Stateless Income's Challenge to Tax Policy, Part 2

Abstract

This report considers the tax policy implications of the phenomenon of stateless income. Stateless income is income that is 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 that is subject to tax only in a jurisdiction that is neither the source of the production factors through which it was derived nor the domicile of the group’s parent company. Google Inc.’s "Double Irish Dutch Sandwich" structure is one familiar example.

Part 1 of this report, available at Tax Notes, Sept. 5, 2011, p. 1021, Doc 2011-14206, 2011 TNT 172-5, showed that the U.S. tax rules governing income from foreign direct investments often are misapprehended: In practice they do not operate as a worldwide system of taxation, but as an ersatz variant on territorial systems, with hidden benefits and costs when compared with standard territorial regimes. That claim holds whether one analyzes these rules as a cash tax matter or through the lens of financial accounting standards. Part 1 of this report rejected 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 corporations 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 reduced coherence in the concept of geographic source; the systematic bias toward offshore rather than domestic investment; the more surprising bias in favor of investment in high-tax foreign countries to provide the feedstock for the generation of low-tax foreign income in other countries; 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 lockout phenomenon, under which the price that U.S. corporations pay to enjoy the benefits of dramatically low foreign tax rates is the accumulation of extraordinary amounts of earnings ($1.4 trillion or more, by the most recent estimates) and cash outside the United States.

Part 2 of this report picks up at this point. It is adapted and condensed from Edward D. Kleinbard, "The Lessons of Stateless Income," 65 Tax L. Rev. 99 (2011).

Part 2 demonstrates that policy conclusions that are useful in a world without stateless income do not follow once its presence is considered. 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 for why the United States should adopt a territorial tax system, and it shows how stateless income tax planning undermines 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 latter’s imperfections can be reduced through the choice of tax rate, the report ultimately recommends a worldwide tax consolidation solution.