Policy Documents

Research & Commentary: Worldwide vs. Territorial Taxation

October 30, 2012

The United States has the highest corporate tax rate among the 34 nations in the Organisation for Economic Co-Operation and Development (OECD) in addition to being one of the few nations still using a “worldwide system.” These are two reasons the United States is in dire need of fundamental corporate tax reform. 

Under the worldwide corporate tax system, U.S.-based corporations are taxed on the income they earn in other countries. Since these companies already pay taxes in their host country, this creates a system of double taxation. Of the OECD countries, eight have such worldwide systems, but the top tax rate in those countries is considerably lower than the top U.S. rate. 

To avoid the high corporate tax imposed by the United States, many U.S.-based companies operating internationally have been keeping their foreign earnings in subsidiaries overseas. That has resulted in billions of dollars of capital being kept in more tax-friendly countries. 

Some lawmakers have proposed a tax holiday to allow U.S. companies to bring their foreign earnings back to the United States. That would provide only a temporary respite from the problems created by the outdated U.S. corporate tax system. A better reform would be to switch to a territorial tax system, as is used by countries around the world. 

Under a territorial tax system, the United States would tax only corporate income earned in the United States and not income of foreign subsidiaries, eliminating the double taxation. Many territorial tax proposals would retain certain types of financial assets held by foreign subsidiaries as taxable earnings, to prevent abuse and erosion of the tax base. 

According to the Tax Foundation, a transition to a territorial system would “free the $1.7 trillion currently locked out of the U.S., place U.S.-based companies on equal footing with competitors in every market, reduce complexity and compliance costs, reduce the incentive to reincorporate abroad, and could be accompanied by improvements to anti-abuse protections.” 

Our current worldwide tax system puts the United States at a competitive disadvantage versus other nations with lower, less-complicated corporate tax rates. Switching to a territorial system would make the United States more competitive by bringing foreign earnings back home to invest while encouraging more companies to set up headquarters here. 

The following articles examine the worldwide and territorial tax systems from multiple perspectives.

Ten Reasons the U.S. Should Move to a Territorial System of Taxing Foreign Earnings
http://heartland.org/policy-documents/ten-reasons-us-should-move-territorial-system-taxing-foreign-earnings
The Tax Foundation presents 10 reasons why the current U.S. international tax rules should be replaced with a territorial or exemption regime that exempts most foreign profits from U.S. tax.

Research & Commentary: Repatriation of Foreign Earnings
http://heartland.org/policy-documents/research-commentary-repatriation-foreign-earnings
Heartland Institute Senior Policy Analyst Matthew Glans discusses the “tax holiday” proposals for repatriated earnings. Under the holiday proposal, corporations would be allowed to bring profits held overseas back to the United States and pay taxes on them at a rate possibly as low as 5.25 percent instead of the current 35 percent. Tax collections would likely rise, though they would decline once the holiday expired and rates returned to their current level. Tax holiday proponents say it could inject up to $1 trillion into the U.S. economy at no cost to taxpayers. 

A Global Perspective on Territorial Taxation
http://heartland.org/policy-documents/global-perspective-territorial-taxation
Philip Dittmer of the Tax Foundation examines the tax systems of countries around the world and their effects on economic growth, comparing worldwide tax systems to territorial ones. 

Territorial vs. Worldwide Taxation
http://www.rpc.senate.gov/policy-papers/territorial-vs-worldwide-taxation 
In the ongoing debate over how to reform the U.S. federal tax system, an important question is how to treat income U.S. corporations earn from their work overseas. This paper from the Senate Republican Policy Committee examines the two major ways countries answer this question: territorial and worldwide tax systems.

Territorial Taxation for Overseas Americans: Section 911 Should Be Unlimited, Not Curtailed
http://freedomandprosperity.org/2005/publications/territorial-taxation-for-overseas-americans-section-911-should-be-unlimited-not-curtailed/ 
Writing for the Center for Freedom and Prosperity, Daniel J. Mitchell argues the Section 911 exclusion, which mitigates the adverse impact of worldwide taxation by allowing workers to protect annual earnings up to $80,000 from double taxation, should be expanded and the U.S. government should not tax any income earned abroad, just as foreign governments should not tax income earned in America.  

Job Creation and the Taxation of Foreign-Source Income
http://heartland.org/policy-documents/job-creation-and-taxation-foreign-source-income
In this Executive Memorandum from The Heritage Foundation, Daniel J. Mitchell contends territorial taxation is good tax policy and the current system of worldwide taxation places U.S. companies at a competitive disadvantage. “Reducing the tax burden on foreign-source income is a simple step in this direction that would help the U.S. economy, resulting in more jobs, better jobs, and improved competitiveness of U.S. companies.” 

Moving to a Territorial Income Tax: Options and Challenges
http://heartland.org/policy-documents/moving-territorial-income-tax-options-and-challenges
Jane G. Gravelle of the Congressional Research Service explains how the international tax system works, and he describes the magnitude and distribution of foreign source income and taxes. The report then considers a territorial tax alternative and its expected consequences. 

Moving to a Territorial System and Reforming the Corporate Tax
http://heartland.org/policy-documents/moving-territorial-system-and-reforming-corporate-tax
Daniel N. Shaviro of the New York University School of Law examines proposals to shift the U.S. tax system to a territorial one. He recommends the shift include a lower tax rate and improvements in the source rules so companies cannot easily shift income outside the United States. 

Why the United States Needs to Restructure the Corporate Income Tax
http://heartland.org/policy-documents/why-united-states-needs-restructure-corporate-income-tax
Jason Fichtner and Nick Tuszynski of the Mercatus Center examine the U.S. corporate income tax rate and system and compare them with other countries’. They identify problems with the U.S. system and show how it is hindering the nation’s economic growth. 

Territorial Tax Study Report
http://heartland.org/policy-documents/territorial-tax-study-report
The National Foreign Trade Council evaluates the idea of implementing a territorial tax exemption system in the United States. The report concludes a broad-based traditional territorial exemption system would improve the competitiveness of those U.S. companies that have substantial foreign active business income taxed at source country rates that are significantly less than U.S. tax rates.

Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit The Heartlander’s Budget and Tax News Web site at http://news.heartland.org/fiscal, The Heartland Institute’s Web site at www.heartland.org, and PolicyBot, Heartland’s free online research database, at www.policybot.org

If you have any questions about this issue or The Heartland Institute, contact Heartland Institute Senior Policy Analyst Matthew Glans at 312/377-4000 or mglans@heartland.org.