[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
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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
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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.
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\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.
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\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\
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\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.
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\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.
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\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
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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\
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\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.
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\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.
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\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.''
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\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.
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\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).
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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
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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.
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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.
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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\
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\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).
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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\
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\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.
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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.
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\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\
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\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\
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\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\
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\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
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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.
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\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\
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\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).
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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\
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\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.
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\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.
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\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
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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
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* 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/.
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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.
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\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.
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\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.
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\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
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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.
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\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\
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\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
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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.
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\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\
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\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
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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.
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\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).
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It bears repeating the Treasury Department's assessment from
January of this year of the economic effect of the unrepatriated
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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\
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\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
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(or 38%) of ``indefinitely reinvested'' offshore earnings.
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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\
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\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.
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\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.
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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.
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\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\
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\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.
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\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.
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\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\
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\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\
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\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.
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\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.
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\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.
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\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).
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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.
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\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:
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\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.
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\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: [email protected]
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.
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\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
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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
[email protected].
Respectfully submitted,
Julia Bryan
International Chair, Democrats Abroad
E-mail: [email protected]
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\
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\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\
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\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\
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\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 [email protected].
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.
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\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
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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\
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\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
[email protected]
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.