NEED TO KNOW
INTERNATIONAL CORPORATE TAXES:
THE “TERRITORIAL” VS. “WORLDWIDE”
SYSTEM
The United States holds a dubious distinction—at 39%, the nation’s
combined state and federal corporate tax rate is the highest in the
developed world (8). There are a number of reasons why such a high tax rate
on business activity is harmful (2). But one reason it bites especially hard is
due to the way our federal government taxes international business income.
Under current law, no matter where in the world American companies earn
income, they are taxed at the high U.S. rate, leaving U.S. companies at a
disadvantage

HOW DOES THE CURRENT SYSTEM WORK?
Under a pure “worldwide” international tax system, U.S. companies that earn
profits abroad would have to pay both taxes to the foreign country at its tax
rate and taxes to the U.S. government at the difference between the foreign
country’s tax rate and the U.S. tax rate, almost always leading to a larger tax
bill. The U.S. system, however, has an important caveat: companies can
indefinitely “defer” this extra layer of tax so long as their foreign income is
not returned (“repatriated”) to the U.S.

QUICK FACTS
As of October 2015, the
United States has the highest
corporate tax rate in the
industrialized world (8).
The current U.S. international
tax regime has “locked out”
well over $1 trillion in funds
earned overseas that could be
reinvested here at home to
create jobs.

NOTABLE & QUOTABLE
“[D]o away with the
worldwide structure and
implement a territorial tax
system like those in most
other industrialized nations.
This would provide a
companies competing in
markets at home and abroad.”
- Edward Rapp, Caterpillar
Inc. (1).

Unfortunately, this encourages companies to keep their money overseas
instead of bringing it back home to invest in the U.S. economy. Recent
estimates show that more than a trillion dollars of “undistributed foreign earnings” are currently sitting abroad as
a result (4).
Here is an example: imagine that an American company called SHOECO sells sneakers in both the U.S. and in
Ireland. If SHOECO’s subsidiary in Ireland earned $100 profit, it would be taxed at Ireland’s low 12.5% rate-a tax bill
of $12.50. However, if that subsidiary wanted to bring that income back to the U.S. to hire more American workers
or expand operations at home, SHOECO would have to make up the difference between Ireland’s 12.5% corporate
tax rate and the U.S. government’s 35% federal rate. This would raise the total tax bill from $12.50 to $35.
Remember, an Irish company operating side-by-side with SHEOCO would only pay the $12.50.
Here SHOECO would have three options: pay the expensive U.S. tax to repatriate the income, keep its income in
Ireland, or move to Ireland all together. In the real world companies tend to pursue one of the latter two options,
reducing economic activity and job growth here in the U.S.

THE ADVANTAGES OF A “TERRITORIAL” SYSTEM
Most other developed economies use a “territorial” system for international taxation. Under this system, the U.S.
would only tax income earned in the U.S. and would exempt all overseas income from extra U.S. taxes. In the case
of SHOECO, income earned by its Irish subsidiary would still be taxed at Ireland’s corporate tax rate, but there
would be no additional tax to bring that income home to the U.S.

 This approach has several advantages (5). Most importantly, it allows U.S. businesses to compete on a
level playing field with their foreign competitors and removes the barriers companies currently face to
bringing home foreign income to the U.S.

THE 2004 REPATRIATION TAX HOLIDAY
We can get a rough idea of the impact of moving to a territorial system by looking at past experience.
In 2004, the American Jobs Creation Act provided a temporary one-year “holiday” from repatriation
taxes-in effect, the U.S. used a territorial system temporarily. Businesses seized the opportunity and
that year brought home more than $300 billion in additional foreign earnings that were otherwise
trapped abroad because of high repatriation taxes. Moreover, they put that money to work in the
American economy by investing in capital and R&D, hiring and training employees, and paying
dividends to shareholders (6).

JOBS HERE OR ABROAD?
Opponents generally argue that a territorial system encourages businesses to shift jobs and production
overseas, chasing the lower corporate tax rates in foreign countries. But this argument relies on the
assumption that increased production and employment in foreign countries are a substitute for
(completely displace) job creation here at home.
In fact, often the opposite is true: foreign business activity is actually a compliment to (increases)
domestic business activity. SHOECO, for example, might produce and sell more sneakers in Ireland, but
that could require more R&D or administrative jobs at its headquarters in the U.S. SHOECO’s U.S.
shareholders would also benefit when the company’s stock rises in response to the increased shoe
sales—those shareholders (which could include pensioners across the country) would use that
increased wealth to invest and spend more in the U.S.
A recent study by economists from Harvard and the University of Michigan illustrates this point. They
found that when American firms increased their foreign operations by 10%, instead of cutting domestic
employment they actually increased it by 3.7% on average (7). In short, more jobs abroad often times
means more jobs here as well.

Endnotes:
1.
House Committee on Ways and Means, Business Leaders in Support of a Territorial Tax System (online at
http://waysandmeans.house.gov/UploadedFiles/Intl_quotes.pdf) (accessed May 16, 2012).
2.
ii. Scott A. Hodge, The Countdown is over. We’re #1, Tax Foundation, Fiscal Fact No. 294 (April 1, 2012) (online at
http://www.taxfoundation.org/news/show/28081.html).
3.
Scott A. Hodge, Ten Benefits of Cutting the U.S. Corporate Tax Rate, Tax Foundation, Special Report No. 192 (May 11,
2011) (online at http://taxfoundation.org/publications/show/27269.html).
4.
David Faber, Undistributed Foreign Earnings on the Rise, CNBC (May 25, 2011) (online at http://www.cnbc.com/
id/43152232/Undistributed_Foreign_Earnings_on_the_Rise).
5.
Scott A. Hodge, Ten Reasons the U.S. Should Move to a Territorial System of Taxing Foreign Earnings
6i.
John R. Graham et al., Barriers to Mobility: The Lockout Effect of U.S. Taxation of Worldwide Corporate Profits (August
25, 2010) (online at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1316576).
7.
Mihir A. Desai et al., Domestic Effects of the Foreign Activities of U.S. Nationals
8.
http://taxfoundation.org/article/corporate-income-tax-rates-around-world-2015

Americans for Prosperity Foundation’s “Need to Know” informational series explores current events
and recent scholarship on public policy isues from a free-market economics perspective. A full list of
“Need to Know” briefings is available at www.AmericansForProsperityFoundation.org/NeetToKnow.
©2012 Americans for Prosperity Foundation. All Rights Reserved.

AMERICANSFORPROSPERITYFOUNDATION.ORG