SPECIAL REPORT (C) Tax Analysts 2011
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SPECIAL REPORT (C) Tax Analysts 2011. All rights reserved. does not claim copyright in any public domain or third party content. tax notes® Across the Great Divide: A Centrist A. Overview ..................... 1040 Tax Reform Proposal B. International Tax Reform ........... 1040 C. Corporate Tax Reform ............. 1047 By Philip R. West IV. Conclusion ....................... 1051 I. Introduction Philip R. West is a partner with Steptoe & Johnson LLP in Washington and a former Treasury interna- Near the end of my tenure at Treasury, a wise tional tax counsel. This report was funded by clients of man said to me: ‘‘There is no objective truth in Steptoe & Johnson, but the views expressed are those international tax policy. Ultimately, the choices are of the author, who acknowledges with thanks the political.’’ Some years later, in a prominent lecture, substantial assistance of Amanda Pedvin Varma. a highly respected congressional staff member ex- U.S. corporate and international tax rules put U.S. pressed a somewhat similar sentiment about tax 1 multinationals at a disadvantage while raising less policy more generally. revenue than would be expected when compared with These views can be interpreted to mean that the revenue collected by other countries with lower either there is no objective measure of good busi- corporate tax rates. U.S.-based companies often do not ness tax policy or there is objective merit in both repatriate profits in the absence of complex and con- sides of the debate. Having lived through years of troversial tax planning transactions, and foreign busi- nesses often find the United States inhospitable from a polarizing arguments about corporate and interna- tax perspective. tional tax reform, I can only conclude that both sides have merit. The time has come for a pragmatic and centrist reform of the U.S. corporate and international tax On one hand, the following propositions regard- rules. Such a reform could involve reducing the cor- ing corporate taxation generally seem compelling: porate rate to the OECD average and exempting active • a low rate, accompanied by a broad base, is the foreign dividends from income. It could involve indi- rectly limiting the deductibility of expenses allocated best foundation for a tax system; to exempt dividends by partially taxing the dividends, • the corporate income tax is highly inefficient2; further restricting the ability of U.S.-based companies • to artificially shift profits out of the United States or to the incidence of the corporate income tax falls engage in round-tripping transactions, reconsidering a on shareholders, employees, or customers, but variety of corporate tax expenditures, and introducing not ultimately on the corporation itself; a VAT. • corporate earnings are taxed twice — once There may be other revenue-neutral reform ideas when earned by the corporation and again that could be integrated into this proposal or that are when distributed to individuals — in the ab- better alternatives. The question is whether a serious sence of some form of dividend and capital discussion is possible. The answer is yes, and the time gain relief; is now. Copyright 2011 Philip R. West. All rights reserved. 1John Buckley, 2007 Woodworth Memorial Lecture, ‘‘Tax Changes Since Woodworth’s Time: Implications for Future Tax Table of Contents Reform,’’ 34 Ohio N.U.L. Rev. 1, 15 (2008) (‘‘Laws enacted without regard to politics seldom last long.’’) 2 I. Introduction ...................... 1025 See OECD, Tax Policy Reform and Economic Growth (Tax Policy Study No. 20) 22 (2010): II. The Case for Reform ............... 1028 Corporate income taxes are the most harmful for growth A. Where We’ve Been ............... 1028 as they discourage the activities of firms that are most B. Where We Are .................. 1031 important for growth: investment in capital and produc- C. Recent Reform Proposals .......... 1034 tivity improvements. Also, most corporate tax systems have a large number of provisions that create tax advan- D. Where We Are (and Should Be) Going . 1037 tages for specific activities, typically drawing resources III. A Proposal for Tax Reform ........... 1040 away from the sectors in which they can make the greatest contribution to growth. TAX NOTES, February 28, 2011 1025 COMMENTARY / SPECIAL REPORT • place of corporate organization is a tenuous • our current international tax system encour- ground on which to base significant tax dis- ages U.S.-based multinationals to retain earn- (C) Tax Analysts 2011. All rights reserved. does not claim copyright in any public domain or third party content. tinctions; ings abroad; • the lower the corporate tax rate, the less the • our current international tax system appears to incentive for planning, sheltering, and other put U.S.