International Aspects of the US Taxation System

Felix I. Lessambo

• Publisher: Palgrave Macmillan
• Year: 2016
• ISBN:
  9781349949359
• Topic: Economics
• Subtopic: Public Finance
• Index: Economics

This book covers a broad range of the most challenging topics in US international taxation laws before breaking into separate discussions of the issues related to both inbound and outbound taxes.Real examples and selected seminal cases are analysed at the end of each chapter to simplify even the most abstract tax provisions. Practitioners, academics, and advanced students specializing in specific areas of international finance will welcome this comprehensive overview of the US tax system's international laws.

© The Author(s) 2016

Felix I. LessamboInternational Aspects of the US Taxation System10.1057/978-1-349-94935-9_1

Begin Abstract

1. Overview

Felix I. Lessambo¹ 

(1)

The Peter J. Tobin College of Business, St. John’s University, Jamaica, NY, USA

 

End Abstract

1.1 Introduction

International taxation is one of the most complex, if not the most complex, component of the Internal Revenue Code (IRC). inception of International Tax, the US Congress faced a challenge in enacting specific provisions that deal with or cover the two aspect of the US Aspect of international tax: the inbound and the outbound. Inept tax policies in place since the 1980s, aggravated by the Bush Tax reforms of 2004–2005, put US multinational companies out of sync with the rest of the world. The 1986 Tax Reform Act was governed by the principle of tax neutrality. Thus, the burden on lobbyists was to demonstrate how their proposals would not lose many supports or how they could be paid for by other revenues. ¹ Since then tax policy debates have been hijacked into an examination of how well tax systems and particular taxes meet the criteria of equity, efficiency, and simplicity. The debate is led by two opposing groups: liberals and conservatives. Liberals see tax policy as a tool for economic distribution. Their approach has been to raise taxes on the wealthy in order to sustain expensive government programmes. In contrast, conservatives advocate for economic growth, lower taxation, and public sector spending cuts. They see consumption as an unstoppable engine of economic growth. ²

Curiously, each side claims to be 100 % correct, while the right approach lies in between. Therefore, the US international tax provisions from the IRC is out of step with the way global business is conducted. Most of the provisions still in effect have been in place since the 1930s. Subsequent tax reforms have worsened or at least perverted the underlying principles that sustained the International Aspects of the IRC. The 1986 Tax Act favors foreign investment in the USA in several ways. Unless a substantial and well-thought-out overall tax reform is conducted by experts in the field, incremental changes could aggravate the complexity of the system to render it incomprehensible to all except lobbyists.

1.2 A Worldwide vs. Territorial Tax Regime

The USA is among only a handful of countries, and the only one in the Group of Seven (the Group of Seven is an informal bloc of industrialized democracies which includes: the US, Canada, France, Germany, Italy, Japan, and the UK), that taxes companies on worldwide earnings rather than the earnings in their home domiciles. That is, in a worldwide system, a country taxes a corporation’s total income, whether generated within its boundaries or outside its boundaries. A worldwide tax regime often provides tax credits for the foreign taxes already paid. In a territorial system, a country taxes only the income that the corporation generates in that country, leaving other countries to tax the income generated within their boundaries. However, the worldwide tax system allows indefinite deferral of US tax on earnings reported in foreign countries and a tax credit for foreign taxes paid. That feature alone does not make the US tax system a case apart. Many other countries use a so-called “territorial tax system” with “territorial” reach beyond their borders to prevent abuse in ways that the US system does not. Many territorial systems have hybrid systems, under which the countries can tax substantial portions of the overseas profits of their multinationals on a worldwide basis. ³ For example, Japan taxes resident companies on foreign-source income at the full Japanese rates if they are paying an effective rate of less than 20 % in the foreign jurisdiction. Further, the Organisation for Economic Co-operation and Development (OECD) is even calling for its member countries to review the “fundamentals” of their predominantly territorial tax systems. ⁴

The US tax regime is often criticized as having among the top rates in the world. Though true, the argument lacks consistency as rates alone do not depict the true reality. Comparisons are often made between corporate tax rates in the United States and those found elsewhere in the world. Such a short-cut analysis is especially frequent among non-economist tax scholars who tend mainly to consider countries’ “statutory rates.” Economists, however, generally prefer to compare “effective tax rates” when making international comparisons. The reason is that, as every country has its own tax system, the statutory tax rate is just one component of each system and does not tell all the story. ⁵ For example, some countries may have higher or lower rates, allow for faster capital recovery (i.e., deprecation), or offer corporate tax credits not offered by other countries. Effective tax rates attempt to account for all the system differences and are more indicative of the tax burden in each country.

