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The Tax Policy Center's

Briefing Book

A citizen’s guide to the fascinating (though often complex) elements of the US tax system.

Tax Policy Center Briefing Book

Key Elements of the U.S. Tax System

  • Briefing Book
  • Taxes and Multinational Corporations
  • What are the consequences of the new US international tax system?
  • Chapters
    • Introduction
      • Introduction
        • Introduction
    • Some Background
      • Federal Budget
        • What are the sources of revenue for the federal government?
        • How does the federal government spend its money?
        • What is the breakdown of revenues among federal, state, and local governments?
        • How do US taxes compare internationally?
      • Federal Budget Process
        • How does the federal budget process work?
        • What is the history of the federal budget process?
        • What is the schedule for the federal budget process?
        • What is reconciliation?
        • How is a budget resolution enforced?
        • What is PAYGO?
        • What are rescissions?
      • Federal Budget Outlook
        • How accurate are long-run budget projections?
        • What have budget trends been over the short and long term?
        • How much spending is uncontrollable?
        • What are tax extenders?
        • What options would increase federal revenues?
        • What does it mean for a government program to be off-budget?
        • How did the TCJA affect the federal budget outlook?
      • Taxes and the Economy
        • How do taxes affect the economy in the short run?
        • How do taxes affect the economy in the long run?
        • What are dynamic scoring and dynamic analysis?
        • Do tax cuts pay for themselves?
        • On what do economists agree and disagree about the effects of taxes on economic growth?
        • What are the economic effects of the Tax Cuts and Jobs Act?
      • Economic Stimulus
        • What is the role of monetary policy in alleviating economic downturns?
        • What are automatic stabilizers and how do they work?
        • What characteristics make fiscal stimulus most effective?
      • Distribution of Tax Burdens
        • How are federal taxes distributed?
        • Are federal taxes progressive?
        • How should progressivity be measured?
        • What is the difference between marginal and average tax rates?
        • What criticisms are levied against standard distributional analysis?
        • How should distributional tables be interpreted?
        • Who bears the burden of the corporate income tax?
        • Who bears the burden of federal excise taxes?
        • How do financing methods affect the distributional analyses of tax cuts?
        • How do taxes affect income inequality?
      • Tax Expenditures
        • What are tax expenditures and how are they structured?
        • What is the tax expenditure budget?
        • Why are tax expenditures controversial?
        • What are the largest tax expenditures?
        • How did the TCJA affect tax expenditures?
      • Tax Gap and Tax Shelters
        • What is the tax gap?
        • What does the IRS do and how can it be improved?
        • What is a tax shelter?
      • Recent History of the Tax Code
        • What did the 2008–10 tax stimulus acts do?
        • What did the American Taxpayer Relief Act of 2012 do?
        • How did the Tax Cuts and Jobs Act change personal taxes?
        • How did the Tax Cuts and Jobs Act change business taxes?
    • Key Elements of the U.S. Tax System
      • Individual Income Tax
        • What is the standard deduction?
        • What are itemized deductions and who claims them?
        • How did the TCJA change the standard deduction and itemized deductions?
        • What are personal exemptions?
        • How do federal income tax rates work?
        • What are tax credits and how do they differ from tax deductions?
        • How do phaseouts of tax provisions affect taxpayers?
      • Capital Gains and Dividends
        • How are capital gains taxed?
        • What is the effect of a lower tax rate for capital gains?
        • What is carried interest, and how is it taxed?
        • How might the taxation of capital gains be improved?
      • AMT
        • What is the AMT?
        • Who pays the AMT?
        • How much revenue does the AMT raise?
        • How did the TCJA change the AMT?
      • Taxes and the Family
        • What is the child tax credit?
        • What is the adoption tax credit?
        • What is the earned income tax credit?
        • Do all people eligible for the EITC participate?
        • How does the tax system subsidize child care expenses?
        • What are marriage penalties and bonuses?
        • How did the TCJA change taxes of families with children?
      • Taxes and the Poor
        • How does the federal tax system affect low-income households?
