accompany a territorial system. And
    this will mean the continued and accelerated export of jobs along with
    erosion of the U.S. tax base.

                                     ______

                                 MEMORANDUM 2
                      CONCERNING INTERNATIONAL TAX REFORM

                Taxation of Accumulated Deferred Foreign Income
                           as of the Transition Date

    The Committee's work to develop international tax reform will
    undoubtedly include some transition from the present deferral system to
    some other system. As an integral part of that transition, it is
    expected as well that proposals will include taxation on all
    ``accumulated deferred foreign income'' existing as of the transition
    date.

    Tax Rate to Apply to Accumulated Deferred Foreign Income Upon
    Transition

    At one end of the spectrum, some such as Citizens for Tax Justice say
    all such earnings should be taxed at the full 35%.\4\
    ---------------------------------------------------------------------------
        \4\ ``. . . Instead of rewarding corporations for dodging U.S.
    taxes, lawmakers should end the system of deferral that encourages them
    to do so, while taxing their offshore profits at the full 35 percent
    rate (while still allowing for a foreign tax credit).'' See ``$2.1
    Trillion in Corporate Profits Held Offshore: A Comparison of
    International Tax Proposals,'' Citizens for Tax Justice (July 14,
    2015), available at: http://ctj.org/pdf/repatriation0715.pdf.

    At the other end of the spectrum, a number of the prior transition
    proposals would apply various rates far lower than 35%, some of them
    being in the single digits with Representative Camp's Tax Reform Act of
    2014 and the House Republican Blueprint bottoming out at 3.5% on
    ---------------------------------------------------------------------------
    earnings reinvested into non-liquid assets.

    Under the CTJ approach, we would, so to speak, clobber every
    multinational (MNC) that has actually conducted real and legitimate
    activities in foreign countries in accordance with a consistent
    congressional intent that goes back almost forever.

    Under the prior transition proposals, we would grant an major windfall
    to every MNC that has engaged in aggressive profit shifting in which
    they moved 35% profits out of the U.S. and into tax havens. They are
    waiting for this windfall with their tongues hanging out.

    Whatever the Committee proposes needs an administratively workable
    mechanism that neither clobbers the former nor rewards the latter.

    Two Approaches for an Administratively Workable Mechanism \5\
    ---------------------------------------------------------------------------

        \5\ See more detail in ``Fair Approaches for Taxing Previously
    Untaxed Foreign Income,'' 146 Tax Notes 1385 (March 16, 2015),
    available at: http://ssrn.com/abstract=2587103.
    ---------------------------------------------------------------------------
    1. ``Camp'' Approach. In his 2014 discussion draft, Camp broke CFC
    earnings into two portions by imposing a higher 8.75% rate on earnings
    being held in cash and cash-equivalent forms. The remaining earnings
    would be subject to the lower 3.5% rate. This approach is
    administratively easy to apply, objective, and definitely a workable
    solution. However, it focuses on the form in which CFC earnings are
    held on the transition date and not on any measure of aggressive profit
    shifting. But having said this, the existence of earnings that have
    been subjected to relatively little or no foreign tax and that are held
    in cash or cash-equivalent form is pretty good evidence of tax
    avoidance planning. So, it will generally be a very fair and
    administratively workable approach.

    With this in mind, the first suggested approach is to use Camp's
    solution with all CFC previously untaxed foreign income--on transition
    to a new tax system--being subject to 35% but with an FTC offset to the
    extent of cash and cash equivalents. All remaining previously untaxed
    foreign income would be taxed on transition at whatever favorable less-
    than-35 % rate Congress chooses.

    2. Tax-Structured Vehicle Approach. This approach defines ``tax-
    structured vehicle.'' For any such vehicle, its previously untaxed
    foreign income--on transition to a new tax system--would be subject to
    35% with an FTC offset. The previously untaxed foreign income within
    all other CFCs would be taxed on transition at whatever favorable less-
    than-35% rate Congress chooses.

    As a first step to identifying tax-structured vehicles, Treasury would
    publish a listing of countries that can be used as the place of
    incorporation of CFCs that earn low- or zero-taxed foreign income
    through profit-shifting arrangements. Treasury would also provide
    examples of structures meant to achieve low- or zero-taxes.

