World Trade Organization (WTO) has ruled that portions of U.S. tax
law--specifically, the Foreign Sales Corporation/Extraterritorial
Income (FSC/ETI) Act--provide an impermissible "export subsidy."
This creates a bad news/good news situation.
bad news is that the WTO is interfering with America's fiscal
sovereignty by insisting that Congress repeal the FSC/ETI
legislation or run the risk of more than $4 billion of compensatory
tariffs on U.S. exports to European Union nations. The good news,
however, is that this creates an opportunity for lawmakers to enact
much-needed tax reforms, especially reducing the tax on income
earned by U.S. companies abroad so that they can compete on a level
playing field with foreign-based firms.
The U.S. tax code currently places American companies at a
competitive disadvantage by taxing them on income earned abroad.
This policy of "worldwide taxation" can subject U.S.-chartered
companies operating overseas to tax burdens several times larger
than those imposed on their foreign counterparts, most of which
come from countries with "territorial taxation" (the common-sense
policy of taxing only income earned inside national borders).
America's high corporate tax rate--the
second highest in the developed world--exacerbates the
anti-competitive impact of worldwide taxation, and American
companies competing in low-tax jurisdictions like Ireland or Hong
Kong are the most adversely affected. As the example in Table 1
indicates, U.S. companies can face an enormous additional burden
because of America's worldwide tax regime.
lawmakers are concerned that moving toward territorial taxation
would encourage companies to relocate jobs and factories from
America to low-tax countries. The high U.S. corporate tax rate is
an incentive for companies to create jobs and expand operations in
jurisdictions with better tax law--or would be if they did not also
have to pay the high U.S. corporate tax rate on overseas
this mean that worldwide taxation protects American jobs by making
it more difficult for U.S. companies to produce overseas?
Absolutely not. Worldwide taxation can--and does--limit the ability
of American companies to compete abroad, but it does not affect the
decisions of non-U.S. companies. In other words, bad U.S. tax law
may prevent an American company from taking advantage of a
profitable opportunity to build a factory in a low-tax
jurisdiction, but this simply makes it easier for a company from
another country to exploit that opening. And since a foreign-based
company can ship goods into the U.S. market under the same rules as
a U.S. company's foreign subsidiary, worldwide taxation does not
insulate America from overseas competition. It simply means that
foreign companies get the business and earn the profits.
Taxation Destroys Jobs
By placing U.S.-based companies at a disadvantage in world
markets, America's worldwide tax system harms the U.S. economy and
undermines job creation. This is because companies with foreign
operations are more likely to purchase raw materials and
intermediate goods from their home countries. The Organization for
Economic Co-operation and Development estimates that every dollar
that a company invests overseas yields two dollars of additional
exports for its home country.
data strongly support the link between foreign operations and
exports. An academic survey found that every dollar of overseas
production by U.S. affiliates generates an average of $0.16 in
exports from the United States. According to Commerce Department
figures, U.S. companies sold $232 billion worth of
American-produced goods to their overseas affiliates in 2000. This
is impressive, but exports surely would be much higher if U.S.
companies competing abroad were not hamstrung by worldwide
taxation. Territorial taxation would allow American companies to
win a larger share of foreign markets, and this would then
translate into higher U.S. exports and more U.S. jobs.
Furthermore, companies generally build
factories in other countries in order to serve foreign markets--not
to produce goods for America. According to Commerce Department
data, nearly 90 percent of the output from U.S.-controlled foreign
companies is sold to foreign consumers. This explains why two
experts found that shifting to a territorial tax system would not
influence where U.S. firms locate their factories. The Council of
Economic Advisers also reviewed the research and found no support
for the notion that jobs and exports suffer when U.S. companies
politicians think that multinational companies hurt the U.S.
economy. In reality, however, companies that produce at home and
abroad generate more than 21 percent of U.S. economic output,
produce 56 percent of U.S. exports, and employ three-fifths of all
manufacturing employees--about 9 million workers. These numbers
would be even higher if these companies were not hindered by an
onerous tax code.
Worldwide taxation places U.S. companies at a competitive
disadvantage reducing their share of the global market. This limits
the degree to which U.S. companies can benefit by operating in
low-tax jurisdictions, but it does not discourage foreign companies
from building new factories in jurisdictions with good tax law or
exporting products to the United States. In other words, worldwide
taxation neither limits competition from factories in low-tax
countries nor restricts imports. Instead, it impedes U.S.
companies' ability to maintain profitable operations in foreign
Territorial taxation is good tax policy,
and reducing the tax burden on foreign-source income is a simple
step in this direction that would help the U.S. economy, resulting
in more jobs, better jobs, and improved competitiveness of U.S.
Mitchell, Ph.D., is McKenna Senior Research Fellow in the
Thomas A. Roe Institute for Economic Policy Studies at The Heritage