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Solomon Comments On Role Played By US Tax System In Competitiveness

by Mike Godfrey, Tax-News.com, Washington

11 June 2007


Speaking last week at a conference organised by the United States Council for International Business, the OECD and the Business and Industry Advisory Committee, US Treasury Assistant Secretary for Tax Policy, Eric Solomon discussed the tax system’s role in US competitiveness.

He observed that:

"There has been a great deal of discussion at this conference and elsewhere about how to improve international tax rules. Today I would like to focus on the US tax system, and the impact of the US tax system on the competitiveness of US businesses in global markets."

"Competitiveness is a word that is used a lot. It is something Secretary Paulson, since coming to the Treasury Department last year, has focused on. Competitiveness has many possible definitions, depending on the context, and means different things to different people. Today, I'd like to outline my thoughts on how the US tax system plays a role in our ability to compete in the global marketplace."

"A key objective of any country's international tax rules is to ensure that its tax system interacts with other countries' tax systems efficiently, preventing, to the greatest extent possible, double taxation of business income and capital, while encouraging investment."

"The United States, like most other countries, seeks to reduce or prevent double taxation through its domestic law, by providing, for example, a foreign tax credit. Nonetheless, bilateral tax treaties are often necessary to mesh the tax systems of two countries to reduce disputes and to reduce withholding taxes which often result in excessive taxation of cross-border trade and investment. Since the 1980s, the United States has signed over 50 tax treaties and protocols aimed at reducing double taxation, and fostering productive economic relationships with some of the world's largest economies."

"The Treasury Department has worked tirelessly not only to negotiate new treaties, but also to work with existing treaty partners to update our treaties and adapt to the changing economic landscape."

The Treasury official continued:

"Of course, any discussion of business competitiveness should not focus solely on specific cross-border trade and investment tax rules - we also need to consider the impact of our entire tax system."

"For example, one aspect to consider is the level of tax rates imposed on businesses and how that positions the US economy to compete in the global marketplace."

"Since the 1980's, the United States has gone from a high corporate tax rate country, to a low corporate tax rate country and, based on some measures, has returned to high corporate tax rate country. Indeed, the United States currently has the second highest statutory corporate tax rate within the OECD."

"The Tax Reform Act of 1986, which dramatically reformed the U.S. tax code, lowered the federal statutory corporate tax rate from 46 to 34 percent. Since then, other developed countries have also lowered their statutory tax rates, recognizing that lower corporate tax rates spur investment in both physical and human capital."

"As the global economy continues to expand and markets become more open to investment, developed economies such as those within the OECD continue to adapt their corporate tax systems to compete in the global marketplace. However, since 1993, our federal statutory corporate tax rate has remained 35 percent."

Speaking with regard to the kind of international tax system that will allows the United States to compete best in the global marketplace, Mr Solomon observed that:

"In selecting the optimal international tax system, one aspect to consider is the conflict between capital export neutrality, which is the concept that tax considerations should not influence a taxpayer's decision of whether to invest in the United States or abroad, and capital import neutrality, which is the concept that all investment in a particular source country should be treated the same, regardless of the residence of the investor."

"We have three basic conceptual choices for taxing foreign source income: a full inclusion approach, a territorial approach, or the current US approach."

He continued:

"Under a full inclusion approach, a US person would pay immediate US tax on its income from all sources, including foreign source income earned by foreign subsidiaries. The US person would be able to take a foreign tax credit for some or all of the foreign taxes paid on that income. Thus, a US corporation that owns a foreign subsidiary would pay current US tax on the foreign subsidiary's income, whether or not that income has been repatriated."

"A full inclusion approach is generally consistent with capital export neutrality - US persons should pay the same amount of tax on foreign operations as on US operations. Various proponents of a full inclusion approach argue that economic data does not show that this approach would have a negative effect on multinational competitiveness, and that, in contrast to a territorial approach, it would not have a distortionary effect on investment location decisions."

"Under a territorial approach, a US person would be subject only to local tax on income earned outside the United States. Thus, a US corporation that owns a foreign subsidiary would not pay US tax on the foreign subsidiary's income, even when the income is repatriated as a dividend. There would be no foreign tax credit for foreign taxes paid on exempt foreign income. In addition, deductions of the US person would be disallowed to the extent attributable to the exempt foreign operations."

"A territorial approach is also generally consistent with capital import neutrality, that US persons with foreign operations should pay no more total tax than foreign persons carrying on the same activities in the same foreign location. Various proponents of a territorial approach argue that tax is a relevant factor affecting the ability to compete in foreign markets and adoption of a full inclusion approach would have a negative effect on US companies' ability to compete in those foreign markets."

"Then, there is our current system of international taxation, which generally defers US taxes on active foreign income until it is distributed to the US owner. In essence, our current system might be described as a blend of full inclusion and territorial systems."

"Our current approach reflects the tension between capital export neutrality and capital import neutrality. Thus, the United States generally taxes its citizens and residents on their worldwide income, with double taxation mitigated by the foreign tax credit."

"US owners of foreign subsidiaries, however, generally are not subject to US tax on active foreign income earned by foreign subsidiaries until the income is repatriated. Expenses of the US owner attributable to foreign income are currently deductible, the expenses may also have the effect of limiting the foreign tax credit. Our system allows deferral, but this can encourage US corporations to keep earnings offshore to postpone the tax on repatriation as long as possible. In addition, our current system provides numerous opportunities for foreign base erosion. We need to consider the extent to which foreign base erosion concerns us, both under our current system or under an alternative system."

He concluded:

"In addition, in assessing international competitiveness, another essential question we need to consider besides corporate tax rates and other tax factors, is the effect of other non-tax factors, such as the openness of markets and regulatory schemes. In other words, the decision whether to invest in a country depends on many factors, not just taxes."

"This conference has been an opportunity for us to discuss all of these issues and many more, and I look forward to continuing our discussions in the future."


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