    A presumption of tax-structured vehicle status would be applied to each
    CFC established in the listed countries. A U.S. shareholder MNC
    involved with the vehicle could attempt to rebut this presumption by
    establishing to the satisfaction of the Treasury secretary or his
    delegate, based on a facts and circumstances review, that the
    establishment and operation of the specific CFC involved no tax-
    motivated structuring. If this presumption is not successfully
    rebutted, any previously untaxed foreign income within the CFC would be
    subject to the 35% tax, with an FTC offset.

    If the Committee chooses this ``tax-structured vehicle'' approach over
    the ``Camp'' approach, it is strongly suggested that applicable
    committee reports include a clear statement of the principles behind
    the definition of tax-structured vehicle and numerous examples.\6\
    Clear legislative instructions would not only provide necessary
    guidance to Treasury and the IRS, but also should importantly limit
    taxpayer presumption-rebuttal efforts to situations that truly deserve
    consideration. Further, the rules should be clear that the burden of
    proof is on the taxpayer to support any effort at rebuttal of the
    presumption.
    ---------------------------------------------------------------------------
        \6\ See a partial listing of such structures in ``BEPS: A Primer on
    Where It Came From and Where It's Going,'' 150 Tax Notes 793 (February
    15, 2016).
    ---------------------------------------------------------------------------

    Application of Interest

    The various proposals and discussion drafts released over the past 6
    years have all provided for installment payments but have been
    inconsistent regarding interest. Several have been silent concerning
    any interest charge.

    This section's discussion assumes that the Committee will include in
    its proposals the above suggestion for application of a 35% tax rate to
    all previously untaxed foreign income that results from profit
    shifting, as determined under the ``Camp'' approach, the ``tax-
    structured vehicle'' approach, or any other approach that the Committee
    adopts.

    For any previously untaxed foreign income that will qualify for a
    favorable less-than-35% rate, any interest charge is economically only
    an adjustment of the favorable tax rate. (This, of course, ignores any
    effect if the interest were tax deductible; in this context, if the
    Committee requires an interest charge, it should specifically be
    nondeductible.) It also seems likely that most taxpayers would choose
    to pay in installments to defer those tax payments. Given that earlier
    payment would be beneficial to our country's finances, perhaps
    discounts for early payment could be considered if there is no separate
    interest charge.

    The previously untaxed foreign income that would be subjected to the
    35% tax rate has resulted from aggressive profit shifting. Therefore,
    the applicable taxpayer has already had the real economic benefit of
    deferral for years. There is no reason for extending the deferral
    period even more by allowing an interest-free installment payment
    scheme. Accordingly, the Committee's proposals should include an
    interest charge to the extent of any installment payments.

                                     ______

                    Reinsurance Association of America (RAA)

                      1445 New York Avenue, NW, 7th Floor

                              Washington, DC 20005

                                  202-638-3690

                              www.reinsurance.org

     Modernization of Rules Governing Foreign Insurance Operations of U.S.
                                   Companies

                               Executive Summary

     Current Tax Rules for U.S. Reinsurers Operating Abroad Do Not Achieve
                         Their Goal and Must Be Updated

    The Active Finance Exception (AFE), adopted in 1998, was intended to
    make U.S. insurers with foreign operations more competitive in foreign
    markets. Changes in foreign regulations, developed in the nearly 20
    years since the AFE rules were adopted, often impose high costs on
    reinsurers seeking to comply with AFE requirements. Worse yet, the AFE
    requirements are, in many respects, inconsistent with typical
    reinsurance group operations in international markets. As a result,
    many insurers' foreign subsidiaries do not qualify for the AFE
    exception.

    Without the deferral of tax provided by the AFE, foreign reinsurance
    subsidiaries of an American insurer bear a higher tax burden than their
    local competitors and are placed at a competitive disadvantage. AFE
    rules must be updated if U.S. insurers with foreign operations are to
    be competitive internationally.

