Going Abroad: Senate Finance's International Tax Options Paper
Conveniently, the same day that House Ways and Means and Senate Finance Committee chairs Rep. Dave Camp (R-MI) and Sen. Max Baucus (D-MT) published a website soliciting public feedback on tax reform, Senate Finance continued its work on tax reform by releasing an options paper on international taxation. The paper lays out issues with the current system plus, as you'd expect, many different paths for reform. It complements a detailed report that CBO put out in January and our corporate tax reform paper, which has some discussion of international issues.
For most foreign-source income, the current system defers taxation of that income until it is repatriated to the US. Passive income, generally financial in nature, is taxed in the year it is earned under the Subpart F regime. When that income is taxed by the US, businesses can claim foreign tax credits for all active and passive income taxed, up to the amount of US tax owed.
This "deferral" system is problematic because it simultaneously encourages businesses to shift income and operations overseas while discouraging them from bringing it back. The two main alternatives to deferral are a worldwide system, where deferral is eliminated and all foreign earnings are taxed as they are earned, and a territorial system, where foreign earnings are generally not taxed, even when they are repatriated. The options paper includes both options, with the territorial system being presented in conjunction with a number of ways to prevent excessive income-shifting abroad. These "anti-base erosion" provisions involve things like taxing low-taxed foreign income in the current year or having a minimum tax for multinational corporations. While the exact designs may vary, these options are in line with what both Chairman Camp and President Obama have proposed (although only Camp proposed a territorial system).
Beyond the broad design, the paper also lays out some options for tightening the taxation of international income. This includes changing Subpart F rules to tax certain income in the year it is earned, such as low-taxed intangible property income or interest and royalties from active businesses. It also includes disallowing or deferring domestic deductions associated with tax-deferred income for affiliates abroad. The paper has many options related to foreign tax credits and other more detailed aspects of the international tax system. There are also a few options for changing the taxation of US citizens abroad, including eliminating the $97,600 foreign income exclusion entirely.
International taxation may be a very technical aspect of tax reform, but it is an important one. Policymakers will need to balance concerns about incentives, competitiveness, and revenue. The Senate Finance Committee's options paper and the House Ways and Means Committee's discussion draft are a good start on this topic.