Obama and GOP: What's holding up corporate tax reform?(Read article summary)
Obama and GOP leaders are in agreement on many corporate tax reform policies. But on the question of how foreign earnings of U.S.-based multinationals should be taxed, the gap remains wide.
Jose Luis Magana/Reuters/File
Reform plans by Obama andÂ GOP leaders such as House Ways & Means Committee Dave Camp (R-MI) seemedÂ simpatico. Both sides embraced lower rates. Both endorsed ending business tax subsidies, through neither had much to say about which ones.Â But on one fundamental issue the gap between Obama and the GOP remains wide.
How would theyÂ tax foreign earnings of U.S.-based multinationals? Both sides agree that the current system is the worst of all worlds: It is immensely complicated, wildly distorts economic decisions, and collectsÂ little revenue.
But when it comes to the solution, Obama and the Republicans seem headedÂ downÂ different roads. Obama wants to force U.S. companies to pay more tax on their overseas profits.Â Many Republicans would exempt offshore earnings from U.S. tax liability.
To understand where reformers are headed, think about todayâ€™s system. Under our current worldwide structure, foreign subsidiaries of U.S.-based firms must pay U.S. tax no matter where they earn their income. To prevent profitsÂ from being taxed twice,Â those firms get a credit against their U.S. tax for the levies they pay to other countries. Â
Those foreign tax rates are nearly always lower than in the U.S.Â But because U.S. rates are relatively high, companies game the system to avoid domestic levies on their overseas income, and even to reduce U.S. tax onÂ domestic income.
Under a practice known as deferral, U.S. firms donâ€™t pay U.S. tax until they bring their profits home. This allows them to reinvest earnings in foreign subsidiaries and, in effect, never pay those high U.S.Â rates.
Firms also use sophisticated accounting gimmicks to shuffle income to low-rate countries while shifting deductible expenses back home, where they can offset domestic profits and lower theirÂ overall U.S. tax liability. Sometimes, they actually move their productionâ€”and their jobsâ€”overseas to avoid U.S. tax (though thatâ€™s rarely the most commonÂ reason).
All of this allows manyÂ multinational firms to pay effective tax ratesÂ well belowÂ the 35 percent statutory rate that is getting all the attention.Â Often they pay less less than they mightÂ under a territorial system.
What to do?
Obama would impose a minimum tax on multinationalsâ€”effectively forcing them to pay immediate tax on foreign income even if they never return the money to the U.S. But Obamaâ€™s plan would be incredibly complicated and may drive more companies to move overseas, since the minimum tax would only apply to U.S.-based firms.
Some Republicans would shift the U.S. to a territorial system and effectively abandon efforts to tax active overseas income of U.S. multinationals. All companiesâ€”foreign or domesticâ€“ would pay tax on U.S. profits. But domestic firmsÂ would owe no U.S. tax on overseas income, either when their foreign subsidiariesÂ earn it or when they pay it as dividends to their U.S. parent.
This would moveÂ the U.S. closerÂ to the territorial systems used by mostÂ of the world. But such a shift might encourage some domestic companies to move more of their operationsâ€”and shift both jobs andÂ more reported incomeâ€“ to low tax countries.Â Preventing such an exodus would require a complicated new set ofÂ rules.
Is there some middle ground between the Obama view and the GOP position? Maybe. Â Perhaps there is a way to increase taxes on foreign profits as they are earnedÂ but lower the additionalÂ tax companies payÂ once profitsÂ are returned to the U.S.Â This could raise U.S. taxes on income earned in tax havens but reduce the penalty for bringing foreign earnings home. Â Â Â
But this is complicated, vexing stuff. And it will require honest cooperation among serious tax mavens, not the sort of political one-upmanship that infects most everything else in Washington.