The Lessons of Stateless Income
75 Pages Posted: 26 Mar 2011 Last revised: 12 Nov 2013
Date Written: March 19, 2012
This paper and its companion (Stateless Income) together comprehensively analyze the tax consequences and policy implications of the phenomenon of “stateless income.” Stateless income comprises income derived for tax purposes by a multinational group from business activities in a country other than the domicile of the group’s ultimate parent company, but which is subject to tax only in a jurisdiction that is neither the source of the factors of production through which the income was derived, nor the domicile of the group’s parent company.
The prior paper focuses on the consequences to current tax policies of stateless income tax planning. It concludes that stateless income privileges multinational firms over domestic ones by offering the former the prospect of capturing “tax rents” – low-risk inframarginal returns derived by moving income from high-tax foreign countries to low-tax ones. Other important implications of stateless income include the dissolution of any coherence to the concept of geographic source, the systematic bias towards offshore rather than domestic investment, the more surprising bias in favor of investment in high-tax foreign countries to provide the raw feedstock for the generation of low-tax foreign income in other countries, the erosion of the U.S. domestic tax base through debt-financed tax arbitrage, many instances of deadweight loss, and – essentially uniquely to the United States – the exacerbation of the lock-out phenomenon, under which the price that U.S. firms pay to enjoy the benefits of dramatically low foreign tax rates is the accumulation of extraordinary amounts of earnings ($1 trillion or more, by the most recent estimates) and cash outside the United States.
This paper extends the analysis along two margins, by considering the implications of stateless income tax planning for the reliability of standard efficiency benchmarks relating to foreign direct investment, and by considering in detail the phenomenon’s implications for the design of future U.S. tax policy in this area, whether couched as the adoption of a territorial tax regime or a genuine worldwide tax consolidation system.
This paper demonstrates that conclusions that are logically coherent in a world without stateless income do not follow once the presence of stateless income tax planning is considered. More specifically, this Article identifies and develops the significance of implicit taxation as an underappreciated assumption in the capital ownership neutrality model that has been advanced as an argument why the United States ought to adopt a territorial tax system, and demonstrates how stateless income tax planning vitiates this critical assumption.
The paper then considers the tax policies might be implemented to respond to a world imbued with stateless income. The paper looks at the problem from the perspective of both territorial tax system designs and a worldwide tax consolidation approach.
The paper concludes that policymakers face a Hobson’s choice between the highly implausible (a territorial tax system with teeth) and the manifestly imperfect (worldwide tax consolidation). Because the former is so unrealistic, while the imperfections of the latter can be mitigated through the choice of tax rate (and ultimately by a more sophisticated approach to the taxation of capital income), the paper ultimately concludes by recommending a worldwide tax consolidation solution.
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