Tax Analysts Blog

Trump, Wyden, and Sanders Are Right About Ending Deferral

Posted on Jun 21, 2016

Donald Trump's tax plan isn't particularly well developed, but he does make his position clear on one major international tax issue.  Trump would retain the United States' worldwide tax system while eliminating the deferral of taxes on foreign profits.  This position is at odds with many reform plans featuring a switch to territoriality, and it is very close to the preferences of Democratic Sens. Ron Wyden and Bernie Sanders.  All three politicians are right -- it is time for the United States to end deferral and finally level the playing field between domestic and foreign profits.

Trump isn't exactly on the same page with Wyden and Sanders.  He does call for an end to deferral and for taxing foreign and domestic profits the same.  However, he would do so under a drastically lower rate -- 15 percent.  Some commentators have said this amounts to the same as a territorial system since foreign tax credits would probably wipe out most tax owed at that rate.  Viewed in this light, Trump's plan looks a bit like President Obama's call for a 19 percent minimum tax on foreign earnings.  But Trump's rate might not be as important as his explicit stance on deferral.  In a speech June 21, the Republican presidential candidate is expected to tweak his proposal to reduce it's projected $10 trillion cost.  If he simply raises his proposed corporate rate to something like 20 percent, his proposal will look more like a worldwide system with no deferral than a territorial system with a super-low rate. 

Deferral is expensive.  The JCT says it costs the United States about $80 billion a year.  Deferral is the reason Apple, pharmaceutical companies, and others keep trillions of dollars offshore.  The longer they can defer taxes at a 35 percent rate, the better.  And there are plenty of tricks that allow them to use those trillions productively without bringing them back to the United States.  That costs the government revenue and the economy investment dollars.

There really isn't a good policy justification for deferral other than "competitiveness."  Deferral originates in the 1918 revisions to the code and was maintained by the Kennedy administration after subpart F (which is completely ineffective) was created to prevent the abuse of tax havens.  Deferral provides a perverse incentive for U.S. multinationals to keep profits locked offshore.  It also explicitly means that the U.S. tax code favors foreign profits over domestic, encouraging companies to engage in aggressive income shifting and transfer pricing strategies.  It's simply terrible tax policy. 

Other Republicans have called for the end of deferral, but not quite in the same context.  Former Ways and Means Chair Dave Camp's plan would have switched the United States to a territorial system and imposed a one-time repatriation tax.  Other GOP plans generally follow a similar approach, and there is even some bipartisan support for this kind of approach to deferral.  But this is all predicated on giving up the worldwide system. 

It's not clear why a territorial system would be in U.S. interests unless you buy completely into multinational assertions that they aren't competitive with foreign firms.  Trump's campaign rhetoric suggests that he sides more with populists like Sanders in thinking that U.S. companies aren't paying their fair share.  In that sense, his plan to end deferral might be more of a core belief than the 15 percent rate.  And if Trump does push strongly to end deferral, other lawmakers should get behind him.  The United States shouldn't have a tax system that encourages companies to earn their profits overseas rather than at home.

Read Comments (2)

Edmund DantesJun 22, 2016

The big advantage of reducing to a 15% corporate tax rate is that it drastically reduces the incentive for all the complicated tax planning, and allows corporations for focus instead on being more productive and profitable. The "lost" revenue is just a mirage, as corporations were never going to pay those high taxes anyway.

Mike55Jun 22, 2016

Great article. One observation:

The conventional wisdom that newly repatriated profits will be reinvested by MNCs inside the U.S. is false. In my experience deferred cash is by definition excess, and excess cash in the home jurisdiction always goes to the shareholders. When excess cash in the home jurisdiction doesn't go to the shareholders the C-Suite gets replaced. Thus in my cynical world view deferral serves largely as an excuse for MNCs to hoard cash that should otherwise go to shareholders.

Watching CEO's complain about the "lock-out" effect always reminds me of the old Disney story about the rabbit and the briar patch. If the CEO/CFO of an MNC don't receive full dividend equivalents on their options/RSAs/RSUs, why on earth wouldn't they try to defer every last penny? I'd be willing to bet there's an identifiable statistical correlation between how aggressively a given MNC pursues deferral and the ability of its top executives to participate in dividends and buy-backs.

Note that I do NOT think this undercuts your argument in the least, it's just a different way of saying the same thing. So like you/Sanders/Trump/Wyden I'd favor eliminating deferral, with the caveat that it must be part of a revenue neutral package (which probably pus me at odds with at least Sanders). Given $80B to play with I firmly believe the Martin Sullivan's of the world could dream up a set of tax expenditures that create far more U.S. economic growth than deferral, which makes everyone better off.

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