PPL: Exposing the flaws of the foreign tax credit

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Article Highlights

  • There’s no reason for the US income tax system to treat foreign income taxes better than foreign taxes on asset values.

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  • The credit is not the best way to achieve global cooperation to combat excessive taxation of cross-border investment.

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  • We must continue the movement in which capital income is taxed only at the individual level in the individual.

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For a complete listing of all On the Margin articles, please visit: www.aei.org/onthemargin/.

 

PPL: Exposing the Flaws Of the Foreign Tax Credit

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On February 20 the Supreme Court heard oral arguments in PPL v. Commissioner. The Court will decide in the next fewmonths whether a windfall tax imposed by the United Kingdom on privatized utilities in 1997 falls within the category of ‘‘income, war profits, and excess profits taxes'' that qualify for the foreign tax credit under section 901. Rather than seeking to answer that question, I argue that the impossibility of providing a satisfactory answer vividly illustrates the underlying flaws of the FTC.

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Much ink has been spilled debating whether the U.K. windfall tax is an income tax that qualifies for the credit or is instead a tax on asset value that does not qualify. In seeking an answer to this elusive question, both sides have relied on gossamer-thin distinctions that have little or no policy relevance to the proper U.S. tax treatment of the U.K. tax. The reliance on those distinctions highlights the underlying reality that there is no sound policy reason for the U.S. income tax system to treat foreign income taxes more generously than foreign taxes on asset values. 

One possible response, suggested by some commentators, is to broaden the set of foreign taxes that are creditable. The best reform, however, would move in the opposite direction and make all foreign taxes deductible at the tax rate imposed on foreign income, the treatment extended to other foreign business costs. Reiterating a point made a halfcentury ago by Peggy Musgrave, Daniel N. Shaviro of the New York University School of Law recently emphasized that from the standpoint of American well-being, U.S. taxpayers' foreign income tax payments are no different than their other foreign tax payments, nontax foreign business costs, and reductions in foreign income. The credit reduces American well-being by artificially and inefficiently diluting U.S. taxpayers' incentives to minimize foreign income taxes, because those taxes can be offset by the credit. The credit prompts American companies to operate in high-tax countries, to be less zealous in challenging foreign tax assessments, and to enter transactions that reallocate other parties' foreign income tax liabilities to them in exchange for other benefits. Statutory and regulatory restrictionson the credit cannot satisfactorily combat those incentives.

Moreover, the credit is not the best way to achieve global cooperation to combat excessive taxation of cross-border investment. That goal is better achieved by continuing the international movement toward a regime in which capital income is taxed only at the individual level in the individual investor's country of residence.

 

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About the Author

 

Alan D.
Viard
  • Alan D. Viard is a resident scholar at the American Enterprise Institute (AEI), where he studies federal tax and budget policy.

    Prior to joining AEI, Viard was a senior economist at the Federal Reserve Bank of Dallas and an assistant professor of economics at Ohio State University. He has also been a visiting scholar at the US Department of the Treasury's Office of Tax Analysis, a senior economist at the White House's Council of Economic Advisers, and a staff economist at the Joint Committee on Taxation of the US Congress. While at AEI, Viard has also taught public finance at Georgetown University’s Public Policy Institute. Earlier in his career, Viard spent time in Japan as a visiting scholar at Osaka University’s Institute of Social and Economic Research.

    A prolific writer, Viard is a frequent contributor to AEI’s “On the Margin” column in Tax Notes and was nominated for Tax Notes’s 2009 Tax Person of the Year. He has also testified before Congress, and his work has been featured in a wide range of publications, including Room for Debate in The New York Times, TheAtlantic.com, Bloomberg, NPR’s Planet Money, and The Hill. Viard is the coauthor of “Progressive Consumption Taxation: The X Tax Revisited” (2012) and “The Real Tax Burden: Beyond Dollars and Cents” (2011), and the editor of “Tax Policy Lessons from the 2000s” (2009).

    Viard received his Ph.D. in economics from Harvard University and a B.A. in economics from Yale University. He also completed the first year of the J.D. program at the University of Chicago Law School, where he qualified for law review and was awarded the Joseph Henry Beale prize for legal research and writing.
  • Phone: 202-419-5202
    Email: aviard@aei.org
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    Name: Regan Kuchan
    Phone: 202-862-5903
    Email: regan.kuchan@aei.org

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