I have a great interest in the U.S. Tax system. As you may have noticed, I will soon have a Master’s degree in Tax Law (known in the industry as a “Tax LLM”). Not only am I an estate planner, but I also practice as a tax attorney. I have studied our tax system at a detailed level, and I find it fascinating. Most recently, I became interested in the way that the U.S. taxes multi-national companies and all of the problems that the system has created for our country. The U.S. tax system applies the corporate tax rate (currently 35%) to all income generated by a U.S.-based company, no matter where in the world that income is earned. As you can imagine, U.S. companies find this policy to be unpalatable. Fortunately for them, there are ways to get around this extremely high tax rate on foreign income.
One interesting fact that people don’t hear about is that our tax rate is the highest in the industrialized world. This is not necessarily a terrible thing if we were just talking about companies that operate only in the U.S.. However, we live in an increasingly interlinked world, and more and more companies have international profits these days. This is especially true of the large multi-national companies, such as Amazon, Apple, and Google. This tax rate is a major disadvantage for these companies, which have to compete with large companies that operate out of other parts of the world and do not have such high tax rates weighing them down. Again, it is fortunate that these companies have found ways to circumvent the world-wide tax system in the United States; these large U.S. multinationals do not currently pay anywhere close to the 35% U.S. corporate tax rate on their profits.
Once upon a time, the U.S. corporate rate was not the highest in the world. Years ago, the 35% rate was somewhat comparable to most of the large industrialized nations. However, many countries started to reduce their rates well below the U.S. rate (for example, Ireland is now at 12.5%). The U.S. government failed to respond to this and instead passively watched as more and more business shifted away from the U.S. and our exorbitant corporate tax rate. I am sure that if you were starting a new business and you had the choice of starting it here in the U.S. and paying 35% on every dollar of profit, or starting it in Ireland and effectively reducing your tax rate to 12.5%, the decision would be a an easy one to make.
These are very difficult and complex issues to understand. I will not go into detail on how these companies accomplish their tax minimization goals; suffice it to say that almost every U.S. multinational company has teams of tax attorneys that work every day to come up with novel and clever tax strategies that can reduce the tax rate they pay on their profits from abroad to as low as 2%. The buzz words in the industry of tax minimization are “transfer pricing,” “intellectual property ,” and “pass-thru entities.” One of the components of these strategies is a U.S. policy of allowing U.S. companies to delay paying tax on foreign earnings until they actually bring the profits back to the U.S., a financial transfer that is known as “repatriation.” It is this policy that has caused much of the damage to the U.S. economy over the years.
Repatriation has caused U.S. multinationals to do everything they possibly can to avoid bringing back foreign profits to the United States. In fact, they bend over backwards to make absolutely certain that they do not have to pay any U.S. taxes on any foreign profits. Over the years, the most creative of the U.S. multinationals have even found ways to shift profits from the U.S. to low-tax foreign countries where this money remains indefinitely. Because there are U.S. rules that require any profits held outside of the country to be used for business purposes, the companies find ways to make sure the money is put towards some business investment outside of the U.S.. As you might imagine, this has resulted in hundreds of thousands of employees hired in foreign countries instead of here in the U.S.. It is one thing for companies to hire employees in other countries for legitimate business purpose; it is a completely separate and distinct matter when this hiring takes place for tax avoidance purposes and the U.S. workforce, and U.S. economy suffers as a result.
I hope it is not too late to undo some of the damage done to the U.S. economy, workforce, and the legendary U.S. corporate environment. We do not know how the Trump tax reform will play out, but I am hoping to see the U.S. become more attractive for businesses to start and grow here, as well as employ well-qualified Americans when the right business decision is to do exactly that. I would also like to see policies changed to remove the disincentives and loopholes that have been causing companies to shift business away from the U.S. In order to accomplish this, the first step is to lower the U.S. corporate tax rate substantially.