The Devil in the Details: Reflections on the Tax Reform Act of 2014
Reuven S. Avi-Yonah
University of Michigan Law School
March 5, 2014
U of Michigan Public Law Research Paper No. 393
U of Michigan Law & Econ Research Paper No. 14-007
The Discussion Draft of the “Tax Reform Act of 2014” (TRA14) released by US House Committee on Ways and Means Chairman Dave Camp (R-MI) on February 26, 2014 represents a major effort for fundamental and far reaching reform of US tax law. Unfortunately, while many parts of the proposal seem quite sensible as an effort to bring back the “spirit of 1986”, the international tax reform proposals are deeply flawed and based on obsolete assumptions on the world facing US multinationals in 2014.
Overall, TRA14 represents a welcome effort to propose a revenue neutral combination of base broadening and rate cutting. TRA14 envisages three individual rates of 10%, 25% and 35% and a corporate rate of 25%. This rate structure is quite sensible, and if it can be achieved in a revenue neutral fashion that is an added advantage.
However, the international tax proposals are based on the assumption that because most other OECD countries have adopted a limited version of territoriality, i.e., a “participation exemption” for dividends out of the active income of Controlled Foreign Corporations (CFCs), the US must follow suit to preserve the competitiveness of US based MNEs. But this assumption is wrong, for three reasons. First, the empirical data indicate that under current law US based MNEs do not face a competitive disadvantage despite the fact that they are nominally taxed on a worldwide basis without a participation exemption. Second, the OECD BEPS project suggests that the effective tax rates of foreign MNEs are headed up, not down. Third and most importantly, reducing the US corporate tax can be done without putting US-based MNEs at a competitive disadvantage even if deferral were completely eliminated, and this has the added advantage of eliminating both lock out (the main problem the participation exemption is designed to solve) and the incentive to shift profits out of the US (which this version of TRA 14 does little to address).
This paper will discuss these points and conclude that as far as the international proposals are concerned it would be better to go back to the drawing board and start from scratch with a simple proposal of full inclusion at whatever corporate rate is judged to be similar to the effective rates paid by foreign-based MNEs.
Number of Pages in PDF File: 8
Keywords: Tax Reform, Camp, territoriality, participation exemption
JEL Classification: H26
Date posted: March 2, 2014 ; Last revised: November 12, 2014
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