Tax the Worldwide Income of U.S. Corporations As It Is Earned

The income that U.S. businesses earn at home and abroad is taxed by the federal government and may also be subject to taxation in the country in which it is earned. To prevent such double taxation, U.S. companies are allowed to claim a foreign tax credit, which reduces their domestic tax liability by the amount of any income and withholding taxes they pay to foreign governments. The foreign tax credit is subject to limits that are designed to ensure that the amount of credits taken does not exceed the amount of U.S. tax that otherwise would have been due. Those limits also are intended to prevent corporations from using foreign tax credits as a way to reduce taxes on income earned in the United States. For computing those limits, the overhead expenses (such as interest costs) that a U.S. parent company incurs for its operations must be allocated between domestic and foreign activities. Most of the income that foreign subsidiaries of

U.S. corporations earn is not subject to U.S. taxation until it is repatriated in the form of dividends that those subsidiaries pay to the parent corporation. Under this option, all income earned by the foreign subsidiaries of U.S. companies would be subject to U.S. taxes as it was earned, regardless of when it was repatriated. To prevent double taxation, foreign tax credits would still be allowed. For determining the limit on those credits, however, the U.S. parent corporation's overhead expenses would no longer be allocated between domestic and foreign activities because all income would be treated identically and taxed concurrently. Together, those changes would increase revenues by $50 billion from 2012 through 2016 and by $114 billion over the 2012-2021 period.

An argument in favor of this option is that by not taxing income until it is repatriated as dividends, the current system reduces the cost of foreign investment relative to that of domestic investment. This option would eliminate that bias and thus increase domestic investment, which in turn would make U.S. workers more productive and boost their earnings.

Other arguments focus on how such a policy change would simplify the tax system. Eliminating the rules for allocating overhead expenses and the provisions that distinguish between "active" foreign income (which is not taxed until it is repatriated) and "passive" foreign income (which is generally taxed as it is earned) would make international tax rules less complex. In addition, the costs of tax planning also would decline for U.S. multinational corporations, which would no longer need to plan the repatriation of dividends from their foreign subsidiaries. Finally, enforcing tax rules would be less costly because U.S. companies would not be able to reduce their worldwide taxes by treating U.S. income as foreign income. An argument against this approach is that it would put

U.S. multinational corporations at a competitive disadvantage: Whereas the cost of foreign investments would increase for U.S. multinationals, similar investment costs for foreign multinationals would remain the same. Such a competitive disadvantage, it is argued, would shift market share and production toward businesses controlled by foreign multinationals. Those concerns could be addressed by reducing U.S. corporate tax rates if such a policy change was implemented.