Stateless Income's Challenge to Tax Policy
Edward D. Kleinbard
USC Gould School of Law
June 25, 2011
Tax Notes, Forthcoming
USC CLEO Research Paper No. C11-8
USC Law Legal Studies Paper No. 11-13
This Report considers the tax consequences and policy implications of the phenomenon of “stateless income.” It is a condensed, more accessible and slightly revised version of two more formal papers on the same topic referenced on page 1.
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. Google Inc.’s “Double Irish Dutch Sandwich” structure is one example of stateless income tax planning in operation.
The Report first demonstrates that the current U.S. tax rules governing income from foreign direct investments often are misapprehended: in practice the U.S. tax rules do not operate as a “worldwide” system of taxation, but rather as an ersatz variant on territorial systems, with hidden benefits and costs when compared to standard territorial regimes. This claim holds whether one analyzes these rules as a cash tax matter, or through the lens of financial accounting standards. This paper rejects as inconsistent with the data any suggestion that current U.S. law renders U.S. multinational firms less “competitive”, when compared with their territorial-based competitors.
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.
The Report then demonstrates that economic policy 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, the Report 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 Report 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, the Report ultimately concludes by recommending a worldwide tax consolidation solution.
Number of Pages in PDF File: 83
Date posted: July 1, 2011