A Global Perspective on Territorial Taxation

August 27, 2012

In today's globalized economy, many countries rely on international business investments to make them competitive. But beyond imposing the highest top marginal tax rate in the developed world, the U.S. tax system's treatment of international business income is exceptionally burdensome, according to Phillip Dittmer of the Tax Foundation.

The most important question that faces policymakers is how to tax international business income. There are two distinct approaches to achieve this. The first approach is known as the territorial approach. Under this system, a country only collects income earned in the border of the country. This system equalizes the tax costs between international competitors in the same jurisdiction to create an even playing field.

The second, which the United States follows, is the worldwide approach. Under this rubric, all income of domestically-headquartered companies is subject to tax, even income earned abroad. This is burdensome to U.S. companies and keeps nearly $1.7 trillion out of the country. Furthermore, it allows U.S. companies to invest more freely in foreign markets.

There are many benefits to pivoting toward a territorial model.

  • First, studies show that 10 percent of foreign investment is associated with 2.6 percent greater domestic investment.
  • Second, countries employing the territorial model have lower rates of unemployment.
  • Furthermore, opponents of the territorial model worry about profit shifting into low tax countries, avoiding U.S. tax law. However, there is no evidence of this occurring in countries with a territorial model, and evidence shows from 2000 to 2009 that territorial systems raised more revenue in nine out of 10 years.

In fact, the worldwide model has proven counterproductive to U.S. interests. Large companies such as Aon, Eaton and Ensco have taken their capital ownership out of the U.S. tax base by moving abroad. This has led to a loss of jobs as well as a source of revenue.

Case studies around the world, ranging from Japan to the European Union, provide ample evidence for why the territorial model is superior. Territorial tax reform would reduce compliance costs for both companies and the government, which would save $40 billion per year.

Source: Phillip Dittmer, "A Global Perspective on Territorial Taxation," Tax Foundation, August 10, 2012.

 

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