U.S. Republicans are engaged in secret negotiations to rework the international tax code before Christmas. It’s good news for the world economy, and for the United States as well. To be clear, a deal would not deal with the trifecta of tax rates and actual domestic taxes on ordinary income. These issues are already part of the business community-specific, U.S. tax-reform measures recently outlined by President Trump, Rep. Kevin Brady (R-Texas), chairman of the House Ways and Means Committee, and Sen. Orrin Hatch (R-Utah), chairman of the Senate Finance Committee. But since legislators face a deadline in the coming weeks for putting something in place for 2018, it is understandable that they would want to address just tax-code changes.
But here’s the thing. Let’s take what we know about the details of a tax deal that will give the largest benefit to global companies, namely international business income that is not brought back to the United States, but instead taxed at international corporate tax rates. For instance, the standard 30 percent tax rate, which falls to 20 percent or so for “pass-through” businesses, would apply to even double-digit foreign profits at international corporate tax rates. This includes currently outside-the-U.S. profit reported by U.S. companies on their U.S. balance sheets. They are charged a one-off tax on the profit as part of the U.S. taxation of the U.S. profits. This “grossing up” of the overseas earnings by U.S. tax authorities is a relatively common international tax feature. It is also a reason why many European countries have different international tax rates, and sometimes have higher taxes than the United States.
It may be in the current worldwide tax system of income tax that tax authorities in several countries have decided that a bit of “gifting” of what is considered “profits” into the hands of foreign authorities is tolerable. If this is the case, this could be the reason why the United States might trade its current higher tax on actual domestically-generated U.S. business income for a lower international tax rate. That’s the general U.S. approach to international taxation—if not only by the Federal tax, but also in many states, where many states (e.g., the District of Columbia) have higher taxes on actual U.S. income.
America’s tax-reform proposals are proposed across the political spectrum, but the tax reform put forth by President Trump has a number of features aimed at lowering and simplifying the U.S. tax code, reducing corporate tax rates, providing relief for middle class families, and raising revenues to meet the cost of revenue neutral tax reform.
One of the most widely noticed provisions in this or other Republicans’ proposals is the requirement that “pass-through” businesses must pay at the lower rate of 25 percent—with the possibility of a deduction—on domestic profits subject to the corporation’s tax rate. The U.S. Treasury’s position is that the legislation should apply the individual 7.8 percent dividend tax rate and “pass-through” corporate tax rate to all profits, regardless of whether they are domestic or foreign. The U.S. Treasury could expand its reasoning on this question to include profits generated in other countries.