        • What is the difference between refundable and nonrefundable credits?
        • Can poor families benefit from the child tax credit?
        • Why do low-income families use tax preparers?
        • How does the earned income tax credit affect poor families?
        • What are error rates for refundable credits and what causes them?
        • How do IRS audits affect low-income families?
      • Taxes and Retirement Saving
        • What kinds of tax-favored retirement arrangements are there?
        • How large are the tax expenditures for retirement saving?
        • What are defined benefit retirement plans?
        • What are defined contribution retirement plans?
        • What types of nonemployer-sponsored retirement savings accounts are available?
        • What are Roth individual retirement accounts?
        • Who uses individual retirement accounts?
        • How does the availability of tax-favored retirement saving affect national saving?
        • What’s the difference between front-loaded and back-loaded retirement accounts?
        • What is an automatic 401(k)?
        • How might low- and middle-income households be encouraged to save?
      • Taxes and Charitable Giving
        • What is the tax treatment of charitable contributions?
        • What entities are tax-exempt?
        • Who benefits from the deduction for charitable contributions?
        • How would various proposals affect incentives for charitable giving?
        • How large are individual income tax incentives for charitable giving?
        • How did the TCJA affect incentives for charitable giving?
      • Taxes and Health Care
        • How much does the federal government spend on health care?
        • Who has health insurance coverage?
        • Which tax provisions subsidize the cost of health care?
        • How does the tax exclusion for employer-sponsored health insurance work?
        • What are premium tax credits?
        • What tax changes did the Affordable Care Act make?
        • How do health savings accounts work?
        • How do flexible spending accounts for health care expenses work?
        • What are health reimbursement arrangements and how do they work?
        • How might the tax exclusion for employer-sponsored health insurance (ESI) be reformed?
      • Taxes and Homeownership
        • What are the tax benefits of homeownership?
        • Do existing tax incentives increase homeownership?
      • Taxes and Education
        • What tax incentives exist for higher education?
        • What tax incentives exist to help families pay for college?
        • What tax incentives exist to help families save for education expenses?
        • What is the tax treatment of college and university endowments?
      • Tax Complexity
        • Why are taxes so complicated?
        • What are the benefits of simpler taxes?
        • What policy reforms could simplify the tax code?
      • Wealth Transfer Taxes
        • How do the estate, gift, and generation-skipping transfer taxes work?
        • Who pays the estate tax?
        • How many people pay the estate tax?
        • What is the difference between carryover basis and a step-up in basis?
        • How could we reform the estate tax?
        • What are the options for taxing wealth transfers?
        • What is an inheritance tax?
      • Payroll Taxes
        • What are the major federal payroll taxes, and how much money do they raise?
        • What is the unemployment insurance trust fund, and how is it financed?
        • What are the Social Security trust funds, and how are they financed?
        • Are the Social Security trust funds real?
        • What is the Medicare trust fund, and how is it financed?
      • Excise Taxes
        • What are the major federal excise taxes, and how much money do they raise?
        • What is the Highway Trust Fund, and how is it financed?
      • Energy and Environmental Taxes
        • What tax incentives encourage energy production from fossil fuels?
        • What tax incentives encourage alternatives to fossil fuels?
        • What is a carbon tax?
      • Business Taxes
        • How does the corporate income tax work?
        • What are pass-through businesses?
        • How are pass-through businesses taxed?
        • Is corporate income double-taxed?
      • Tax Incentives for Economic Development
        • What is the new markets tax credit, and how does it work?
        • What is the Low-Income Housing Tax Credit and how does it work?
        • What are Opportunity Zones and how do they work?
      • Taxes and Multinational Corporations
        • How does the current system of international taxation work?
        • How do US corporate income tax rates and revenues compare with other countries’?
        • What are the consequences of the new US international tax system?
        • How does the tax system affect US competitiveness?
        • How would formulary apportionment work?
        • What are inversions, and how will TCJA affect them?