-based multinationals at a disadvan- activity creating dead-weight loss in the sys- tage compared with competitors in numerous tem; other countries that use a territorial system; • job growth is more likely when businesses are more profitable3; and • to the extent that other countries’ international • the more attractive our tax system is to busi- tax systems establish an international norm, nesses, the more likely we are to attract foreign our current system is inconsistent with that investment and retain domestic investment. norm; On the other hand, the following propositions • our current international tax system is highly also seem compelling: complex and appears to encourage planning, • if we reduce corporate tax, we are likely, at sheltering, and other deadweight loss activity; least in the short term, to reduce revenue that • our current system relies on complex and con- may need to be recouped through other taxes; • tinually tested gatekeepers to prevent existing if corporations do not pay the same tax as other corporations from expatriating, but encourages businesses, there will be a bias in favor of new businesses to start abroad; and doing business in corporate form solely for tax reasons (stated differently, the corporate tax • our corporate tax base is mobile and becoming serves as an anti-deferral mechanism); more so, and the challenges to imposing cor- • if corporations do not bear a specified mini- porate tax on multinational businesses and mum tax burden, the system may seem unfair, capital are growing, perhaps to the point of individuals may have less respect for the sys- being not worth the cost. tem, and compliance may suffer; On the other hand, the following propositions • although corporate rate reductions may be regarding international tax reform also seem com- justified on grounds of competitiveness, there pelling: are few, if any, rigorous cross-country compari- • sons of tax competitiveness, and the United the adoption of a more purely territorial sys- States appears to compare quite favorably with tem could encourage companies to move some other jurisdictions when competitiveness is functions (and thus jobs) overseas where the evaluated by taking into account all business income generated by those functions would factors, not just taxes; not be subject to U.S. tax; • U.S. corporate organization provides some • there is no clear empirical evidence of the benefits, which may justify the imposition of a extent to which U.S.-based multinationals are corporate income tax; and at a competitive disadvantage as a result of the • corporate tax rate reductions could be the first current U.S. international tax system; step in a race to the bottom that would impair • repeal of deferral would eliminate the lockout the ability of governments to provide needed effect just as effectively as a territorial system; services. Similarly, the following propositions regarding • a territorial system could be easily manipu- international tax reform seem compelling: lated without strong transfer pricing, source, • reduced taxation of foreign earnings would and anti-deferral rules for passive income; encourage expansion and therefore strengthen- • a territorial system without a limitation on ing of U.S.-based multinationals; deductions for expenses incurred to earn that income could adversely and inappropriately affect the tax base; and 3President Obama is reported to have said to business • exemption of foreign income, which will leaders at a meeting: ‘‘We want to be boosters because when you mostly be availed of by large taxpayers, may do well, America does well.’’ Helene Cooper, ‘‘Obama Tries Charm Offensive on Group of Top Executives,’’ The New York seem unfair, create disrespect for the system, Times, Dec. 15, 2010. Similarly, former House Ways and Means and result in reduced compliance. Committee Chair Charles B. Rangel, D-N.Y., has reportedly stated that he wants businesses to do well because it will be Both sides of the debate have merit. Despite this, business, not government, that will supply the jobs that keep it often seems that the usual players on all sides people working. simply continue to take their predetermined roles 1026 TAX NOTES, February 28, 2011 COMMENTARY / SPECIAL REPORT and dig themselves deeper and deeper into posi- views herein.7 These views, informed by my experi- tions from which they cannot (or will not) back out. ences evaluating and considering tax policy as well (C) Tax Analysts 2011. All rights reserved. does not claim copyright in any public domain or third party content. Perhaps as a result, tax reform has moved slowly.4 as observing the role of taxes in business decision So how best to advance the debate? I believe making, represent an attempt to advance the debate there are two critical components. First is an ac- about how the United States should tax businesses knowledgement that there is no clear right or in today’s international economy — or, better yet, wrong answer, that people come to the debate with an attempt to change the debate. In this spirit, I offer competing policy orientations, and that we all may a pragmatic, centrist approach to reforming our have to sacrifice some sacred cows.5 Second is a international tax policy.8 determination to inform the debate with both (a) The balance of this report is divided into two empirical research, in particular (if possible) on parts.