But there is no easy solution to taxing global profits

THERE is something wrong with a system where some of the largest and most profitable companies contribute a pittance to the Treasury.

And President Barack Obama was right to call attention to the problem when he proposed corporate tax increases on Monday. The administration noted that in 2004, the latest year for which data were available, American multinational corporations paid about US$16 billion ($23.5 billion) on US$700 billion in foreign earnings, an effective tax rate of about 2.3 per cent.

A deeper problem, however, is that, with few exceptions, there are no easy fixes to tax problems posed by global profits. The Obama proposals oversimplify the challenge, both technically and politically.

One of the most controversial proposals would delay deductions against overseas profits until those profits are brought back to the United States.

In theory, that makes perfect sense, because matching deductions and income in the same year is a fundamental principle of US tax law.

In practice, applying the matching principle to overseas operations could put American companies at a competitive disadvantage to foreign companies that do not face US tax laws.

It could even impede job creation in the US — exactly the opposite of what the Obama administration intends. That's because some of the expenses incurred in generating foreign profits are for support jobs in the US, like human resources and accounting positions. If companies cannot write off those employment expenses in the year they are incurred, they may move the jobs overseas.

The administration has also proposed to make it harder to abuse the foreign tax credit, a provision that allows companies to claim a credit on their American taxes for taxes paid to another country. No one objects to curbing abuse.

Unfortunately, the extent of the alleged abuse is unclear. That presages a much tougher fight, with arguments on each side as to whether the proposal is a mere loophole closer or a fundamental shift in how the credit is calculated and applied.

The administration is on firmer ground in proposing to change a practice whereby companies shift income from foreign subsidiaries to foreign tax havens, erasing their US tax liability in the process. The practice was first allowed in the Clinton administration, despite warnings at the time that it would lead to aggressive tax avoidance. That is exactly what has happened, reducing tax revenue by billions of dollars a year.

The Obama administration deserves credit for putting some of the problems of the corporate tax system on the table, but we hope it is only a warm-up act. Once the economy begins to recover, comprehensive reform of the tax system will be needed to raise enough money in a way that spreads the burden as widely as possible.

Done properly, that would inevitably require new tax sources, like a value-added tax or energy taxes — or both. Enacting those would be a monumental challenge that would make enacting the current package of corporate proposals look puny by comparison.


From TODAY, Business – Wednesday, 06-May-2009

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