        • What is a territorial tax and does the United States have one now?
        • What is the TCJA repatriation tax and how does it work?
        • What is the TCJA base erosion and anti-abuse tax and how does it work?
        • What is global intangible low-taxed income and how is it taxed under the TCJA?
        • What is foreign-derived intangible income and how is it taxed under the TCJA?
    • How Could We Improve the Federal Tax System?
      • Comprehensive Tax Reform
        • What is comprehensive tax reform?
        • What are the major options for comprehensive tax reform?
      • Broad-Based Income Tax
        • What is a broad-based income tax?
        • What would and would not be taxed under a broad-based income tax?
        • What would the tax rate be under a broad-based income tax?
      • National Retail Sales Tax
        • What is a national retail sales tax?
        • What would and would not be taxed under a national retail sales tax?
        • What would the tax rate be under a national retail sales tax?
        • What is the difference between a tax-exclusive and tax-inclusive sales tax rate?
        • Who bears the burden of a national retail sales tax?
        • Would tax evasion and avoidance be a significant problem for a national retail sales tax?
        • What would be the effect of a national retail sales tax on economic growth?
        • What transition rules would be needed for a national retail sales tax?
        • Would a national retail sales tax simplify the tax code?
        • What can state and local sales taxes tell us about a national retail sales tax?
        • What is the experience of other countries with national retail sales taxes?
        • What did the President’s Advisory Panel on Federal Tax Reform say about the national retail sales tax?
      • Value Added Tax (VAT)
        • What is a VAT?
        • How would a VAT be collected?
        • What would and would not be taxed under a VAT?
        • What would the tax rate be under a VAT?
        • What is the difference between zero rating and exempting a good in the VAT?
        • Who would bear the burden of a VAT?
        • Is the VAT a money machine?
        • How would small businesses be treated under a VAT?
        • What is the Canadian experience with a VAT?
        • Why is the VAT administratively superior to a retail sales tax?
        • What is the history of the VAT?
        • How are different consumption taxes related?
      • Other Comprehensive Tax Reforms
        • What is the flat tax?
        • What is the X-tax?
      • Recent Comprehensive Tax Reform Proposals
        • Simple, Fair, and Pro-Growth: Proposals to Fix America’s Tax System, Report of the President’s Advisory Panel on Federal Tax Reform, November 2005
        • The Moment of Truth: Report of the National Commission on Fiscal Responsibility and Reform, December 2010
        • Debt Reduction Task Force, “Restoring America’s Future,” Bipartisan Policy Center, November 2010
        • The Tax Reform Act of 2014: Fixing Our Broken Tax Code So That It Works for American Families and Job Creators, House Ways and Means Committee
        • The Graetz Competitive Tax Plan, Updated for 2015
      • Return-Free Tax Filing
        • What is return-free filing and how would it work?
        • What are the benefits of return-free filing?
        • What are the drawbacks of return-free filing?
        • How would the tax system need to change with return-free filing?
        • Who would qualify for return-free filing?
        • Would return-free filing raise taxes?
        • What was the experience with return-free filing in California?
        • What other countries use return-free filing?
    • The State of State (and Local) Tax Policy
      • State and Local Revenues
        • What are the sources of revenue for state governments?
        • What are the sources of revenue for local governments?
      • Specific State and Local Taxes
        • How do state and local individual income taxes work?
        • How do state and local sales taxes work?
        • How do state and local property taxes work?
        • How do state and local corporate income taxes work?
        • How do state estate and inheritance taxes work?
        • How do state earned income tax credits work?
        • How do state and local severance taxes work?
        • How do state and local soda taxes work?
        • How do marijuana taxes work?
      • Fiscal Federalism and Fiscal Institutions
        • How does the deduction for state and local taxes work?
        • What are municipal bonds and how are they used?
        • What types of federal grants are made to state and local governments and how do they work?
        • What are state rainy day funds, and how do they work?
        • What are tax and expenditure limits?
        • What are state balanced budget requirements and how do they work?
    • Glossary
      • Glossary
        • Glossary

