Borderline Case International Tax Policy, Corporate Research and Development, and Investment (1997) / Chapter Skim
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9 U.S. TAX POLICY AND MULTINATIONAL CORPORATIONS: INCENTIVES, PROBLEMS, AND DIRECTIONS FOR REFORM
9 U.S. TAX POLICY AND MULTINATIONAL CORPORATIONS: INCENTIVES, PROBLEMS, AND DIRECTIONS FOR REFORM
Pages 109-132
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From page 109... ...
international tax rules have become more complex and more distorting in the past several years, particularly since the passage of the Tax Reform Act of 1986. Discussions in Congress and the administration over the past several years indicate a willingness to consider significant reforms.
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international tax rules and consider possible reforms.3 Finally, I describe how recent proposals for fundamental tax reform could affect multinational firms. TAX REFORM OBJECTIVES To frame a discussion of international tax reform or any broad tax reform it is necessary to articulate the objectives clearly.
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, achieve production efficiency? Production efficiency could be achieved only in the unlikely event that all countries choose the identical effective tax rate on capital income.
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The costs of compliance with international tax rules may pose serious efficiency and competitiveness concerns, and both business leaders and policymakers have voiced concern that the complexity of U.S. international rules increased after the passage of the Tax Reform Act of 1986.7 5The substitutability of direct and portfolio capital is an empirical question.
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As noted earlier, satisfying both principles at the same time is possible only if effective tax rates on capital income are identical across countries.8 The U.S. Treasury Department has generally favored the norm of capitalexport neutrality,9 with a system that taxes the worldwide income of resident multinational firms and provides a tax credit for taxes on foreign-source income paid abroad.~° However, concern over preservation of the U.S.
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Hence, a U.S. firm receives full tax credits for foreign tax payments paid only when it is in an "excess limit" position, that is, when its average foreign tax rate is less than the average tax imposed by the United States on foreign-source income.
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It is possible for deferral to encourage firms facing low foreign tax rates to delay the repatriation of dividends.~4 i5 This incentive is enhanced when firms expect that future years offer a more favorable tax climate for repatriation, for example, in anticipation of a reduction in the domestic corporate income tax rate on excess foreign tax credits to use in offsetting U.S. tax liability on repatriations.
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In addition, the combined use of AMT foreign tax credits and net operating loss deductions may not decrease tentative minimum tax by more then 90 percent. Such credits denied are treated like other excess foreign tax credits and may be carried back for two years and forward for five years to offset tentative minimum tax.
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For firms with excess credits, the interest allocation rules can lead, in effect, to a partial disallowance of interest deductions. The Tax Reform Act of 1986 adopted a "one-taxpayer rule" in which the characteristics of all members of a controlled group determined interest allocation.
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In the context of FDI, these implications permit Hartman and others to ignore effects of permanent changes in home country tax parameters on FDI in "mature" subsidiaries paying dividends to their parent firms.24 Hartman estimates the effects on U.S. inbound FDI of changes in the aftertax rates of return received by foreign investors in U.S.
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It allows one to ask the question: Given a change in a tax parameter, how does a subsidiary's return to investing change, and how does FDI change? Tax considerations can affect subsidiaries' new capital investment decisions through two channels.26 First, host country corporate income tax rates, investment incentives, and depreciation rules affect the cost of capital for foreign investors.
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, subsidiary dividend decisions and the cost of capital are not affected by permanent changes in the tax price of repatriations, although temporary changes can affect both repatriations and FDI.27 In this channel, there are two sources of variation in the tax price of dividend repatriations. The first reflects variation over time in host and home country statutory corporate income tax rates.
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statutory corporate tax rates or parent firms' foreign tax credit positions affect the cost of capital and FDI. If, for example, a parent firm expects to move from an excess limit position to an excess credit position, its cost of capital rises relative to a parent firm with no change in foreign tax credit status if its investments are in high-tax jurisdictions, leading the firm to reduce its FDI.30 Efficiency, Competitiveness, and Simplicity Concerns The findings in Cummins and Hubbard (1995)
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33Since passage of the Tax Reform Act of 1986, section 904(d) of the Internal Revenue Code specifies separate foreign tax credit limitation for eight types of income.
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Although either system provides relief from double taxation and a territorial system may in some ways be less expensive to administer, a move to a territorial system would significantly increase pressure on transfer pricing and allocation rules to address potential income shifting.36 In addition, a territorial system might lead to an expansion of tax-haven activity and erosion of the tax base.37 To shed light on this concern, researchers and the Treasury Department should examine the experience of France and the Netherlands with territorial systems. Complications from the Alternative Minimum Tax Empirical evidence on incentive effects of the AMT is not abundant, though the significant stock of outstanding corporate AMT credits indicates the potential importance of these effects (see Gerardi et al., 1994~.
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Consider the case of equity-financed investments by firms in excess limit status for foreign tax credit purposes. Firms expecting to be subject to the AMT for 10 years face roughly equivalent effective tax rates for domestic and foreign-use equipment, whereas regular tax firms face significantly higher effective tax rates for foreign investment than for domestic investment.
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With respect to interest allocation rules, the Tax Reform Act of 1986 applied a "water' e-edge fungibility" approach.41 In principle, "worldwide fungibility" could be implemented by combining domestic and foreign affiliates' interest expense and apportioning this combined amount to the income of the group by assets of domestic and foreign group members. In practice, this strategy is difficult to implement because of deferral.
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It is productive to examine reforms in two steps: first, incremental changes to reduce significant problems or anomalies under current law, and second, to consider "international tax reform" in the context of reform of capital taxation.44 As a first step it is possible to reduce violations of efficiency and competi tiveness goals by modifying interest allocation rules and R&D allocation rules. Moreover, substantial simplification of foreign tax credit rules may be possible even in the context of the current worldwide tax system with deferral (see, for example, U.S.
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Fundamental tax reform also raises the issue of the effects of required rates of return on debt and equity in capital markets. Replacing the current tax system with the Comprehensive Business Income Tax or the Hall-Rabushka Flat Tax could significantly affect debt and equity returns and international flows of debt and equity capital (see Gentry and Hubbard, 1998~.47 45See descriptions in American Business Conference (1993)
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tax policy on the income and repatriation patterns of U.S. multinational corporations." In Studies in International Taxation, A
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1998. "Fundamental tax reform and corporate financial policy." In Tax Policy and the Economy, Vol.
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1995. "The impact of international tax rules on the cost of capital." In The Effects of the Taxation of Multinational Corporations, M
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737 U.S. Deponent of me Treasury.
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"HERE AND NOW" OF INTERNATIONAL TAXATION In the 1950s, 1960s, and even the 1970s, the United States entertained a "grand vision" of the international tax system. This vision was built around several foundation facts and assumptions (Hufbauer, 1992~: Countries that were important players in the international economy generally operated "classical" tax systems, consisting of separate corporate and individual income taxes.
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