Why we should tax overseas corporate income

This week, we learned that Apple is sitting on over $100 billion in untaxed overseas cash, and this cash will remain untaxed until and unless Apple repatriates this income (that is, brings the cash home to the United States).

In a blog post, Jared Bernstein asked about how we can stop this sort of international tax avoidance. The simplest and most direct way of taxing offshore income would be to simply end deferral entirely. Taxing the overseas income of U.S. multinationals would raise revenue, helping ease current budget pressures, and eliminate incentives for complicated tax avoidance schemes.

Not only do millionaires have low tax rates, so do many corporations, with some large corporations paying less in taxes than the typical middle-class American taxpayer. So how do large multinational corporations avoid paying taxes? The full answer is as complicated as the tax code; the short answer involves profit-shifting and deferral.

Multinational corporations shift profits from relatively high-tax countries (such as the United States) to low- or no-tax countries (tax havens). One method used to do this is transfer-pricing—the pricing of intellectual property rights and other assets when transferred from the U.S. parent company to an offshore affiliate. The problem as noted (in lawyerese) by the Joint Committee on Taxation (pdf) is a multinational’s “profits may be artificially inflated in low-tax countries and depressed in high-taxed countries through aggressive transfer pricing that does not reflect an arms-length result from a related-party transaction.” In other words, the companies put a great deal of effort into bending (just short of breaking) the tax rules regarding transfer pricing.

Once profits are offshore, they are not subject to U.S. taxes until they are brought back to the United States; that is, repatriated as dividends from the foreign subsidiary to the U.S. parent company. This is known as deferral, and taxes can often be deferred indefinitely. The Permanent Subcommittee on Investigations of the Senate Committee on Homeland Security and Governmental Affairs notes that U.S. multinationals have over $1.7 trillion in undistributed foreign earnings (pdf).

Congress simply needs to change the law to end deferral. If these earnings were taxed at an effective corporate tax rate of 27 percent (approximately the U.S. effective corporate tax rate), then corporate tax revenues would be increased by over $400 billion—almost two-thirds of the projected 2013 budget deficit.