President Obama released his FY 2016 budget yesterday. It contains dozens of tax increases that go on for page after page. Buried in there is a series of tax increases on U.S. employers who also do business abroad. Because the U.S. has a "worldwide" tax regime, any further U.S. taxation of overseas income represents a double tax on that income. By definition, these overseas profits have already faced taxation in the country where they were earned. The United States should instead move to a "territorial" tax system, where the IRS only taxes profits earned inside our borders. That's what the rest of the developed world does, and it's time to modernize the code to reflect current best practices.
Unfortunately, the Obama budget moves in the wrong direction in three key ways.
Immediate 14 percent tax on overseas earnings. U.S. companies who earn money overseas have a problem. They have already paid taxes on these profits in whatever country they earned the money in. But if they try to bring their after-tax profits back to the United States, they face a double tax from the IRS. They have to pay the difference between the U.S. corporate income tax rate (which is over 39 percent when states are--properly--included), and the rate they already paid overseas (the OECD average is under 25 percent).
The Obama budget makes this problem even worse by slapping an immediate 14 percent tax (close to 20 percent when states are included) on all after-tax earnings overseas--whether the money ever comes back to the United States or not.
A much saner strategy would be to make this decision optional and beneficial for companies. Back in 2005, companies could voluntarily bring back overseas after-tax corporate earnings with a small double tax of 5.25 percent. When given this choice, over $300 billion came back that year alone. In the absence of a territorial system, which would have no double taxation at all, U.S. policymakers should give strong consideration to another round of repatriation.
A new global minimum tax of 19 percent. Another provision in the Obama budget would say that companies have to pay a tax rate of 19 percent (really 24 percent when states are included) on their global profits. This means that companies who do business in countries with the good sense to have low, internationally-competitive corporate income tax rates will be punished. This is a clear case of rich, developed, and bloated countries picking on developing countries in Eastern Europe and elsewhere who are trying to attract capital. American companies are merely being used as a football here.
A real territorial system would not care what the tax rate overseas is, since it would not concern itself with overseas profits. Trying to slap global minimum taxes around the world is a sure recipe for forcing companies out of the United States entirely. Speaking of that...
New restriction on "corporate inversions." President Obama and Congressional Democrats like to rail against "corporate inversions" (when a U.S. company is bought out by a foreign company) in the same way an angry drunk objects to the bruises on his wife's face. We have the worst corporate income tax system in the world. We impose the highest marginal income tax rate in the world. We force our companies to live under a totally insane worldwide tax regime which exposes their profits to all sorts of international double taxation. We force companies to slowly deduct investments and double tax their equity, yet they can write off debt interest immediately. It's the opposite of what you want to do if you want to attract jobs and capital to the United States.
Yet the Obama budget makes it worse. It changes tax rules so that if 50 percent or more of the shareholders in the acquired company were in the old company, the new business is treated as if it were domestic. To translate that into English, it exposes these companies to full international double taxation, and potentially causes massive "exit taxes" on companies just trying to comply with a very punitive tax system.
The solution for "corporate inversions" is simple--fix the U.S. tax system so that we're inviting capital and jobs in, rather than pushing them out the door.
Obama Budget Creates Second Death Tax