More Compromises for the Budget: Corporate Tax Deferral on Foreign Earnings

November 20th, 2013

The budget conference committee, which is currently charged with negotiating a compromise on the U.S. federal budget, has met publicly for a second time last week. The committee must deliver a report to Congress by December 15 and, to avert another shutdown, Congress must extend government funding by January 15.

Leaders in the budget committee leaders have said they “won’t waste time debating the areas where they already know there’s no agreement, but will focus on where deals can be cut.” Some Senate Democrats believe those compromises could lie in tax expenditures—including by eliminating “egregious” loopholes that wealthy individuals and corporations use to lower their net tax burdens.

Many have focused compromise in this realm on corporate tax loopholes. For good reason: while the United States has a statutory tax rate of 35% (the second highest among developed nations) corporations in this country pay an effective tax rate of just 12.6%. Senator Tom Coburn, a Republican from Oklahoma, has responded to these statistics, saying: “An individual’s or corporation’s tax rate shouldn’t be dependent on their ability to hire a tax lobbyist. It’s especially wrong to ask families who are struggling to make ends meet to subsidize special breaks for corporations.”

One of the “egregious” loopholes Democrats have put on the table is an end to corporate tax deferral on foreign earnings. Though the United States technically taxes all of its corporations’ earnings, the tax code allows corporations to defer tax payments on foreign earnings until they repatriate them to America. In practice, this means corporations can reduce their net tax burden by masquerading domestic income as foreign income. They accomplish this by engaging in abusive transfer pricing to shift profits overseas. As a result, companies like Microsoft and Apple hold $50 and $100 billion, respectively, in foreign cash and investments.

To fix this problem, the United States could end the credit that allows corporations to defer taxes on foreign earnings. The FACT Coalition has supported this proposal—it a memo on tax reform the Coalition asked Congress to end corporate tax deferral on foreign earnings and enact a tax system for U.S. corporations that is truly worldwide. According to the Congressional Budget Office (CBO), closing this loophole would generate an additional $114 billion in revenue for the U.S. government over the next ten years. The CBO also noted that this change would “boost efficiency.”

There may be room for a deal on this proposal in the current budget negotiations. Some conference committee members and Senators are already on board. Senator Ron Wyden, a Democrat of Oregon and a member of the budget conference committee, has astutely observed that “When there are a trillion dollars worth of tax expenditures, a number of which both sides said are foolish and wasteful, it is possible to trim wasteful tax expenditures as part of our conference to generate the revenue.”

You’ll hear some common counter arguments. Some U.S. corporations will say this tax system helps them keep competitive and foreign investment is good for domestic job creation. These arguments turn out to be relatively disingenuous, however. While corporate competitiveness is important, it is not U.S. policymakers only concern. At the moment, reducing the budget deficit—for many at least—is a higher priority. The argument that foreign investment creates U.S. jobs is a long and uncertain walk. While though corporations maintain American workers are needed to produce goods and services in foreign markets U.S. multinationals have, in recent years, reduced domestic employment while foreign employment has increased.

Some corporations point out, in an argument against the current system, that it disincentives them from repatriating their profits. This is absolutely true, but it’s a better argument for reform than the status quo. Eliminating the foreign deferral tax credit would eliminate this disincentive.

As the FACT Coalition has pointed out, the United States needs corporate tax reform that stops corporations from avoiding the “taxes that support the essential goods and services that government provides.” In the current political climate, we also desperately need some economically sensible and politically feasible compromises that reduce the deficit in the long-term. While—in economic terms—this particular measure is not sufficient to significantly change the deficit outlook over the long-term, it would make a $100 billion dent in the problem. Right now, politically and economically, that’s exactly what America needs.

Written by Ann Hollingshead

Follow @FinTrCo