    AFE rules should be revised to promote U.S. reinsurers' growth and
    competitiveness in international markets:

        1.  The related party reinsurance disallowance should be revised or
    eliminated so that internal reinsurance from members of a worldwide
    group does not disqualify a global reinsurance company from AFE status
    (as it does under current law).

        2.  The home country requirements should be repealed or revised.

        3.  The insurance rules should exclude the full amount of
    investment income from assets held to satisfy foreign regulatory
    capital requirements.

        4.  Property-casualty (P&C) insurance companies should be allowed
    to compute reserves using local rules, as life insurers can under
    current law.

        5.  If a minimum tax on foreign earnings is adopted in tax reform,
    it should exclude any insurance income that cannot be repatriated due
    to local regulatory requirements.

                                   DISCUSSION

    Reinsurance Association of America

    The Reinsurance Association of America (RAA), headquartered in
    Washington, DC, is the leading trade association of property and
    casualty reinsurers doing business in the United States. The RAA is
    committed to promoting a regulatory environment that ensures the
    industry remains globally competitive and financially robust. RAA
    membership is diverse, including reinsurance underwriters and
    intermediaries licensed in the U.S. and those that conduct business on
    a cross border basis. The RAA represents its members before state,
    federal and international bodies.

    Background

    Reinsurance is a transaction in which one insurance company
    indemnifies, for a premium, another insurance company against all or
    part of the loss that it may sustain under its policies of insurance.
    Reinsurers play a critical role in the insurance industry, and thus the
    economy, through their ability to mitigate risk for individual
    insurance companies. Reinsurance enhances the solvency of direct
    insurers and thereby helps to protect insured individuals and
    businesses.

    Reinsurance is a global business, with U.S. companies writing
    substantial foreign business, and foreign reinsurers writing
    substantial U.S. business. By assuming a variety of risks, diversified
    by line-of-business and geographic location, a reinsurer creates a more
    resilient portfolio, and one more likely to withstand the volatility of
    the property-casualty insurance business. A widely diversified
    portfolio enables a reinsurer to use its capital more efficiently, and
    thereby to hold down costs for primary insurers and policyholders.

    After the 2008 financial crisis, insurance and reinsurance companies
    have become subject to increasing levels of regulation, such as
    stricter, risk-based capital requirements (EU Solvency II) and greater
    internal controls such as Own Risk and Solvency Assessments (ORSA).
    Compliance costs for local regulation have increased dramatically since
    the AFE was enacted in 1998. In the Senate Finance Committee's
    International Tax Working Group Report (2015), these problems were
    identified as requiring modification.

    Modernizing the Active Finance Exception rules for foreign operations
    of U.S. insurers is consistent with the Administration and Congress's
    goals of simplifying the tax code, reducing the regulatory burden on
    American taxpayers, and growing the American economy. It will make U.S.
    reinsurers more competitive in foreign markets and expand jobs at U.S.
    headquarters that oversee foreign operations.

    Modernization of Insurance Tax Rules

      Related party insurance income is excluded from qualifying insurance
    income under current law. This prohibition penalizes a reinsurance
    company for following standard industry practice. In order to operate
    efficiently, reinsurers must pool their global risks in order to
    achieve risk diversification and to manage capital more efficiently.

          The law should recognize that reinsurance from
    members of a worldwide group is not a related party risk if the
    underlying risks are from unrelated parties.

      The 30% home country requirement for ``Exempt Insurance Contract''
    and 50% home country requirement for ``Qualifying Insurance Company''
    status in AFE prevent foreign reinsurers from qualifying under AFE.

          The EU has become more integrated, and EU passporting
    rights now allow insurers regulated in one EU country to freely operate
    through the EU. The transfer of risks from many EU countries to a
    regional headquarters--standard industry practice--means that an EU
    headquartered company cannot meet the AFE's same country requirements.

          This freedom to operate through the EU from a single
    country causes the 30% home country requirement for an ``exempt
    contract'' and the 50% requirement for a ``Qualifying Insurance
    Company'' to be overly restrictive.

