Reforming U.S. Corporate Taxes

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The US corporate tax code encourages US firms to retain profits abroad. Their taxes are deferred, and only payable when the money comes home. This is a tax-avoidance opportunity and an artificial inducement to firms to invest abroad rather than in the United States. Robert Pozen has a proposal: move to a modified territorial system.

To reform the current system, Congress should exempt from U.S. taxes corporate income earned in foreign countries with an effective corporate tax rate of 20 percent or higher. Such earnings could be repatriated to the U.S., subject to payment of a 5 percent administrative charge. Such a fee, applied in France and other countries, would be a simple way to account for prior deductions from U.S. taxes by American corporations to generate foreign source income -- for example, on salaries of U.S. executives who helped start European operations.

At the same time, Congress should end the current deferral system for foreign source income earned by U.S. corporations in countries with effective tax rates under 20 percent. Instead, that income would be taxed every year in the U.S. at a rate equal to the difference between 20 percent and the actual rate paid by the corporation in the tax haven. For example, if an American company generated $100 million of income in Bermuda, which collected $2 million in taxes on that income, the corporation would pay $18 million in U.S. taxes. And if the company repatriated that income to the U.S., it would pay the 5 percent administrative charge.

The plan is not without its difficulties--but Pozen answers the main objections. It is a good idea.

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