International Tax Reform Should Begin at Home: Replace the Corporate Income Tax with a Territorial Expenditure
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The present U.S. system of international taxation is riddled with
problems because it does not satisfy critical principles of
economics, justice, or common sense. It fails to accomplish the
most important goals that an international system should
achieve-that is, protecting the domestic tax bas...
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Northwestern Journal of International Law & Business
Volume 30
Issue 3 Summer
Summer 2010
International Tax Reform Should Begin at Home:
Replace the Corporate Income Tax with a
Territorial Expenditure
William B. Barker
Follow this and additional works at: http://scholarlycommons.law.northwestern.edu/njilb
Part of the International Law Commons, and the Tax Law Commons
Recommended Citation
William B. Barker, International Tax Reform Should Begin at Home: Replace the Corporate Income Tax with a Territorial
Expenditure, 30 Nw. J. Int'l L. & Bus. 647 (2010)
This Article is brought to you for free and open access by Northwestern University School of Law Scholarly Commons. It has been accepted for
inclusion in Northwestern Journal of International Law & Business by an authorized administrator of Northwestern University School of Law Scholarly
Commons.
,International Tax Reform Should Begin
at Home: Replace the Corporate
Income Tax with a Territorial
Expenditure Tax
William B. Barker*
PREFACE
The present U.S. system of internationaltaxation is riddled with
problems because it does not satisfy critical principles of
economics, justice, or common sense. It fails to accomplish the
most important goals that an international system should
achieve-that is, protecting the domestic tax base in a way that
fosters domestic economic development and the creation ofjobs.
This paper explores alternatives to the present system to see if
they do a better job. Some of the alternativesfail for the same
reasons as the present system because they arepredicatedon the
same outmoded theories. Some are clearly an improvement, but
at the same time raise other significant issues. There is one
system, however, that consistently overcomes these defects in a
way that would promote domestic business activity and job
growth. That system is a destination-based, territorial
consumption tax for all corporations.
I. INTRODUCTION
Every nation faces the same problem. Economic forces unleashed by
free trade, open capital markets, and the enhanced mobility of many of the
factors of production, have led to intense tax competition among nations
and, as a result, have tested nations' ability to tax business income. The
common principles of international taxation, derived one hundred years ago
in simpler times, are inadequate to overcome the challenges brought about
by dramatic changes in world production and consumption. The United
States hangs on to an illusive principle of residence taxation of business
income through a hodgepodge of complex, conflicting approaches-
deferral of business and equity capital income (territorial approach), anti-
avoidance provisions (residence approach), and a liberal foreign tax credit
system (residual residence approach). Though the U.S. system is nominally
* Professor of Law, The Dickinson School of Law of Pennsylvania State University.
647
,Northwestern Journal of
International Law & Business 30:647 (2010)
a residence system, it is in fact a hybrid; it hardly taxes the foreign business
income of corporations, and it regularly results in the under-assessment of
the U.S. business income of both U.S. and foreign-owned enterprises.
International tax rules must reflect the world in which multinationals
produce goods and services both within and without the borders of their
"own" country for sale to customers both within and without their "own"
country.I To get a sense of corporate dominance of trade, U.S.
multinationals and their foreign affiliates accounted for 57% of total U.S.
exports and 37% of U.S. imports in 2003.2 Forty-one percent of
multinational exports were to foreign affiliates, 44% of imports were from
3 owned foreign affiliates'
related affiliates. Only a small part of U.S.
activities are involved with U.S. imports; 11% of sales of U.S. foreign
affiliates are imports into the United States.
The picture would be incomplete, however, without considering the
role of foreign-owned U.S. affiliates. In recent years, foreign multinationals
and their U.S. affiliates accounted for 20% of total U.S. exports and 30% of
U.S. imports.4 The majority of this trade involved intercompany trade,
approximately 50% of exports and 80% of imports.5
The U.S. tax system is designed to tax the income from exports as they
leave the United States, but to exempt the income from imports when they
come in. Sales by U.S. domestic corporations are included in income,
purchases from foreign affiliates are deductible, and those foreign affiliates'
income is deferred until repatriation as a dividend to the United States.
This is the same pattern for foreign-owned multinationals and their U.S.
affiliates. U.S. affiliates are treated as U.S. corporations; foreign parents
are non-resident entities taxed only on the basis of U.S. source income.
