Tax Earnings Where Products Are Sold

From Alan Auerbach on corporate taxes:

More than a century old, our corporate tax is showing its age. To modernize it, the basic challenge is to implement a corporate tax that is fair and provides sufficient revenue while making the United States an attractive place for companies to locate and produce, and create the good jobs we need.

The fundamental problem is our reliance on the concepts of residence, or where a company is located, and source, or where the company’s assets and production activities are located. These concepts may have worked reasonably well in the 1930s, but they do not hold up when confronting a multinational company with global operations.

Where a company is based and where assets or production are located are obsolete concepts in a global intellectual market.

The source of earnings is particularly ambiguous for companies relying heavily on intellectual property. U.S. residence is not a central element of identity for companies with worldwide shareholder bases, in competition with similar companies from around the globe.

Most alleged solutions to the failings of our corporate tax system address some problems but exacerbate others. The bottom line, though, is that without moving away from taxation based on the source of income and the residence of companies, we will remain an unwilling participant in the global race to the bottom, compelled to reduce our corporate tax rate as other countries do the same, hoping to entice companies and their income 
not to move offshore.

A better approach would be to tax a company’s earnings based on where its products are sold, using what is known as the destination approach. For example, earnings from the production of a smart phone sold in the United 
States would be subject to U.S. corporate tax, regardless of the company’s residence or where the company reports its production to have occurred.

Using destination to determine tax liability would allow the United States to impose tax on its fair share of multinational earnings while eliminating any incentive for companies to move their activities or themselves to other countries, since the same U.S. tax would still apply regardless of residence or source.

A complex economy needs a simple tax system.

HT: Brad Delong

About ozidar

I'm an Assistant Professor of Economics at the University of Chicago Booth School of Business and a Faculty Research Fellow at National Bureau of Economic Research. You can follow me on twitter @omzidar.
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