US multinational corporations booked a disproportionately large share of their profits in very low tax rate jurisdictions, with seven of the top 10 most popular offshore locations offering very low corporate effective tax rates. US tax law creates distortions that encourage the offshoring of activity and profits, since it offers perverse incentives to earn income abroad—an “America last” approach to tax policy.
Corporate income earned in the US is taxed at a 21 percent rate from the first dollar of taxable income earned. By contrast, the US tax system treats the first 10 percent return on foreign tangible assets as tax-free and the remaining reported income (with income streams blended across high- and low-tax countries) is taxed at a 50 percent discount relative to income earned domestically. These rules incentivize US firms to move assets and profits offshore—to places like the Netherlands, Singapore, and the Cayman Islands—to reduce their tax obligations.
Reforming the international tax system to reduce corporate tax base erosion and distortions to market competition is useful, and it will become even more so as US fiscal challenges mount. US fiscal deficit and debt-to-GDP ratios are set to rise over the next decade. It is not possible to tackle deficits through spending cuts alone—increased tax revenues will be needed to preserve budget stability.
Following the international tax agreement of 2021, many countries are now reexamining their tax systems and adopting country-by-country minimum taxes. The US should embark on similar reforms, committing to build both a fairer system and one that is more aligned with the rest of the world.
This PIIE Chart is adapted from Kimberly Clausing’s testimony before the US Senate Committee on the Budget.