Even a Less Than “Pure” Territorial Tax System Carries Serious Risks

A White House official told Politico yesterday that the President doesn’t support a “pure” territorial tax system, under which U.S.-based multinational corporations would face a zero or very low tax rate on their foreign profits.  That’s good news — but even a less than “pure” territorial system carries serious risks.

As our new report explains, U.S.-based multinationals already pay much lower taxes on their overseas profits than on their domestic profits.  A territorial tax system would give them an even greater incentive to invest overseas rather than in the United States and to shift U.S.-earned profits overseas.  That would risk hurting domestic businesses, boosting deficits over the long run, and weakening the economy.

Even “impure” territorial tax systems don’t completely avert these risks.  Many countries that supposedly have territorial systems actually have hybrid systems that tax substantial portions of their multinationals’ overseas profits, as well as other “tough” rules to make it harder for multinationals to avoid taxes by artificially shifting profits overseas.  These less than pure territorial tax systems are often referred to as “tough” territorial tax systems.  Yet, these countries have found that multinationals can still shift profits to tax havens and avoid tax.

This problem is becoming increasingly pressing:

• In recent weeks, policymakers in the UK, France, Germany, and Italy have been “cracking down on U.S.-based multinational companies such as Google, Apple, Facebook and Amazon, claiming they pay little or no tax in Europe in spite of generating billions in revenue there.”

• The European Union is considering steps to address this problem, possibly by coordinating member states’ rules for taxing multinational profits so that all corporate income is sourced to some country.

• British Prime Minister David Cameron has promised to use his country’s year-long presidency of the G8 group of large economies (which includes the United States) to target tax avoidance.

• A strikingly direct November 2012 release from the Organisation for Economic Co-operation and Development (OECD) pressed developed countries to rethink the “very fundamentals” of their (predominantly territorial) tax rules, noting that in many cases multinational profits aren’t taxed anywhere.

Particularly given the problems that other countries are having with even “tough” territorial systems, the United States shouldn’t move in the territorial direction.