Hearing of the Senate Finance Committee - The Foundation of International Tax Reform: Worldwide, Territorial and Something In Between
Statement
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This hearing sets the stage for the debate on international tax reform, and it's long overdue. I made that very same statement five years ago when this committee held a series of hearings on this very same subject.
On the current economic slowdown that we have now, I think it is even more important to explore what Congress should do or not do to make U.S. businesses competitive globally. The current economic environment should be a wake-up to pay attention to how the tax rules impact U.S. businesses in their ability thrive in the global marketplace.
I agree with the premise that the U.S. multinationals should pay their fair share of U.S. taxes. It is a fact of life that we must fund our government, and taxing business entities is one of the ways to do that, even though we all know that corporations don't pay taxes, only people pay taxes, and corporations are tax collectors. But we still get a massive amount of money from that source and we're going to continue to, so we have to make it work.
Our goal, however, should be to minimize as much as possible the tax system's interference with rational business behavior. We need to carefully examine and also carefully balance approaches that would raise the necessary revenue, but we should be mindful that we not poison the well with anti-competitive tax policy.
Our current system is based on a framework enacted during President Kennedy's administration. Since then, we've seen an era of expanding global markets, falling trade barriers and technological innovations that have served to melt away traditional notions of national borders. Our tax code has obviously not kept pace with these changes. Our tax policy should enable U.S. companies to operate in the global marketplace without the artificial boundaries set in place by the tax code.
Globalization of the marketplace creates its own unique set of rules and complexities. Companies have responded by updating their systems and business models. Our tax code should address that reality. Our -- one would hope that a country known for great innovation as we are would be able to craft a tax code that encourages economic development, collects the necessary revenues and foster growth of jobs.
There has been a long-standing debate about whether our international tax system should be fundamentally changed. Some say that the transfer pricing regime used by virtually every major country is broken and call for taxing all foreign income on a current basis. Without significant corporate tax rate reduction, eliminating deferral would have the effect of exporting our high tax rates and putting our companies at a competitive disadvantage in the global marketplace. Furthermore, the piecemeal cutbacks on deferral for active foreign income that we have seen here in the Senate would do nothing but complicate the tax code and create opportunities for tax planning around those cutbacks.
Others argue for completely exempting active foreign income under a territorial system, as many of our trading partners do. However, this proposal is a not without its issues. Concerns about tax treatment of royalties and transfer pricing would need to be addressed head-on in exploring this as an option.
So we have a few real choices: to build a protectionist wall or develop a tax system that fosters growth and innovation. I am on record as criticizing legislation that would eliminate or whittle away the current deferral of active foreign earnings. Beyond that, however, I don't profess to have preconceived notions as to which direction our tax rules should go. We seem to all agree that something should be done and I believe we should be open-minded about what direction that reform should take.
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In previous hearings, I raised the question of what revenue neutrality means in the whole concept of tax reform. If we assume revenue neutrality against current law, then individual income taxpayers are going to face a 10 percent tax increase. If assume -- we assume revenue neutrality against current law policy reflecting this year's tax burden, then there is no widespread tax increase. If it is decided that revenue neutrality against current law is the test, then there will be major political pressure to alleviate that huge burden on individual income taxpayers.
Our last big test on this point occurred in the '86 tax reform bill. In that case, joint tax told us we shifted $120 billion from individuals to business. That was $120 billion over five years in 1986 dollars. Today, that figure would be much higher.
So my question to the panel is this, particularly Mr. Shay: If Congress were to face similar political pressures in a reform exercise, would you caution us to forgo that path? That is, would you suggest we not use tax reform to shift more burden onto business?
MR. SHAY: Not as a per se recommendation. I guess I'm not sure I'm quite following the question.
There is always a decision in an overall tax system as the allocation of tax on business and individuals. I share the view that tax on business ultimately is borne by the participants, particularly. We don't really know (incidents ?) of corporate taxes very clearly, but it's partly shareholders, partly consumers. But there's no reason to on a per se basis say that you shouldn't increase a tax on business.
