International Tax Reform Prepared for SIEPR-TPC Tax Reform Conference Rosanne Altshuler January 18, 2013

The Current System 35%

The Current System Lowland 15% 35%

The Current System 35% 15% A U.S. corporation sets up an affiliate In Lowland…

The Current System … earns $100 and pays $15 in tax to Lowland 35% 15%

Worldwide taxation with credit Owes $35 to U.S. ─ $15 credit for taxes paid to Lowland = $20 residual tax to U.S. 35% 15% $100

Worldwide taxation with credit earns $100 in Highland and pays $55 in taxes 35% 55%

Worldwide taxation with credit $100 35% 55% Owe $35 to U.S. ─ $35 credit for taxes paid to Highland = $0 residual tax and $20 of “excess credits”

Worldwide taxation with credit 15% Earns $100 35% 55%

Worldwide taxation with credit 15% 35% 55% Use $20 of “excess credits” from Highland to offset $20 owed on income from Lowland = $0 residual tax $100

When is Tax on Foreign Earnings Paid? Owe $20 residual tax to U.S. on earnings in Lowland ONLY when the $100 is repatriated $100 35% 15%

The current worldwide credit and deferral system creates many avenues for sophisticated tax planning

It’s complicated… Transfer of intellectual property Royalties License Royalties Sub license RoyaltiesSub license Overseas buyers

Even Dilbert does Google’s Double Irish with a Dutch Sandwich

Discontent with the current system has focused policy makers and analysts on possible reforms…

How do Territorial Systems work? $100 35% 15% No tax owed to U.S. on the active income earned in Lowland Territorial taxation through dividend exemption (royalty payments made to parent would be taxed)

List of OECD countries Australia, Austria, Belgium, Canada, Chile, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Israel, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Slovenia, Slovak Republic, Spain, Sweden, Switzerland, Turkey, United Kingdom, United States

Territorial Tax Systems Australia, Austria, Belgium, Canada, Chile, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Israel, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Slovenia, Slovak Republic, Spain, Sweden, Switzerland, Turkey, United Kingdom, United States

Worldwide Tax Systems Australia, Austria, Belgium, Canada, Chile, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Israel, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Slovenia, Slovak Republic, Spain, Sweden, Switzerland, Turkey, United Kingdom, United States

Combines central and sub-government taxes. Source: OECD tax database.

Problems with current system Income shifting and its effects on investment location decisions and revenue Lockout effect of repatriation tax and associated costs of avoidance Complexity May put U.S. multinationals at a competitive disadvantage Raises little revenue

(Some) Possible Reforms Fundamental reforms – Worldwide taxation with repeal of deferral – Dividend exemption Grubert and Altshuler (2012): combine dividend exemption with a minimum tax of 15% – Formulary apportionment

(Some) Possible Reforms Incremental reforms – Lower the statutory rate – Repeal check the box – Administration budget proposals and other reforms of current law

Evaluating the Reforms Key considerations – Repatriation tax? – Income shifting incentives? – Tax revenue? – Simplicity? – Location incentives for tangible and intangible capital? – Expatriation incentives? – Transition rules?

Effective Tax Rate Simulations* Home country (U.S.) with tax rate of 30% Low tax country (5% tax rate), high tax country (25% tax rate), tax haven (0% tax rate) A discrete high tech investment in low tax country based on U.S. R&D A routine investment in high tax location Income shifting possible but is not costless *From Grubert and Altshuler, 2012, “Fixing the System: An Analysis of Alternative Proposals for the Reform of International Tax”

Effective Tax Rate Simulations* Investment in low tax country (5% tax rate) Investment in high tax country (25% tax rate) Current law with 30% rate-23.6%13.0% Current law, 30% rate, repeal of deferral30.0% Current law, 30% rate, repeal of check the box -18.2%24.2% Dividend exemption-29.5%10.7% Dividend exemption with minimum tax of 15% 5.6%12.1% *From Grubert and Altshuler, 2012, “Fixing the System: An Analysis of Alternative Proposals for the Reform of International Tax”. Assumes check the box remains in place unless noted.

Conclusions Look for reforms that make improvements to the current system across many dimensions including lockout effect, income shifting, competitiveness, and complexity Goals may not be in conflict – A minimum tax combined with dividend exemption may have advantages over repeal of deferral and dividend exemption alone, and reduce their shortcomings