Does a Grand Bargain Have to Include a Bad Bargain?

According to various media outlets, President Obama will propose, in a speech today, changes to the corporate income tax “so long as the initial revenue generated goes toward job creation.” Increasing corporate tax revenue to fund job creation, infrastructure improvements, and strengthening U.S. manufacturing is very welcome news. The not so welcome news is he is proposing a revenue-neutral corporate tax reform with a one-time corporate tax revenue increase by granting a tax break on foreign earnings of U.S. corporations. The proposed tax break appears to be a low tax on all $2 trillion of deferred foreign earnings. This one-time revenue increase will be used to pay for job creation and infrastructure improvements.

U.S. corporations are holding almost $2 trillion overseas. This income is not subject to the U.S. corporate tax until it is brought back to the U.S. or “repatriated”—this loophole is known as deferral. A common misperception is the firms will pay 35 percent of the repatriated earnings to the federal government. However, because of various deductions and other loopholes (some legitimate, some not), the multinational ultimately pays considerably less to the government. Also, the corporations get a credit for foreign taxes paid. This deferral of taxes on overseas profits is one of the costliest corporate tax loopholes, reducing tax revenue by up to $50 billion per year.

Almost everybody agrees on the need for tax reform and long-term debt reduction. One critical way to achieve the latter is to make sure that tax reform increases tax revenue over the longer-term. Corporate tax revenues have been falling as a percent of GDP since the 1950s, from 6 percent of GDP in 1952 to less than 2 percent in the 2000s. One obvious way to increase corporate tax revenue is to end deferral on foreign earnings, that is, tax all corporate income (domestic and foreign) as it is earned. Corporate tax reform should result in increased tax revenues, even if the corporate tax rate is reduced.

Additional revenue could be raised by taxing the $2 trillion currently held overseas and allow the tax payments to be spread out over, say, 7 years. If this income were taxed at an effective corporate tax rate of 23 to 27 percent (depending on which study you believe), an additional $60 to $75 billion could be raised per year for the next 7 years.

Giving a tax break to multinational corporations that have moved jobs and profits offshore is a bad bargain. It may raise some revenue today, but it also encourages multinationals to engage in tax avoidance behavior in the expectation of getting another tax break sometime in the future.