These are -- this is part of a broader fairness decision that you're making. And part of my recommendation of increasing taxation of foreign income, again, is if you're going to tax businesses on income it is, in my view, unwise to differentiate to the extent we do between foreign income and domestic income because it creates bad incentives and it's unfair. I think we're looking for solutions to help the exporter as much as the foreign-based -- multinational with foreign activities and for the purely domestic business as well. So if that results in an increased tax on business, which it probably would, although it's not really revenue-oriented as such. It's really -- the proposals I'm making -- you can set the tax rate -- corporate rate where you want. The proposal I'm making are really designed to have a more efficient tax base across the board so that hopefully you can get the lower corporate rates within your overall revenue needs but there will be less incentive to artificially shift income outside the United States.
SEN. GRASSLEY: Professor Hines and Mr. Dilworth, comment on my --
MR. HINES: The United States already has a very heavy business tax burden compared to other countries. That's the issue and that's part of the reason why, you know, Steve Shay is right that we need to -- and others are right -- that we need to be concerned about shifting of taxable income outside the United States to other countries.
We definitely need good enforcement of our rules on that. But the reason is because the tax rates are high in the United States. A movement in the direction of higher still business tax rates, you know, would have consequences for that as well as consequences for productivity of the economy and, you know, all the things that go along with it, employment and affluence, so I would be wary about an '86-style solution where, you know, you've lowered the tax burden on individuals in return for a higher burden on corporations.
SEN. GRASSLEY: Mr. Dilworth.
MR. DILWORTH: I think that the question from the standpoint of a practitioner is very much like what Chairman Rostenkowski said in '86 -- don't tax you and don't tax me; tax the companies beyond the sea.
SEN. GRASSLEY: I think that's Russell Long.
MR. DILWORTH: That was don't -- that's tax the guy under the tree I think, but I thought it was refined in '86 --
SEN. GRASSLEY: Oh, okay.
MR. DILWORTH: -- to make sure that we hammered the foreign companies.
And I don't think that's a very good idea because I -- the reason I don't think it's a very good idea is we don't know who owns the U.S. multinationals, for openers, so some portion of it, no doubt the burden of the tax, falls on U.S. shareholders, the wealthier among us. But some of it falls on foreigners. And if they have competing alternative investment opportunities between (MB ?) Phillips and GE, we will not have done ourselves a good day's deed.
The second point, the lock-in effect -- going back to Chairman Baucus's posit about don't we have a problem with $365 billion in Ireland or wherever, Cayman Island -- I don't know how big a problem that is. I'm not confident as Professor Hines that it's not a problem; it could very well be a problem.
But I don't know what the total pool of income of all those enterprises was on a worldwide basis during the period that the income was accumulated in the foreign jurisdiction.
Was that all of their income of these 863 companies or was it just half? Was it a third? Was it a tenth? And what was it attributable to? Was it attributable to U.S. origin IP? Is that what the problem's really all about? If it's U.S. origin IP, let's look at U.S. origin IP and not disable the rest of the conduct of U.S. multinational business overseas by repealing deferral, because unlike Steve, I don't think anybody who's ever done 959 calculations would confuse that with -- (inaudible) -- I mean, that's what happens when you try to deal with undistributed income that's been previously taxed. You know that you're eventually going to pay tax on a number different than what you put on the tax return because you will have future losses, you'll have currency fluctuation.
Finally, as far as the lock-in effect on not being able to deploy assets in the United States, we are the only country I ever heard of that prohibits foreign subsidiaries from making business investments in the resident country. We put that back in in 1962 as a vestige almost like an appendix to an entirely different system that was proposed in Subpart F and passed the House. The Senate rejected that version but left the 956 piece in there. And a Mr. Miller from Iowa correctly pointed out that the premise of 956 as finally passed was strange because it allowed the deployment of assets outside the United States but not in the United States.
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