A Territorial Fix for the Corporate Tax

After a decade of hefty profits, by summer 2012 Apple Inc. was sitting on $117 billion in cash, 23% of the entire company’s value. Yet despite no acquisition plans to justify the staggering figure, Apple long refused to return a single dollar back to its shareholders. By August intense pressure became intolerable, pushing the company finally to pay $2.5 billion in cash dividends, a mere two percent of its total dough. Even for this scrawny sum, Apple rebuffed efforts to shrink meaningfully its cash balance, instead financing the dividend with fresh borrowing. What could make Apple so loath to use its own cash? Safely secure in the basement vault of an Irish bank, two thirds of the company’s horde represents profit from international sales, money that the firm cannot repatriate without incurring a tax bill in the tens of billions. So today, there the money lies, dollars with no passport. If this phenomenon seems unusual, it is. In fact, such situations are only possible in one place on the entire planet – the United States of America.

While every other country taxes its multinational businesses “territorially,” whereby profits are taxed at the rate where each transaction is conducted, the United States stands alone in taxing all global profits at the U.S. rate. The procedure in the rest of the world is quite simple: Canadian firms making profit in the U.S., Canada, and England must pay tax to each authority, on transactions within the jurisdiction of each authority, at the rate legally prescribed in each authority. But for American multinationals making profit in these same countries, Uncle Sam picks up the tab owed to Canada and England, and firms pay Uncle Sam tax on all their global profits at the single U.S. legal rate. Furthermore, businesses only pay tax on overseas profit once they return the cash to U.S. soil. This complex arraignment, the legacy of a bygone era, today threatens American growth and American jobs. The time has come to join the rest of the world in adopting a territorial tax for corporations.

First, unlike the current framework, a territorial system eliminates crushing repatriation penalties. Today, corporations are strongly incentivized to keep cash outside the United States since they only pay tax upon repatriation, a scheme that drives a substantial amount of investment outside the country. U.S. corporations now have a majority of their cash, more than one trillion dollars, held inactively offshore because of this repatriation penalty. With American businesses struggling to access good credit and create jobs, with American entrepreneurs struggling to implement good ideas and create growth, how can we quarantine one trillion dollars of our own cash in the basement vaults of Europe’s banks?

Second, unlike the current framework, a territorial system achieves capital ownership neutrality. When taxes are conducted territorially, all businesses operating in a region are charged the same local rate, leveling the competitive playing field. This system allows businesses to compete on their underlying performance attributes so that the firm with the best product survives, not the firm with the best tax rate. Conversely, current law forces U.S. businesses to pay higher taxes, disadvantaging American growth around the world and undermining the competitive forces necessary for market economies to function properly. Incentivize our multinationals to manage their operations well, not their taxes.

Third, unlike the current framework, a territorial system saves valuable American headquarters. Because of lower tax rates abroad, our current system strongly encourages U.S. businesses with substantial overseas sales to merge into foreign companies and pay less tax. If U.S. headquarters expatriate, we will lose all the economic activity and jobs these institutions now support at home. Honest men and women with no direct control over tax policy will lose their jobs and lose their livelihoods while the congressmen responsible will likely lose neither.

Proponents of the status quo argue that with tax rates constant across location, only the current framework can ensure post-tax returns on global investment will align directly with true economic, pre-tax returns. They express concern that under a territorial system, U.S. firms will simply invest in countries with low tax rates even if there are superior pre-tax investment alternatives domestically. While certainly a valid worry, this view inherently assumes investment is substitutable: a firm will invest either internationally or domestically. However, the evidence suggests investment is actually complementary: a firm investing more internationally tends also to invest more domestically. In fact, according to research from the Harvard Business School in 2005, greater foreign investment is associated with greater domestic wages, exports, and jobs. Rather than jeopardize domestic investment, low taxes abroad may actually bolster it, further supporting the case for a territorial system.

We know many of the status quo’s defenders have only the best intentions at heart when advocating their position, just as we do. Let us then elevate this debate beyond the petty fear tactics often recruited to resist reform of the beleaguered corporate tax code. Logic and reason will better advance our common American cause than fear and smear ever have in the past.

One thought on “A Territorial Fix for the Corporate Tax”

  1. After 25 yrs of failing in attempts to lift its economy from recession, Japan is now exploring “post growth economy.” Exactly what does a post growth economy look like??? Structures? Trends? Employment? Social constructs?

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