          These requirements are inconsistent with reinsurance
    company business models. Insurance groups in Europe, Asia and South
    America, as well as the EU, pool risks at a regional headquarters
    company, yet foreign subsidiaries of U.S. insurers following industry
    ``best practices'' cannot satisfy the home country requirements because
    they transfer non-home country risks. U.S. insurers should be allowed
    to compete internationally without tax penalties.

          The home country requirement should be repealed or
    revised.

      AFE Should Recognize Regulatory Capital Requirements: Current APE
    rules limit the amount of investment income excluded to \1/3\ of
    premiums earned for P&C and health insurance, and 110% of reserves for
    life and annuity contracts, computed using U.S. tax principles. After
    the 2008 financial crisis, many foreign regulators imposed risk-based
    capital requirements for greater amounts than permitted under current
    AFE rules.

          The investment income from these assets is not
    available to the U.S. parent--the U.S. parent is being taxed on income
    it cannot receive.

          The AFE rules should exclude investment income from
    the full amount of assets held to satisfy regulatory capital
    requirements.

      Translation of Foreign Reserves: Current law's requirement that
    foreign insurance reserves must be restated using U.S. tax accounting
    principles, with respect to the computation of both underwriting income
    and investment income, should be streamlined to avoid burdensome
    recalculations.

          The need to allow ``more realistic assessment of
    insurance company reserves'' was specifically mentioned in the 2015
    International Tax Working Group Report (p.79).

          Life insurance companies are permitted to elect to
    use foreign reserves; P&C companies should also be permitted to use
    foreign reserves.

          The law should permit property-casualty insurers and
    reinsurers to compute reserves based on local regulatory principles, as
    life insurers can under current law.

      Tax on Deemed Repatriated Foreign Earnings: Since insurers and
    reinsurers are subject to regulatory restrictions on their ability to
    repatriate earnings, any one-time tax on accumulated foreign earnings
    should exclude income which cannot be repatriated due to local
    regulatory requirements.

          If there are two rates for the tax, as proposed in
    the Camp bill (H.R. 1, 2014), income associated with the insurance
    business (reserves and capital or ``surplus''), should be taxed at the
    lower rate, since it is used for the active conduct of an insurance
    business.

      Minimum Tax: If a minimum tax on future foreign earnings is adopted,
    income from insurance business should not be taxed twice, once as
    ``insurance in come'' and, in addition, as ``intangible income,'' as
    was possible in the Camp bill.

                                     ______

                    Tax Innovation Equality (TIE) Coalition

                              Washington, DC 20005

                             info@tiecoalition.com

                             202-530-4808 ext. 109

    The Tax Innovation Equality (TIE) Coalition \1\ is pleased to provide
    this statement for the record of the Finance Committee's hearing on
    International Tax Reform. The TIE Coalition comprises leading U.S.
    technology and bio-pharma companies that rely on and invest in
    intellectual property and intangible assets. Such investments help make
    companies innovative, successful and globally competitive. The TIE
    Coalition supports comprehensive tax reform that will modernize the
    U.S. tax system and help American businesses compete in a global
    market. The TIE Coalition believes that the U.S. must: (i) implement a
    competitive territorial tax system; (ii) lower the U.S. corporate tax
    rate to a globally competitive level; and (iii) not pick winners and
    losers in the tax code by discriminating against any particular
    industry or type of income--including income from intangible property
    (IP).
    ---------------------------------------------------------------------------
        \1\ The TIE Coalition is comprised of leading American companies
    and trade associations that drive economic growth here at home and
    globally through innovative technology and biopharmaceutical products.
    For more information, please visit www.tiecoalition.com.

    Unfortunately, some past proposals would tax IP income adversely
    compared to income from other types of assets, creating an unfair
    advantage for companies who don't derive their income from IP, and
    significantly disadvantaging innovative U.S. companies, especially
    compared to their foreign competition. For example, the Tax Reform Act
    of 2014 (H.R. 1) as introduced by former House Ways and Means Chairman
    Camp would seriously disadvantage innovative American companies. Under
    that proposal, Chairman Camp chose the anti-base erosion option known
    as Option C. The problem with Option C is that it would tax IP-based
    income at significantly higher rates than non-IP income, significantly
    disadvantaging U.S. IP-based companies who compete globally, which
    would result in more inversions of U.S. companies and more foreign
    acquisitions of U.S. companies. The TIE Coalition is opposed to Option
    C because it would have a devastating impact on both innovative
    technology companies and the nation's leading biopharmaceutical
    ---------------------------------------------------------------------------
    companies.

