In today’s global economy, the U.S. international tax rules, which govern how we tax cross-border investment, are increasingly important. Nearly everyone agrees that the existing rules are terrible. Their defects largely reflect the difficulty that both U.S. policymakers and analysts have experienced in choosing between two sharply etched approaches, known in the literature as (1) worldwide or residence-based taxation of U.S. taxpayers, including resident companies, and (2) source-based or territorial taxation, also known as exemption as it involves exempting U.S. companies’ foreign source income (FSI).
Unfortunately, evaluation of these and other choices in international tax policy is impeded by the fact that the underlying literature, despite a more than fifty year history of frequently intensive academic study by exceptionally talented and knowledgeable economists and lawyers, at some point went badly off the rails. Its main terms of debate reflect crucial misunderstandings of key issues and distinctions, along with a misguided focus on concepts that verge on being completely unhelpful. A major rethinking is therefore needed, taking advantage of tools that are routinely used elsewhere in the public economics and tax policy literatures.
Among the common errors in existing literature that the book addresses are the following:
(1) Misdescription of the core underlying problem as one of addressing “double taxation” and “double non-taxation.” Relative tax burdens at various relevant margins are what matter, not the number of different times that the same dollar is taxed under different countries’ systems.
(2) Failure to distinguish between domestic taxes and foreign taxes from a domestic tax policy standpoint. We only get to use the revenues from our own taxes, not those levied by other countries. Yet the U.S. rules, backed by bad analysis in the literature, often treats this important distinction as if it were wholly irrelevant.
(3) Conflation between multiple margins. In practice, worldwide residence-based taxation and exemption differ at two main margins, not one. First, they differ in the statutory tax rate that they apply to FSI, which typically equals the domestic rate in a worldwide system and zero percent under a pure exemption system. Second, they differ in the marginal reimbursement rate (MRR) that they apply to foreign income tax liabilities. Worldwide systems typically provide foreign tax credits, which at least in principle create an MRR of 100 percent. Exemption systems provide a zero percent MRR, but more precisely their MRR equals the marginal tax rate for FSI (i.e., zero percent in a pure exemption system), thus making them what I call implicit deductibility systems for foreign taxes. Distinguishing between these two margins turns out to be indispensable for a coherent analysis of the underlying issues in international tax policy.
(4) Drowning in “alphabet soup.” Much of the international tax policy literature eschews typical tax policy or public economics frameworks, in favor of relying on what I call “alphabet soup” or the “battle of the acronyms.” Under this approach, one starts by describing a single decisional margin at which tax neutrality might be a nice thing. Each margin is given its own acronym, such as capital export neutrality (CEN), capital import neutrality (CIN), and capital ownership neutrality (CON). Supposedly, all that one needs to do is pick one’s favorite acronym and apply it without further thought about multiple margins or complicated tradeoffs. This is not a persuasive, or even a useful, approach to international tax policy analysis. Its problems include the fact that CEN, CIN, and CON are all about maximizing global economic welfare – whereas a given country would be expected to emphasize that of its own citizens and residents. While there actually are possible rationales (albeit generally poorly articulated) for using a global rather than a national welfare approach to international tax policy, these rationales prove unpersuasive upon fuller analysis.
(5) Lack of conceptual integration between entity-level corporate taxation and that of individuals. A final problem in the literature, albeit one that a number of writers have begun to address seriously in the last ten years, is overlooking the full implications of the fact that the dominant taxpayers in cross-border business activity are corporations, not individuals. The imposition of entity-level corporate income taxation, based on entity-level determinations of corporate residence, turns out to be crucial to both the conceptual and practical difficulties that we face in international tax policy. Even if these difficulties cannot be solved, focusing on them more explicitly can be helpful.Rather than just critiquing the existing international tax policy literature, the book offers a new approach, potentially with concrete implications for policymakers, based on useful ideas from elsewhere in the broader tax policy literature. Examples include the literatures about tariffs, optimal commodity taxation, and cheap versus costly electivity in the tax planning realm.