The Need for Tax Reform, Part 3: Unlocking Foreign Earnings to Create American Jobs

Apr 11, 2012

As part of this series on the need for comprehensive tax reform, I want to get into a lesser-known part of the tax code: Moving from a worldwide system to a territorial system. Yes, that doesn’t sound sexy, but it's important because under the current tax code, job-creating capital is kept away from the United States.

Many American companies do business globally through foreign divisions, and they pay taxes to the countries where income is earned. Income earned in Canada is paid to the Canadian government; income earned in Italy is paid to the Italian government; etc.

The problem comes when the company wants to send those earnings back to the United States. It doesn’t matter if the earning are used to hire American workers, pay down debt, or issue dividends—some of it going into IRAs and 401(k) retirement funds. Under the current worldwide system of taxation, companies have to pay the difference in the tax on those earnings.

In the example the Tax Foundation uses in the video above, a business that earns money in the United Kingdom (and pay the 25% rate) has to pay the difference between the U.K.’s tax rate and the U.S.’s 35% corporate rate.  Since we have the world’s highest corporate tax rate that means extra tax has to be paid from nearly every other country just to bring these earnings into the United States.

Being rational, companies respond to this disincentive by keeping foreign earnings outside the United States. J.P. Morgan estimates that it’s at least $1.4 trillion dollars. How many jobs could be created in the United States if a fraction of that money flowed to the U.S.? It’s a missed job-creating opportunity.

Earlier this year, U.S. Chamber President and CEO Tom Donohue said, “America is the only major country that disadvantages its own firms competing globally” by having a worldwide system. Last year, Walter Gavin, vice chairman of St. Louis-based Emerson, wrote in Investors Business Daily that the worldwide system punishes “businesses that choose to headquarter in the U.S. rather than offshore” and gives “an advantage to our international competitors.”

Rep. Dave Camp (R-MI), the House Ways and Means Committee Chairman has been a leader in pushing for reform. Last fall, in a tax reform discussion draft, he included transitioning the U.S. from a worldwide system to a territorial system. This parallels the U.S. Chamber’s long support for a territorial tax system as part of comprehensive tax reform.

The combination of the worldwide tax system and the high corporate tax rate shows the need for comprehensive tax reform. America’s worldwide tax system is closely tied to its high corporate tax rate which can’t be reformed all by itself because it’s tied closely to the individual tax code through “pass-through entities.” Our tax system is a complicated mechanism that needs to be reformed in toto, else we’ll suffer the wrath of the Law of Unintended Consequences. Effective reform will have to tackle all parts of the system in a comprehensive fashion to make America’s economy more competitive and friendly to job creation and economic growth.

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