Technical Committee on Business Taxation
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1996-06

International Implications of U.S. Business Tax Reform

Andrew B. Lyon

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Abstract

This paper examines the effects of recent tax law changes in the United States and the potential for fundamental tax reform to alter the incentives facing businesses in their real and financial behaviour. After first providing an overview of the tax system of the United States, the paper examines the changes enacted as part of the 1986 Tax Reform Act affecting business taxation at both the domestic and international level. These tax changes are shown to affect locational choices for real investment, the reported location of profits resulting from the use of transfer prices, and the financial choices of multinational corporations in their use of debt. Despite predictions that the U.S. tax changes would result in a significant increase in the excess foreign tax credits of U.S. multinationals, nearly contemporaneous reductions in the statutory tax rate in other countries has minimized the effects of the U.S. tax rate reduction.

The paper considers three different proposed reforms of the U.S. tax system that would replace the income tax with a tax based on consumption. The proposals (a retail sales tax, the Hall-Rabushka flat tax, and the USA personal expenditure tax), by exempting from taxation the marginal return to new investment, would make the United States a very attractive location for multinational corporations relative to current law. Further, the generally low statutory tax rate applying to business rents under these proposals would give strong incentives for corporations to engage in aggressive transfer pricing to relocate earnings to the United States.

Although the motivation for U.S. tax reform today, as in 1986, is largely independent of international concerns, the proposed consumption-tax reforms may make the United States a more attractive location for multinational corporations than currently. If the United States does adopt such reforms, other industrialized countries will face many pressures to adopt similar reforms.

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