By encouraging multinational corporations to use accounting techniques to shift their profits to foreign tax havens, the U.S. tax code invites tax avoidance by corporations.
The extent of this profit shifting was made clear by a recent Congressional Research Service analysis that found that U.S. multinationals reported 43 percent of their overseas profits came from tax havens like Bermuda, even though few of their actual foreign investments (7 percent) or foreign workers (4 percent) were in those countries.
Tax havens account for 43 percent of U.S. multinationals' overseas profit, but few of their foreign investments or foreign workers.
Profit-shifting is so lucrative because U.S. multinationals can defer U.S. taxes on their foreign profits indefinitely — until they bring those profits back to the United States. (The tax havens, of course, charge little if any tax.) At the same time, multinationals can reduce their U.S. tax bills by claiming immediate tax deductions for some expenses related to those tax-deferred profits.
These elements of the U.S. tax code help tax havens thrive, while draining revenues and creating a bias against domestic firms and firms that don’t have access to sophisticated tax expertise. Policymakers can start to level the playing field by no longer allowing firms to take immediate deductions on expenses related to tax-deferred foreign profits, as the president has proposed.
What they shouldn’t do is grant the multinationals’ wish to eliminate or sharply cut U.S. taxes on foreign profits. Countries that have such “territorial” tax systems have tried to make it harder for multinationals to avoid taxes through profit-shifting. But policymakers in several territorial tax countries, like the United Kingdom and Germany, are growing increasingly frustrated that large multinationals — including some U.S.-based companies like Starbucks, Google and Apple — pay very little in tax on the billions of dollars of business they do there every year.
The Organization for Economic Cooperation and Development recently warned that the erosion of corporate tax revenues “constitutes a serious risk to tax revenues, tax sovereignty and tax fairness for O.E.C.D. member countries and nonmembers alike.” The report recommended that countries tighten their tax regimes and better coordinate their tax rules to stop international tax avoidance.
For the United States, adopting territorial taxation would only make tax havensmore attractive and the problem worse.
Chye-Ching Huang is a federal tax policy analyst with the Center on Budget and Policy Priorities.