Later today, the House Ways and Means Committee will hear Treasury and expert witnesses on the use of transfer pricing by U.S. multinational firms. Under the current system of international taxation, multinational corporations are taxed on income generated by both domestic and foreign operations. However, taxation on foreign income is deferred until the money is repatriated domestically.
This hearing is part of the drumbeat to find PAYGO revenue offsets to pay for future tax cuts. Note, the Joint Committee on Taxation also published this pamphlet that’s worth reviewing as a primer.
The current international tax regime is troubling for several reasons. By deferring taxation until money is repatriated home, businesses face incentives to accumulate capital abroad rather than return it domestically in the form of dividends. Additionally, the process of repatriation is complicated and encourages costly forms of tax planning.
These concerns have generated advocates for moving to a territorial-based taxation system, in which American companies would simply pay the taxes of the country in which they are located.
However, momentum is now moving in the opposite direction on this issue. The Obama Administration has mooted a system of transfer pricing that would raise taxes on the foreign operations of American companies to domestic levels, regardless of tax rates prevailing overseas. The motivation behind this proposal is to curb the supposed tax incentives of “shifting jobs overseas.”
As Matthew Slaughter has pointed out, these proposals are based on a misleading interpretation of the role of multinational corporations. Economic research has found that foreign expansion by multinational companies supports job growth domestically as well. Foreign operations complement domestic industry, rather than simply replacing it.
Forcing American companies to pay American corporate tax rates – which are generally higher than those prevailing in other countries – would put these firms at a competitive disadvantage. The losers would not only be American multinationals and foreign countries, but domestic workers as well. This could end up being a particularly pernicious reform to implement in the midst of a serious recession.
While it is more popular to tax corporations, rather than average Americans, the reality is that corporations are simply legal aggregations of individuals – shareholders, management, Boards of Directors, and employees. Higher corporate taxes necessarily imply lower wages to individuals, higher prices for consumer products, and lower returns to shareholders. Are progressives willing to raise taxes on wages, consumer goods, or capital? If the answer is “no” – then they should be careful not to advocate raising those taxes indirectly either.
As this Administration and Congress try to foot the bill for the elevated spending levels – while also trying to preserve the pledge to not raise taxes except on the very rich – you can expect even more proposals that include these sorts of indirect levies.