Though the statutory corporate income tax rate is 35 %, the effective tax of US corporations has been estimated at less than half that much, at 13 %, reduced through a variety of mechanisms, including tax provisions that permit multinational corporations to defer US tax on active business earnings of their offshore subsidiaries until those earnings are brought back to the USA. ⁶ Although the USA has one of the highest statutory tax rates, a study by Avi-Yonah and Lahav comparing US-based multinationals with the 100 largest EU multinationals concludes that the effective US tax rate is the same or lower than effective EU tax rates despite the USA having a corporate statutory tax rate 10 percentage points higher than the average EU corporate statutory tax rate. ⁷ The main finding was that the EU tax base is broader than the US tax base. Despite the evidence, several lawmakers still cling to their hypothetical “pure territorial tax system” which exists nowhere in the world. The mere fact that, among OECD nations, 26 have territorial systems—including Australia, Canada, France, Germany, Japan, Spain, and the United Kingdom—does not justify the USA shifting from the predominantly “worldwide tax system” to a territorial tax system. ⁸

1.3 US Taxation of Individuals and Corporations

Today, corporate tax accounts for 8.9 % of federal tax revenue, whereas individual and payroll taxes generate 41.5 % and 40 % respectively, of federal revenue. ⁹ The decline in corporate tax revenues is due in part to more corporate income being reported abroad in low-tax jurisdictions such as Ireland, Bermuda, and the Cayman Islands. ¹⁰

1.4 Reforming the US Tax System

1.4.1 Broadening the Tax Base

The USA needs to increase the amount of income subject to tax. This can be done by eliminating some loopholes and corporate expenditures such as the deductibility of interest which is not an expenditure.

1.4.2 Integration of the Corporate and Individual Tax Systems

One integration approach would be to eliminate corporate tax and allocate earnings directly to shareholders in a manner similar to which partnerships and S corporations allocate income to their partners and shareholders. In effect, C corporations, partnerships, and S corporations would be treated identically for tax purposes, with all being treated as pass-throughs. ¹¹

1.4.3 Taxing Certain Large Pass-throughs

Taxing large pass-throughs as corporations would also allow for lower tax rates as it would broaden the corporate tax base. Lower tax rates combined with a reduction in business tax disparity could improve business tax equity and the allocation of resources relative to current policy.

Depending on how “large” pass-throughs were identified, a relatively small percentage of businesses currently structured as pass-throughs could be affected by the corporate tax under certain reforms. ¹²

Notes

1. 1.
   Bruce C. Wolpe (1996) Lobbying Congress: How the System Works, 2d Edition, Congressional Quarterly, Inc.
    
2. 2.
   Ken Messere, Flip de Kam and Christopher Heady (2002): Tax Policy: Theory and Practice in OECD Countries.
    
3. 3.
   Chye-Ching Huang, Chuck Marr, and Joel Friedman (2013): The Fiscal and Economic Risks of Territorial Taxation, Center on Budget and policy Priorities, p. 4.
    
4. 4.
   OECD (2013) Confronting the Reality of ‘Leaky’ Territorial Systems in Other Countries,” p. 15.
    
5. 5.
   Mark P. Keightley, Molly F. Sherlock (2014): The Corporate Income Tax System: Overview and Options for Reform, Congressional Research service, p. 12.
    
6. 6.
   United States Senate- Permanent Subcommittee on Investigations (April 1, 2014): Caterpillar’s offshore tax strategy, p. 9.
    
7. 7.
   Avi-Yonah, R., Lahav, Y. (2012): The effective tax rates of the largest US and EU multinationals, New York University Tax Law Review, 65, 375.
    
8. 8.
   William Simon (2012): Territorial vs. Worldwide Taxation at rpc.senate.go/policy-papers.
    
9. 9.
   United States Senate- Permanent Subcommittee on Investigations (April 1, 2014): Caterpillar’s offshore tax strategy, p. 8.
    
10. 10.
    United States Senate- Permanent Subcommittee on Investigations (April 1, 2014): Caterpillar’s offshore tax strategy, p. 8.
     
11. 11.
    Mark P. Keightley, Molly F. Sherlock (2014): The Corporate Income Tax System: Overview and Options for Reform, CRS, p. 25.
     
12. 12.
    Idem, p. 26.
     

© The Author(s) 2016

Felix I. LessamboInternational Aspects of the US Taxation System10.1057/978-1-349-94935-9_2

Begin Abstract

2. The Underlying Principles of the US Tax System

Felix I. Lessambo¹

(1)

The Peter J. Tobin College of Business, St. John’s University, Jamaica, NY, USA

End Abstract

2.1 Introduction

In his seminal ...