What are the consequences of the new US international tax system?

Taxes and Multinational Corporations

<3/11>
Business Taxes
Q.

What are the consequences of the new US international tax system?

A.

Despite enactment of the 2017 Tax Cuts and Jobs Act, which reduced these incentives, current rules still encourage US multinational firms to earn and report profits in low-tax foreign countries, enable both US- and foreign-based firms to shift profits earned in the United States to other countries, and encourage companies to incorporate in foreign jurisdictions.

INCENTIVES TO EARN AND REPORT PROFITS IN LOW-TAX COUNTRIES

Multinational corporations typically operate overseas through foreign subsidiaries that are mostly taxed as independent corporate entities. This separate entity system gives multinationals incentives to shift reported profits to their affiliates in low-tax jurisdictions by underpricing sales to them and overpricing purchases from them.

For tax-reporting purposes, most governments require firms to use an “arm’s length” standard, setting prices for transactions within the corporate group (“transfer prices”) equal to the prices that would prevail if the transactions were between independent entities. Yet ample room remains for firms to manipulate transfer prices, especially for intangible assets such as patents that are unique to the firm and for which there is no easily established market price.

Leading multinationals often shift the ownership of their intangibles, which generate a large share of their worldwide profits, to affiliates in very low tax jurisdictions, such as Ireland and Singapore. Through complex transactions, multinationals can then shift reported profits from these jurisdictions to countries with no corporate income tax, such as Bermuda and the Cayman Islands. Typically, multinationals generate very little real economic activity—as measured by output, employment, sales, or investments in plant and equipment—in tax-free jurisdictions.

Before the 2017 Tax Cuts and Jobs Act (TCJA), US multinationals booked a disproportionate share of their profits in low-tax locations. In 2017, US multinationals reported over 40 percent of their overseas profits in three low-tax countries: the Netherlands, Ireland, and Luxembourg (figure 1). The top 10 foreign locations of their profits, including other low-tax countries such as Bermuda, Switzerland, Singapore, the UK Caribbean Islands, and the United Kingdom, accounted for over four-fifths of their non-US profits.

Despite evidence that firms shift the location of real economic activity in response to tax-rate differences among countries, a substantial share of US multinationals’ real activity remains in high-tax countries. These are mostly large economies with close ties to the United States (figure 2). Before TCJA, the effective corporate tax rates on new investments in such countries was slightly lower than the US rate.

The TCJA substantially reduced, but did not eliminate, the incentive for US corporations to shift profits to tax havens. It did this by introducing a new minimum tax on Global Low Tax Intangible Income (GILTI) at 10.5 percent beginning in 2018, increasing to 13.125 percent in 2026. The GILTI rate remains below the 21 percent US corporate rate and the rate in other countries in the G7 (which ranges from 19 percent in the United Kingdom to 34 percent in France). The TCJA also reduced incentives for US companies to hold intangible assets in low-tax foreign countries by providing a special rate (13.125 percent beginning in 2018 and 16.406 percent beginning in 2026) for export income from intangible assets held in the United States (Foreign Derived Intangible Income).

How the TCJA affects the location of reported profits and real activities of US multinationals overseas will not be known for several years. However, we can expect that over time US companies will report lower shares of their profits in low-tax countries with little economic activity.

 INCENTIVES TO INCORPORATE OVERSEAS

The United States bases its definition of corporate residence on place of incorporation. This definition need not be consistent with where a company’s production and employment is located, where its sales take place, where its shareholders reside, or even where its top managers live.

For some firms, the tax benefits of foreign residence, combined with the lack of economic substance to the residence definition, have led them to shift the formal incorporation of their parent companies overseas. This type of transaction (“inversion”) can often be accomplished without changing the location of any real business activities.

