In 2008, 12 percent of all federal revenues came from corporate income taxes; about half was paid by multinational corporations reporting income from foreign countries. How the federal government taxes U.S. multinational corporations has consequences for the U.S. economy overall as well as for the federal budget. Tax policies influence businesses’ choices about how and where to invest, particularly as corporations assess whether it is more profitable to locate business operations in the United States or abroad. The tax laws also can create opportunities for tax avoidance by allowing multi-national corporations to use accounting or other legal strategies to report income and expenses for their U.S. and foreign operations in ways that reduce their overall tax liability. U.S tax revenues decline when firms move investments abroad or when they strategically allocate income and expenses to avoid paying taxes here.
A country can take two general approaches to taxing the income of corporations that operate both domestically and abroad:
- Under a worldwide approach, the home country considers all of the income of its multinational corporations to be taxable, regardless of where that income is earned. But to avoid taxing income twice—in the home country and in the country where it is earned— a country would generally allow multinational corporations to claim a foreign tax credit against domestic tax liability for taxes paid elsewhere.
- Under a territorial approach, the home country taxes only the income earned within its borders.
No major developed country has adopted either approach entirely. Although many developed countries use a more territorial approach, the system in the United States leans toward a worldwide approach, but one that allows multinational corporations to defer or, in some cases, completely avoid paying U.S. taxes on some income they earn abroad.
This study examines policy options that could move the United States closer to one system or the other, along with several approaches to addressing particular concerns about the current system of taxation. All would affect multinational corporations’ investment strategies and reporting of income as well as U.S. revenues from corporate income taxes.