Senate Finance Committee Chairman Max Baucus released his international business tax reform discussion draft yesterday. This is an ambitious and fairly thorough proposal and the Senator is to be commended on offering such a detailed draft with legislative language.

But from the start it fails in one crucial area—revenue. Senator Baucus apparently is looking for additional revenue for short-term deficit reduction, but the international tax reform discussion draft is intended to be long-term revenue neutral (more on this below). Corporate taxes already provide too little revenue; corporate tax revenue, which was about 4 percent of GDP in the 1950s, is equal to about 1.5 percent of GDP today. If corporate tax revenue as a percent of GDP had been at its 60-year average last year, corporate tax revenues would have been 43 percent higher, or about $120 billion. Meanwhile, corporate profits are currently at an all-time high.

Revenue aside (and it’s a big aside), it is difficult to fully assess the policy merits of a discussion draft that offers two options and is necessarily incomplete until the rest of the corporate income tax proposal is released. Nonetheless, I have a few comments, based on what has been released and my reading between the lines.

Senator Baucus is absolutely correct in identifying problems with how the current U.S. corporate tax code taxes profits made overseas. In the jargon, the current U.S. international tax system can be described as a worldwide tax system with deferral. This system gives multinational firms an incentive to shift profits overseas to tax havens through aggressive transfer pricing schemes, as well as to keep foreign-sourced income offshore because it would be taxed once it is repatriated to the United States. This produces what is known as the “lock-out” effect because of the corporate income tax is triggered by repatriation. Recent estimates suggest that more than $2 trillion may be sitting “offshore” as liquid assets (e.g., cash, Treasury securities, tax-exempt bonds).

The Baucus discussion draft quite correctly states that ending the lock-out effect requires either taxing all foreign-sourced income of U.S. multinationals immediately or not at all. This would suggest moving to either a pure worldwide tax system (i.e., one without deferral) or a pure territorial system. However, neither of the two options put forward by Baucus is anywhere near pure. Both have some sort of minimum tax (at a preferential rate) on foreign-sourced income as it is earned. However, these preferential rates would provide multinationals an incentive to continue what they are already doing—move income overseas, either through moving production offshore or using accounting games to recognize income in foreign jurisdictions.

The Baucus proposal does include many rules designed to protect the U.S. tax base by strengthening subpart F of the tax code. One has to wonder, however, whether or not these rules will actually make it to the final bill, since the trend over the past 40 years has been to weaken subpart F. (Subpart F was added to the tax code in the 1960s to deny deferral to income that could easily be moved to tax havens.) A pure worldwide system (with a foreign tax credit) would eliminate the lock-out effect, reduce the need for detailed rules to protect the tax base, and raise revenue. In short, what one comes back to again and again with issues of corporate tax reform is that ending deferral is the most direct and powerful single reform that can happen.

Senator Baucus proposes a transition rule for the estimated $2 trillion in previously deferred foreign income that has not been subject to U.S. tax: this income would be subject to a one-time 20 percent (the exact rate is negotiable) effective tax rate whether or not it is repatriated. The tax is payable in installments over eight years. This could increase corporate tax revenues by about $400 billion over the next 10 years relative to a baseline where this income is not repatriated in this time, but it provides a low tax rate that essentially rewards multinationals for the behavior they have engaged in over the past several years, namely profit shifting by bending and perhaps even breaking tax laws.

My suspicion is this proposal will lose revenue outside of the 10-year budget window if any of the additional revenue from the transition tax on previously deferred income is used to lower the tax rate. According to Tax Notes Today (subscription only), committee staff has suggested a tax rate of less than 30 percent, and Senator Baucus appears to want something in the upper 20s. Given the difficulties in broadening the tax base, I think it likely that to get the corporate tax rate this low some of the transition rule tax revenues will have to be used for this purpose rather than for deficit reduction. If long-term debt reduction is truly a goal, then additional corporate tax revenues are needed, and claims that lowering the tax rate on corporate income is the pressing economic priority for the U.S. seem awfully hard to sustain.

I suppose the discussion draft could provide a place to start in negotiations over corporate tax reform, but it seems rather odd to start from the position of having already given away the hen house.