Posted originally by the Tuck School of Business at Dartmouth Center for Global Business & Government; January 26, 2015.
Last week in the United States, President Obama delivered his penultimate State of the Union address before a joint session of Congress. Amidst the traditional pomp and circumstance of standing ovations and nods to the gallery, the president voiced his desire to pursue a broad policy agenda across a number of areas. One of those areas was the always-scintillating issue of tax policy: “We need a tax code that truly helps working Americans trying to get a leg up in the new economy, and we can achieve that together.”
Yes, we can. But with tax reform the devil is in the details, especially in the “new economy” of today in which global companies have an ever-widening array of options for where to locate their high-productivity, high-wage jobs and investments that help workers get a leg up. Being released today is a new white paper authored by one of us that discusses why tax reform should not discriminate against intangible property and its increasingly important contributions to the American economy.
One impetus for this report was the sweeping Discussion Draft on comprehensive tax reform, the Tax Reform Act of 2014, issued in the last Congress by the just-retired Chairman of the House Committee on Ways and Means, Dave Camp (R-Mich.). Chairman Camp admirably aimed to simplify and rationalize America’s taxation of both people and companies—and as a result may well provide a starting point on any tax-reform conversations of the new Congress. On the corporate side, however, this Discussion Draft would single out intangible income—i.e., income related to innovation and intellectual-property assets such as patents and trademarks—to be taxed quite differently than other forms of income.
Under current law, when a foreign subsidiary of a U.S.-headquartered multinational earns income in a foreign jurisdiction, that income—regardless of whether related to tangible property or to intangible property (IP)—generally can be deferred and does not bear U.S. tax until the income is distributed to the U.S. parent. Under the Discussion Draft, the IP-related income of these foreign subsidiaries would be treated quite differently, however. A new category of immediately taxable income would be created that’s linked to IP, such that today’s deferral-based worldwide system would be replaced with a pure worldwide system for IP-related income.
How much more would IP income be taxed than non-IP income? Under the Discussion Draft, a foreign affiliate of a U.S.-headquartered multinational would face a U.S. tax rate on IP income somewhere between 12 and 20 times the effective tax rate of 1.25 percent that the Draft would levy on non-IP related earnings of that foreign affiliate. Relative to current law, which leaves untaxed by the U.S. any un-repatriated foreign-affiliate intangible income, this change would raise substantial revenue. The Joint Committee on Taxation estimated that this new IP-income tax on foreign affiliates, along with some related changes, would raise net U.S. tax revenues by $115.6 billion over the years of 2014 through 2023.
What could all this possibly have to do with a leg up for American workers? Plenty. U.S.-headquartered multinational companies create the large majority of America’s IP. In 2012, the most recent year of data available, their U.S. parents performed a remarkable 74.9 percent of the total research and development undertaken by all U.S. companies. And these global companies increasingly rely on their worldwide operations to maximize the creativity and benefits of their U.S. inventions. The clear conclusion from research to date is that, on average, foreign affiliates and U.S. parents expand together. In particular, foreign-affiliate growth tends to stimulate, not reduce, U.S.-parent IP investments. Tax reform that penalizes foreign-affiliate IP income and related activity is precisely the wrong policy direction for helping America reaccelerate economic growth through innovation and the resulting growth in U.S. jobs and incomes.
Oh, and these IP-related jobs back in America tend to be high-quality. In 2010, average weekly wages in IP-intensive industries were 42 percent above that of other industries. This IP compensation premium has been growing over time: from 22 percent in 1990 and 38 percent in 2000 to 42 percent in 2010.
Talk of international-tax reform often makes eyes glaze over. But if the details of tax reform are not carefully, holistically considered then misguided reform can hurt American workers and their families. Here is hoping that if the president and new Congress can find common ground for tax reform, they do so with clear eyes.
Matthew J. Slaughter, the Signal Companies’ Professor of Management and associate dean for faculty at the Tuck School of Business at Dartmouth, has been named the school’s 10th dean, Dartmouth announced January 22, 2015. A scholar of international economics and an expert in globalization, Slaughter is a renowned academic who has held several key leadership roles at Tuck since joining the faculty in 2002. He will assume his new role on July 1.
Slaughter succeeds Dean Paul Danos, who announced in March he would not seek reappointment at the end of his fifth term in June 2015.
The Slaughter & Rees Report is a weekly post with expert analysis and insights into global economic news written by Associate Dean Matthew Slaughter and consultant Matthew Rees. Sign up for weekly emailed updates!
Associate Dean Matthew Slaughter teaches in several Executive Education programs including:
Tuck Executive Program
Global Leadership 2030
Smith-Tuck Global Leadership Program for Women
select Custom Programs
Articles © 2014 Matthew Slaughter and Matthew Rees. All rights reserved.
Publication © 2014 Trustees of Dartmouth College. All rights reserved.
Matthew J. Slaughter
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