NCPA - National Center for Policy Analysis

Territorial Tax System

May 25, 2011

After paying taxes to the host countries, U.S. companies that do business overseas have two choices for the residual profits: bring them back to the United States or reinvest them in their foreign operations.  If they chose to bring the profits back home, they must pay the difference between the amount of tax paid to the foreign government and what would be owed under the U.S. rate of 35 percent for most large firms, says Scott A. Hodge, president of the Tax Foundation.

  • Critics of this process, known as "deferral," say that the system encourages companies to keep their profits offshore and avoid paying U.S. taxes on that income.
  • Defenders of deferral say that it simply recognizes the well-established principle that income should not be taxed until it is realized (or repatriated).
  • Others say our current international tax regime needs to be replaced with a territorial system that more closely resembles those of most other capitalist nations.

Reasons to consider a territorial system include:

  • Parity: The U.S. system must be aligned with our global trading partners.
  • The premise of the worldwide tax system -- capital export neutrality -- is obsolete when subsidiaries have access to global capital markets and can self-fund their expansion with retained earnings.
  • The worldwide tax system violates the benefit principle of taxation.
  • The United States maintains a territorial tax system for foreign-owned companies but a worldwide system for U.S. companies; moving to a full territorial system will level the playing field.

Source: Scott A. Hodge, "Ten Reasons the U.S. Should Move to a Territorial System of Taxing Foreign Earnings," Tax Foundation, May 2011.


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