    Section 4211 of H.R. 1 specifically targets ``foreign base company
    intangible income'' for higher taxation by creating a new system in
    which that income will be immediately taxed in the U.S. at much higher
    rates (15% or 25%) rather than the 1.25% tax rate for all other foreign
    income, which is only taxed upon distribution back to the U.S. The
    provision does not provide a definition of an intangible asset
    generating IP-based income subject to Option C. Instead it uses a
    formula which essentially provides that if a company earns more than a
    10% return on its foreign depreciable assets, the income over the 10%
    threshold will be considered ``intangible income'' and subject to the
    higher immediate U.S. tax. Many innovative companies have higher
    margins and earn more than 10% on their depreciable assets, so they
    will be disproportionately affected by this adverse provision.

    To understand the full scope of Option C, the TIE Coalition
    commissioned a study by Matthew Slaughter, the Dean of the Tuck School
    of Business at Dartmouth. See: ``Why Tax Reform Should Support
    Intangible Property in the U.S. Economy'' by Matthew J. Slaughter,
    http://www.tiecoalition.com/wp-content/uploads/2015/07/IP-White-
    Paper_January-2015.pdf. According to the study, ``Policymakers should
    understand the long-standing and increasingly important contributions
    that IP makes to American jobs and American standards of living--and
    should understand the value of a tax system that encourages the
    development of IP by American companies.'' (Executive Summary)

    The study found that Option C in the Camp legislation would
    fundamentally (and adversely) change the measurement and tax treatment
    of IP income earned by American companies abroad and would disadvantage
    IP income earned abroad by U.S. companies in three ways. First, it
    would tax IP income at a higher rate than under current law. Second, it
    would tax IP income more than other types of business income. Third, it
    would impose a higher tax burden on the IP income of U.S. companies
    compared to their foreign competitors. As a result, the study found
    that Option C ``would aggravate the nettlesome issue of corporate
    inversions and would create additional incentives for foreign
    acquisitions of U.S.-based IP-intensive companies.'' (Executive
    Summary)

    According to the Slaughter study, since globally engaged U.S. companies
    have long performed the large majority of American's IP discovery and
    development, it is increasingly important to America's economic success
    that these companies operate profitably overseas. The Slaughter study
    finds that the ``United States, not abroad, is where U.S.
    multinationals perform the large majority of their operations. Indeed,
    this U.S. concentration is especially pronounced for R&D, which
    reflects America's underlying strengths of skilled workers and legal
    protections such as IP rights that together are the foundation of
    America's IP strengths, as discussed earlier'' (page 30). The Slaughter
    study concludes that the overseas operations of these companies
    complement their U.S. activities and support, not reduce, the inventive
    efforts, related jobs, and positive economic impact of their U.S.
    parents on the U.S. economy.

    In addition to Option C, other international tax reform proposals have
    singled out income from IP for adverse treatment. In 2012, Senator
    Michael Enzi (D-WY) introduced an international tax reform bill, S.
    2091. While the Enzi bill did not propose lowering the corporate tax
    rate, it did propose a territorial system with a 95% dividends received
    deduction (DRD) for qualified foreign-source dividends. Unfortunately,
    while the bill reduced the scope of the current law Subpart F regime in
    some respects (by eliminating the current foreign base company sales
    and services income rules under Section 954), it proposed creating a
    new category of Subpart F income under which all income of a controlled
    foreign corporation (CFC) would be immediately taxable in the U.S. at
    the full U.S. rate unless the CFC's effective tax rate (ETR) exceeded
    half of the maximum U.S. corporate rate. Under Senator Enzi's bill, the
    ETR in the foreign country would have to be more than 17.5% to qualify
    for territorial tax treatment with a 95% DRD and avoid immediate
    taxation at the maximum U.S. tax rate.

