Chairman of the Senate Finance Committee Max Baucus (D–MT) released his draft proposal for reforming the tax treatment of multinational businesses. It is a positive step, if overdue, for tax reform.
Increasing discussion about tax reform is a welcome step, because the U.S. badly needs to fix the system it uses to tax its multinational businesses. Our “worldwide” system suppresses investment by U.S. businesses, which reduces job creation and wages for U.S. workers.
The worldwide system taxes the income U.S. businesses earned through their subsidiaries in foreign countries. It is out of step with the “territorial” system (which taxes only income businesses earn within their borders) that most other developed nations use. This extra tax U.S. businesses pay on their earnings abroad makes them less competitive compared to foreign competition.
However, the only benefit Baucus’s plan confers on tax reform is generating more interest in the debate. It would keep the present worldwide system in place and thus fail to undo the damage it inflicts on the economy. Establishing a territorial system is the only antidote to the pain that worldwide taxation inflicts on the economy. The proposal released more than two years ago by Baucus’s tax-writing counterpart in the House, Ways and Means Committee chairman Dave Camp (R–MI), would establish a territorial system.
The Baucus plan would levy a minimum tax on all the foreign income of U.S. businesses at the time their foreign subsidiaries earn it. The rate would be either 80 percent of the U.S. tax rate on all foreign income or 60 percent on active business income and 100 percent on all other forms. U.S. businesses would then be able to repatriate their foreign earnings without additional tax when they choose.
Under either system Baucus proposes, U.S. businesses would owe residual U.S. tax on a substantial portion of the foreign earnings of their subsidiaries, which means they would face a disincentive to invest compared to a sound, neutral policy such as territorial taxation. And U.S. businesses would still remain uncompetitive compared to their foreign counterparts that reside in countries with territorial systems.
Baucus’s plan will keep talk of tax reform moving, but the U.S. would be better served by a territorial system such as that proposed by Camp.