Sunday, August 21, 2011
The Obama Administration has proposed a dramatic reworking of the way US corporations are taxed on income they earn outside the US. Although less prominent than other Washington policy debates, these changes are no less contentious. The result is either a fairer tax system yielding the government an extra $210 billion, or the end of US-based multinational corporations, depending on who one asks. Yet both sides of the debate have opted for rhetorical simplicity over accuracy, sidestepping sixty years of theoretical scholarship on the subject. The world economy is a dynamic system, and the current projections of US companies’ reactions to Obama’s proposals ignore (potentially) countervailing reactions by foreign firms and other nations’ tax policies.
This Article harnesses the insights of international tax theory and general equilibrium economics to explain the long-term implications of Obama’s reforms. Comparing Obama’s reforms against efficiency-based tax policy benchmarks suggests that the changes may neither increase US tax revenue nor induce net capital inflow, two major selling points of the plan. Equity benchmark comparisons reveal that the fairness of Obama’s proposed revisions may be illusory, distorting the tax burden more than alternatives in the long-run.
With hundreds of billions of dollars at stake in the decision, tax reform should not be undertaken lightly. Unfortunately, the current policy debate fixates on short-term policy predictions which may not reflect the lasting effects of Obama’s changes. A long-term view is crucial because national tax systems interact dynamically with each other; any policy analysis that misses the worldwide responses to a US policy change will be dangerously incomplete. This Article uses the lens of general equilibrium economic theory to show that many of the current policy predictions are based on unrealistic assumptions. By shifting the focus from rhetoric to a deeper discussion of how foreign agents and nations will respond to US tax revisions, this endeavor to connect policy to theory will facilitate a more well-informed decision.