Globalization and tax competition have placed intense pressure on the
present U.S. international tax system's "ability to apply transaction-based
tax and intercompany transfer pricing rules to a range of common
transactions."' For many years, Congress has been content with
incremental change. Congress sometimes patches the existing system in
1See discussion infra accompanying notes 52-54 for a discussion of the problems of
conceptualizing the residence of a firm that is engaged in business in many countries.
2 Raymond J. Mataloni, Jr., U.S. Multinational Corporations:Operations in 2003, DEP'T
OF COMMERCE, SURVEY OF CURRENT BUSINESS, July 2005, at 9, 9-10.
Bureau for Workers' Activities, Int'l Labour Org., Multinational Corporations (1995),
http://actiav.itcilo.org/action-english/teleam/globalilo/multinat/ multinat.htm.
4 William J. Zeile, US. Affiliates ofForeign Companies: Operations in 2003, DEP'T OF
COMMERCE, SURVEY OF CURRENT BUSINESS, Aug. 2005, at 208.
5 Id.
6 See I.R.C. § 861 (2006) (resident companies), I.R.C. § 871 (2006) (nonresident
companies engaged in a trade or business with the United States).
American Bar Association Section on Taxation, Report of the Task Force on
International Tax Reform, 59 TAx LAW. 649, 658 (2006) [hereinafter ABA Task Force
Report].
648
, InternationalTax Reform Should Begin at Home
30:647 (2010)
order to close loopholes and raise additional revenue. Other times,
Congress elevates the tax expenditure function over the tax revenue
function and increases the tax benefits for overseas operations. 8 The result
is a system that raises little revenue from foreign operations and sometimes
reduces substantially the domestic tax base.9
Over the years, there have been many proposals for significant change
to the international tax system. One proposal would end the deferral of the
tax obligation for the foreign affiliates of U.S. corporations.' 0 A second
proposal would exempt foreign active business income of U.S. taxpayers."
A third proposal would exempt foreign economic rents.12 A fourth would
adopt a territorial allocation of worldwide income based on formulary
apportionment.' 3 At the same time, there has been considerable discussion
that targets the overhaul of our entire income tax system by replacing it
with a consumption tax model.14 This paper seeks to examine those
international tax reform proposals in terms of several types of inquiry. The
first is the need to evaluate tax systems in terms of the societal goals and
optimum conditions for appropriate, successful taxation. The second is the
need to face the lessons from experience that have identified the principal
problems in international taxation. The third is the need to determine why
the present system, which is the product of a hundred years of intense self-
examination, still does not work well. Finally is the need to test reform
proposals against these factors to see if any present a superior solution. The
object is to reach some conclusions on the efficacy of both income tax
solutions and consumption tax solutions in providing international tax
solutions. 15
See, e.g., American Jobs Creation Act of 2004, Pub. L. No. 108-357, 118 Stat. 1418
(2004). For further discussion see text infra accompanying notes 41-47.
9 See Zeile, supra note 4, at 692-716 (reviewing the present state of U.S. international tax
law).
1oSee, e.g., J. Clifton Fleming, Robert J. Peroni & Stephen E. Shay, Fairness in
InternationalTaxation: The Ability-to-Pay Casefor Taxing Worldwide Income, 5 FLA. TAX
REv. 299 (2001).
" See, e.g., PRESIDENT'S ADVISORY PANEL ON FED. TAX REFORM, SIMPLE, FAIR, AND PRO-
GROWTH: PROPOSALS TO Fix AMERICA'S TAx SYSTEM 103 (2005) [hereinafter PRESIDENT'S
ADVISORY PANEL].
12See William B. Barker, An International Tax System for Emerging Economies, Tax
Sparing and Development: It Is All About Source!, 29 U. PA. J. INT'L L. 349 (2007).
13See, e.g., Joan M. Weiner, Using the Experience in the U.S. States to Evaluate Issues
in Implementing FormulaApportionment at the InternationalLevel (U.S. Dep't of Treasury,
OTA Paper 83, 1999), availableat http://www.ustreas.gov/offices/tax-policy/library/ota83.
pdf.
14 See, e.g., DAVID F. BRADFORD, UNTANGLING THE INCOME TAX (1986); William D.
Andrews, A Consumption-Type or Cash Flow PersonalIncome Tax, 87 HARV. L. REV. 1113
(1974).
15Only reforms that the U.S. could practically adopt unilaterally will be analyzed.
Formulary apportionment will not be addressed since practical implementation requires a
649
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