Require a Minimum Level of Taxation of Foreign Income as It Is Earned

CBO periodically issues a compendium of policy options (called Options for Reducing the Deficit) covering a broad range of issues, as well as separate reports that include options for changing federal tax and spending policies in particular areas. This option appears in one of those publications. The options are derived from many sources and reflect a range of possibilities. For each option, CBO presents an estimate of its effects on the budget but makes no recommendations. Inclusion or exclusion of any particular option does not imply an endorsement or rejection by CBO.

Billions of Dollars 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2017-2021 2017-2026
Change in Revenues 6.1 18.5 26.2 31.8 33.9 35.0 35.8 36.2 37.7 39.7 116.5 300.9

Source: Staff of the Joint Committee on Taxation.

This option would take effect in January 2017.

Businesses that are incorporated in the United States are subject to U.S. taxes on both their domestic income and their foreign income. To offset potential double taxation, a foreign tax credit is provided to account for foreign taxes paid on foreign income. Most types of foreign income earned by the foreign subsidiaries of U.S. companies, however, are not subject to U.S. taxation until the income is brought back to the United States—that is, repatriated. There are exceptions to the deferral of U.S. tax payments on that foreign income. Certain types of income—such as interest income—are considered passive (that is, received by taxpayers who are not actively involved in the operation of the business). Other types of income—such as royalty payments—are considered highly mobile (that is, easily shifted across borders). Foreign income categorized as passive or highly mobile is subject to U.S. taxes as it is earned.

Under this option, all future foreign income of U.S. corporations and their foreign subsidiaries would be subject to U.S. taxes as it is earned. Foreign income that is not passive or highly mobile would be taxed at a combined U.S. and foreign tax rate of at least 19 percent. That minimum tax rate would be applied separately for each country in which the U.S. corporation or its foreign subsidiary earns income. If income is taxed by more than one country, then the income would be assigned to the highest-tax country.

To provide a credit for foreign taxes paid, the U.S. tax rate on the taxable foreign earnings in each country would be equal to 19 percent minus 85 percent of the foreign effective tax rate on those earnings. The effective tax rate would be calculated as the ratio of qualifying foreign taxes to foreign income over a 60-month period; qualifying foreign tax payments would include all tax payments that are eligible for foreign tax credits under the current U.S. tax code. (The U.S. tax rate would be zero on earnings for which 85 percent of the foreign effective tax rate is greater than 19 percent.)

The resulting U.S. tax rate would be applied to foreign income that is not passive or highly mobile minus a deduction for return on equity. (That deduction is intended to exempt from the minimum tax the risk-free return—generally approximated by the market interest rate for long-term government bonds—on active investments in each country). Passive and highly mobile foreign income would be taxed at the full U.S. statutory corporate tax rate, and current rules governing foreign tax credits for that income would continue to apply. There would be no further federal tax payments due on foreign income when it is repatriated. If enacted, the option would increase revenues by a total of $301 billion from 2017 through 2026, the staff of the Joint Committee on Taxation estimates. That increase includes some revenues that would be collected after 2026 under current law.

The main argument in favor of this option is that the current system of deferral provides an incentive to hold profits overseas. Because companies do not have to pay U.S. taxes on foreign income until the income is repatriated, deferral reduces the cost of foreign investment relative to the cost of domestic investment. By ending deferral, this option would reduce the after-tax return on foreign investment, which could increase domestic investment.

Another argument in favor of this option is that it would provide greater certainty about the timing and size of tax payments. That would reduce the gains from strategies that lower businesses’ tax liabilities through the use of deferral, which would result in companies’ incurring lower tax planning costs. Those resources could be reallocated to more productive activities.

The main argument against this option is that it would put U.S. multinational corporations at a disadvantage relative to foreign multinationals. To the extent that deferral is used to permanently avoid U.S. tax payments, the minimum tax would increase total taxes paid by U.S. multinationals. The increase in tax payments and resulting reduction in after-tax profits could reduce both domestic and foreign investment by U.S. multinationals. (That reduction in domestic investment would offset at least a portion of the increase in domestic investment mentioned above.) The increase in the benefits associated with being a foreign corporation would also increase the incentive for U.S. corporations to be acquired by a foreign corporation or for new companies to incorporate outside of the United States.

Another argument against this option is that the requirement to report tax payments and income on a per-country basis would increase compliance costs for U.S. multinationals. Each foreign subsidiary of a U.S. multinational would have to devote time and resources to allocating its earnings and taxes across all countries in which it operates. Those resources would be diverted from more productive activities.

Compared with an approach that would tax worldwide income as it is earned at the full U.S. statutory corporate tax rate, this option would result in a smaller increase in tax payments for U.S. multinationals, so it would put U.S. multinationals at less of a disadvantage relative to foreign multinationals. U.S. taxation at a reduced rate would, however, be more complicated to administer, as companies and tax-enforcement agencies would have to continue to distinguish passive and highly mobile income from other types of corporate income.