Over the years, Congress has enacted rules to limit inversions. A company can still “redomicile,” though, by merging with a foreign-based company under certain conditions, including that the original foreign company contribute at least 20 percent of the shares of the new merged company if other conditions are not met. The TCJA added new provisions to penalize new inversions. In exchange for the TCJA eliminating the tax on repatriated dividends, it imposes a 35 percent transition tax on overseas assets that newly inverted firms held before the TCJA. Other US companies with foreign assets pay a comparable transition tax at 15.5 percent for cash and 8 percent for other assets. The TCJA also introduced other penalties on newly inverted firms, including a provision that makes dividends to shareholders taxable as ordinary income instead of at the preferred rates generally applied to qualified dividends and long-term capital gains.

The current US system still provides benefits for some multinational corporations to establish their parent company’s residence outside the United States, although this incentive is smaller at the new reduced corporate tax rate. The United States now imposes GILTI on the intangible profits US-resident corporations earn in low-tax countries, while our major trading partners have so-called territorial systems that exempt active foreign-source profits. In addition, rules for US controlled foreign corporations limit US-based multinationals’ ability to use debt-equity swaps and other earnings-stripping techniques to shift reported income out of the United States. But the United States is unable to apply its controlled foreign corporation rules to foreign-resident multinationals.

The US Department of the Treasury (2016), however, has recently issued new regulations to deter earnings stripping through interest payments to foreign-related parties and the Base Erosion and Anti-abuse Tax (BEAT), enacted as part of TCJA, imposes a minimum tax on a base that disallows deductions for certain payments, including interest, to foreign-related parties. Both Treasury regulations and BEAT aim to limit foreign-resident multinationals’ ability to shift profits out of their US affiliates, although BEAT also affects US-resident companies.

A corporation’s formal residence may be losing significance in an increasingly global economy where capital flows freely and a firm’s research and development, production, and sales are often spread worldwide. The location of a multinational firm’s investment, jobs, research and development, and tax revenue matter more than the site of its parent company. Corporate residence, however, does have some effect on US tax revenues and arguably may matter for research and development and other high-value activities often associated with a company’s headquarters.

Updated May 2020
Data Sources

Bureau of Economic Analysis. “Operations of US Parent Companies and their Foreign Affiliates, 1981–2013.”

———. US Direct Investment Abroad (USDIA), Activities of US Multinational Enterprises (MNEs). “All Foreign Affiliates: Selected Data by Country,” 2017.

Further Reading

Clausing, Kimberly A. 2014. “Corporate Inversions.” Washington, DC: Urban-Brookings Tax Policy Center.

              . 2020. "Profit Shifting Before and After the Tax Cuts and Jobs Act." January 20, 2020.

Desai, Mihir A. 2009. “The Decentering of the Global Firm.” World Economy 32 (9): 1271–90.

Gravelle, Jane G., and Donald J. Marples. 2020. “Issues in International Corporate Taxation: The 2017 Revision (P.L. 115-97).” CRS Report R45186. Washington, DC: Congressional Research Service. Updated February 20, 2020.

Grubert, Harry. 2012. “Foreign Taxes and the Growing Share of US Multinational Company Income Abroad: Profits, Not Sales, Are Being Globalized.” Washington, DC: Office of Tax Analysis.

Grubert, Harry, and Rosanne Altshuler. 2013. “Fixing the System: An Analysis of Alternative Proposals for Reform of International Tax.” National Tax Journal 66 (3): 671–712.

Kleinbard, Edward D. 2011. “The Lessons of Stateless Income.” Tax Law Review 65: 99–171.

Marples, Donald J., and Jane G. Gravelle. 2014. “Corporate Expatriation, Inversions, and Mergers: Tax Issues.” CRS Report R43568. Washington, DC: Congressional Research Service.

Shaviro, Daniel N. 2018. “The New Non-Territorial U.S. International Tax System.” Tax Notes. July 2.

Sullivan, Martin A. 2018. “Where Will the Factories Go? A Preliminary Assessment.” Tax Notes. January 29: 570–579.

US Department of the Treasury. 2016. “Treasury Issues Final Earnings Stripping Regulations to Narrowly Target Corporate Transactions That Erode US Tax Base,” press release, October 13.

Business Taxes
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