Republican presidential candidate Mitt Romney has released his "Believe In America" economic plan, laying out his proposals to stimulate the U.S. economy and create jobs. Among Governor Romney's tax reform proposals is a U.S. transition from a worldwide tax system to a territorial tax system. Fellow Republican presidential candidate, former Governor and Ambassador Jon Huntsman, has also called for the U.S.'s move to a territorial tax system in his economic plan. Romney's likely chief rival for the GOP nod, Governor Rick Perry, as of this writing, has not released a comprehensive economic plan detailing his tax reform proposals. However, the U.S move to a territorial tax system is generally favored by conservatives (e.g., Americans for Tax Reform. See http://www.atr.org/trade-international-tax-a5990). Governor Perry's tax reform proposals would likely fall in line with this view. Romney and Huntsman join the ranks of CEOs of large U.S. corporations who argue that the U.S.'s worldwide tax system disadvantages U.S. companies operating abroad.
Calls for a shift to a territorial tax system are not new, and, frankly, how much careful attention is given to tax reform ideas proffered by presidential hopefuls this early in a campaign? However, the current and immediate foreseeable political environment is one that favors comprehensive tax reform, and a move to a territorial tax system could be a plausible part of a post-election legislative package. Also, although generally favored by conservatives, the idea of a territorial tax system is not a highly political or publicly controversial one, such as the privatization of Social Security, for example. In addition, a shift to the territorial system is not an inherently polarizing, partisan idea. As noted in Governor Romney's plan, the Bowles-Simpson Commission, appointed by President Obama, recommended a move to a territorial tax system. (See "The Moment of Truth: The National Commission on Fiscal Responsibility and Reform (December 2010)). Also, according to Damian Palette and John D. McKinnon ("Treasury Weights New Tax Scheme," The Wall Street Journal (Sept. 10, 2011)), Treasury is currently considering a so-called "tough" territorial system.
The U.S. has, in general, a worldwide tax system. Under the U.S. version of a worldwide tax system, profits earned abroad by U.S.-based corporations are free from U.S. taxation until they are repatriated. Foreign taxes previously paid on such profits are eligible for the foreign tax credit. In general, the U.S. worldwide tax system is in contrast to a proposed U.S. territorial tax system, under which overseas profits would not be subject to U.S. tax at all, even when brought back to the U.S. (See Lexis Tax Advisor -- Federal Topical Ch. 4A:1.01.)
As noted above, the main critique of the U.S. worldwide tax system is that, coupled with the relatively high U.S. corporate tax rate of 35%, the worldwide tax system places U.S. companies operating abroad at a competitive disadvantage with respect to other international companies based in countries with a territorial tax system. On the other hand, critics of a move to a territorial tax system argue that under such a system, U.S.-based corporations will have more incentive to increase overseas operations and likely will not repatriate foreign profits. (See "Congress Should End 'Deferral' Rather Than Adopt a 'Territorial' Tax System," Citizens for Tax Justice (March 23, 2011)).
As with most debates over tax policy or reform, the merits of both positions can be pointed out. It is difficult to argue against the claim that U.S. companies are disadvantaged under the current system which imposes the second highest corporate tax rate in the world at 35% and taxes repatriated profits, while other countries have lower corporate tax rates and do not tax repatriated profits. It is also difficult to argue against the skeptical view that under a territorial system, U.S. companies likely will not significantly re-direct overseas profits to the creation of jobs in the U.S. without some sort of built-in legislative requirement to do so. For example, some studies have shown that the last "tax holiday" for repatriated profits in 2004 resulted in no significant increase in investment in U.S. jobs. (See "CBPP Says Tax Holiday Unlikely to Create Promised Investments, Jobs," Tax Notes Today (TaxAnalysts, June 23, 2011)). Realistically, it is difficult to envision a significant reversal of the trend of shifting operations overseas in view of the incentives that originally motivated and continue to motivate U.S. corporations to move operations abroad, such as lower wages and less regulation. At any rate, both sides of the argument would likely agree that the current U.S. worldwide tax system should change in some way. Campaign/election season and proposals for significant tax reform, Social Security reform, education reform, and so on go hand-in-hand, but the slow recovery and stagnant job growth appear to be pushing fundamental tax reform to among the forefront of national issues. Given the current economic environment, the possibility of a fundamental change to the U.S.worldwide tax system may not be as unlikely as previously thought.
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