This past Tuesday, Susan Morse appeared at our colloquium to discuss her paper draft, "International Corporate Tax Reform and a Corporate Offshore Excise Tax."
The paper concerns the idea, which I have been floating for some time and which appeared in the international and corporate tax reform proposal disseminated by Ways and Means Chairman Camp, of addressing the windfall gain that U.S. companies would enjoy with respect to existing foreign earnings that have not yet been repatriated if the U.S. shifted to an exemption system for foreign source income. While one can (and I have) said a lot more about this idea, and its pluses and minuses, the core idea is as follows: U.S. companies have apparently racked up about $2 trillion in foreign earnings under the current U.S. international tax regime. Collection of the tax has merely been deferred until the income is repatriated. Why should this expected tax be reset to zero, just because we decide to adopt a new regime prospectively?
Among the proposal's advantages is that, if anticipated, it would reduce pre-enactment lock-in of U.S. companies' foreign earnings. The CFO of a given U.S. company would feel really stupid if the company ended up paying a repatriation tax that could have been avoided by waiting for exemption to be enacted. But if a transition tax would be waiting for the earnings anyway, then perhaps no reason not to repatriate earnings today (depending, of course, on how the tax would work).
I felt the paper was a bit too cautious in suggesting that perhaps the COET tax rate shouldn't be higher than the 5.25% "tax holiday" rate that companies handed themselves (via their legislative influence) a few years back. But why would one ever accept a self-serving "opening offer"? I could certainly see arguments for a full 35% rate (offset by the cash-out, to zero on this tax but not below, of foreign tax credits), even if the domestic rate simultaneously declines to 25%. After all, that new lower rate is itself a transition windfall for earnings that are realized under the new system but reflect decisions that were made under the old one.
I'd also note that:
(a) even if companies figured they might never repatriate and pay the 35% tax, they wouldn't have strong grounds for viewing themselves as ex post expropriated if the U.S. simply made indefinite continuation of deferral harder to sustain,
(b) we can monetize into the tax rate the present value of the deadweight loss that companies would avoid through the elimination of the repatriation tax, without making the firms worse-off than under present law.
A further issue presented by the paper is: 35% (or 5.25%) of what? The obvious tax base here would be the earnings and profits (E&P) of US companies' controlled foreign subsidiaries, grossed-up by foreign taxes paid if the credit is being allowed. The paper suggests using instead the accounting measure of permanently reinvested earnings (PREs), or those which the companies swore to the accountants would never ever ever be brought home. While I actually like the idea (which most accountants, I'm sure, would hate) of penalizing after-the-fact the use of this accounting technique, I'm not at this point persuaded that there are good grounds for not simply using the familiar tax concept of E&P.
One last and somewhat frivolous note: in the interests of catchiness, I would propose taking the COET (for "Corporate Offshore Excise Tax"), and renaming it the "COPE" (for "Corporate Offshore Profits Excise-tax"). I'm no marketing expert, but this is a lot catchier, and I can already see the journalistic possibilities ("Can U.S. Companies Cope with the COPE?").