    However, ``qualified business income'' (as defined in the bill) would
    be excluded from this punitive tax treatment and qualify for the 95%
    DRD. But, ``qualified business income'' specifically would not include
    ``intangible income'' as defined in Section 936(h)(3)(B). As such,
    Senator Enzi's proposal effectively repeals deferral for intangible
    income earned by CFC's and denies territorial tax treatment with the
    95% DRD for intangible income, clearly discriminating against income
    from intangible assets. In addition to discriminating against income
    from intangible assets, the Enzi bill would result in significant
    additional disputes between the IRS and taxpayers regarding how much
    income is from intangible property as broadly defined in Section
    936(h)(3)(B).

    In designing a competitive territorial tax regime, both Congressman
    Camp and Senator Enzi decided that anti-base erosion provisions needed
    to be included to protect the U.S. tax base, but they both chose
    options that discriminate against IP income. The TIE Coalition has
    offered several anti-base erosion proposals that do not discriminate
    against income from intangibles. Two anti-base erosion measures that we
    could support are Option D and Option RS. If base erosion is a concern,
    it is a concern for all income, not just income from intangibles.

    Option D proposes a territorial system with a graduated DRD based upon
    the effective tax rate paid by the CFC. The general rule of a 95% DRD
    would apply to foreign source dividends paid from a CFC that has an
    effective tax rate equal to or greater than 15%. But if the effective
    tax rate of the CFC is less than 15%, the DRD exemption would be
    reduced using a simple sliding scale. Under Option D, if the CFC tax
    rate is at least 7.5% but less than 15%, the DRD would drop to 85%. If
    the CFC effective tax rate is less than 7.5%, the DRD would be 75%. If
    the CFC effective tax rate is less than 7.5% and the CFC is domiciled
    in a jurisdiction that does not have a tax treaty/possession status/
    TIEA (or similar relationship) with the U.S., the DRD would be 60%. All
    low-tax active foreign income is treated similarly. Income from
    intangibles is not singled out for especially harsh treatment.

    Under Option RS, low-taxed foreign income of a CFC would be subject to
    immediate U.S. tax unless it is derived from a substantial local
    business in the foreign jurisdiction where the income is reported and
    subject to tax in that jurisdiction. Income would be considered low-
    taxed if the foreign effective tax rate (ETR) is 15% or less. The
    substantial local business activity test would be met if all three of
    the following tests are met: (1) the income is derived in the active
    conduct of a trade or business in the foreign country; (2) substantial
    local activities are conducted in the foreign jurisdiction; and (3) the
    income is treated as taxable in the foreign country.

    Both of these options would address the policy concerns about the
    possible erosion of the U.S. tax base by companies shifting income to
    low tax jurisdictions, but they would not single out income from
    intellectual property for special treatment. Targeting income from
    intangible property has sometimes been justified by describing it as
    ``highly mobile'' income, but that description is not accurate.
    Transferring an intangible asset out of the U.S. is a taxable event
    under IRC Section 367(d) so that any company transferring an intangible
    asset to a foreign entity must pay an immediate tax on the transfer as
    if the property had been sold. Determining the value of an intangible
    asset can be difficult but companies and the IRS have been doing these
    valuations for years with greater and greater sophistication and
    accuracy. Moving intangible assets is not an easy or invisible process,
    and describing intangible assets as ``highly mobile'' gives the
    impression that somehow title to these assets can simply be transferred
    around the globe with no U.S. tax consequences, when in fact the
    transfer of intangible assets to a foreign entity is already subject to
    immediate taxation under Section 367(d).

    In conclusion, the TIE Coalition supports comprehensive tax reform that
    modernizes the U.S. tax system, allowing American businesses to compete
    in global markets, in a manner that does not discriminate against any
    particular industry or type of income, including income from intangible
    property. At a time when many other countries are adopting tax rules
    designed to attract IP companies to their shores, it would be
    especially harmful to the U.S. economy to adopt a tax policy that will
    hurt, not help, American IP companies who compete globally. Now is not
    the time to drive high paying American jobs overseas.