International tax policy research at Northwestern Law
Prof and associate dean Jide Nzelibe wrote this succinct, informative note in response to a query from a distinguished alum who asked “what are NU law profs doing to contribute to vital tax policy debates?” In a separate note, we will profile some of the terrific applied and doctrinal work from professors who work in our esteemed LLM Tax program. This note describes part of what is happening in the international tax policy world:
In terms of hands-on engagement with ongoing tax policy debates, our colleague Charlotte Crane completed a term just over a year ago as the Professor in Residence (2010-2011) at the Office of Chief Counsel of the IRS. The Professor-in-Residence program provides some of the nation’s top legal academicians the opportunity to contribute to the development of legal tax policy and administration. Reporting directly to the IRS Chief Counsel, the Professor in Residence provides advice and assistance on a wide array of legal issues within the scope of his or her expertise. Charlotte herself has also written widely on the problems of defining broad-based taxes and the mechanisms through which these rules evolve.
Your email also raised issues about how tax policy affects the ability of the United States to be competitive in today’s economic environment. Our colleagues have also been at the forefront of these debates as well. For instance, in the past few years, Professors Cameron and Postlewaite have analyzed and critiqued two comprehensive proposals to reform the international tax system. The first proposal would move the current regime closer to an exemption or territorial system and provide that foreign income, whether earned directly or through a foreign subsidiary, would not be subject to United States taxation. Both the 2005 President’s Advisory Panel on Federal Tax Reform and the Treasury Department under the Bush Administration proposed reforms that would implement an exemption or territorial system. The second proposal would move the current regime closer to a pure worldwide tax system, sometimes referred to as a “full inclusion” system, under which the foreign income of foreign subsidiaries would be attributed to the United States parent. Postlewaite and Cameron have argued that proposals that dramatically shift the United States international tax system closer to a territorial system or to a full inclusion system are fraught with technical difficulties and uncertainties. But more importantly, they argue, such proposals strain an already polarized political system that must draft and consider such complex legislation. They argue that a more appropriate, and realistic, approach in such a situation is simply to “muddle through” by proposing incremental, rather than fundamental, changes to the status quo that move in the direction of generally agreed upon policy objectives before tackling the more politically difficult issues associated with fundamental reform. But they clarify that one cautionary aspect of incremental, as opposed to comprehensive, tax reform is the risk that an incremental approach may advance only those proposals that are projected to raise government revenue, particularly given the current budgetary constraints that confront the federal government, and that such proposals will be viewed by the legislative process as largely a means to fund other budgetary priorities.
Professor Thomas Brennan has written about the effects of the American Jobs Creation Act of 2004 (AJCA). This legislation granted a tax holiday to U.S. corporations with foreign subsidiaries, allowing the subsidiaries to remit certain funds to their parents at a much lower tax rate than previously possible. Many firms acted during this window of opportunity, and foreign subsidiaries distributed more than $300 billion in qualifying dividends to their U.S. parents. Assuming that a return of foreign earnings to the United States was the sole policy goal, Brennan argues that the AJCA was unarguably a short-term success, as substantial amounts of cash were returned to U.S. parent corporations during the window permitted by the statute. But he also shows that since the holiday window, there has been a dramatic increase in the rate at which firms add to their stockpile of foreign earnings kept overseas. The long-term result has been an aggregate increase in new foreign earnings added to the overseas stockpile that is greater than the amount of funds repatriated pursuant to the holiday. From this perspective, it seems that the AJCA may have been a net failure in achieving the policy goal of returning foreign earnings to the United States.
Professor Dharmapala, visiting at Northwestern from Illinois this semester, has also written about central issues in international tax policy, including empirical studies of the impact of the US international tax regime on US-based multinational firms. One contribution (coauthored with Mihir Desai of Harvard Business School) uses data on international direct and portfolio investment and finds empirical evidence consistent with the idea that the US international tax system disadvantages US-based multinational firms as vehicles for global diversification by shareholders. Like our colleague Tom Brennan, Professor Dharmapala has also analyzed the effects of the American Job Creation Act of 2004, which allowed US-based multinational firms to repatriate foreign earnings at a greatly reduced tax rate during 2005. He has also been invited to speak later this month (October 2013) at a conference of the International Tax Policy Forum, a Washington-based organization that promotes nonpartisan academic research and an informed dialogue on international tax issues. This presentation will focus on the findings of the empirical literature on multinational firms’ responses to taxes, and draw policy lessons relevant to the OECD’s current global initiative on “base erosion and profit shifting.”