NCPA - National Center for Policy Analysis

Territorial Tax the Solution to EU Trade Dispute

March 5, 2004

The World Trade Organization (WTO) recently ruled on the side of the European Union (EU), which alleged that U.S. tax law provides impermissible subsidies to American exporters. Though the ruling means that the United States must either raise taxes on businesses or pay compensatory tariffs, researchers for the Heritage Foundation suggest an alternative: a territorial tax system.

Currently, the United States has a "worldwide" tax system, which means that the federal government taxes the income earned by Americans in other nations. However, because foreign governments have the primary right to tax income tax earned inside their borders, this creates the risk of double taxing that, ultimately, makes U.S. companies abroad less competitive.

A territorial tax, on the other hand, would only allow the federal government to tax income that is earned within the United States. While that does lower federal tax in the short run, such a tax system would provide many benefits, including:

  • As jobs and capital flow to jurisdictions with lower taxes, there will develop tax competition to lure foreign businesses, thus creating a liberalization force in the world economy.
  • U.S. companies situated abroad typically buy raw materials from America -- the Organization for Economic Cooperation and Development (OECD) estimates that for every $1 invested oversees by a nation's companies yields $2 of additional exports for that country.

The Heritage Foundation says that if wholesale changes cannot be made to the tax system, then putting in place incremental reforms, such as permitting the repatriation of overseas income, would be a good first step.

Source: Daniel J. Mitchell, "Making American Companies More Competitive," Backgrounder No. 1691, Heritage Foundation, November 2003.


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