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U.S. Taxation of International Income: Blueprint for Reform.

This book examines the current system the United States uses to tax international income and recommends specific measures for reform. The need for reform is based upon two central propositions. First, current international tax rules are complicated and distortional. This has occurred because the contemporary system evolved piecemeal from tax laws dealing with domestic income. Second, by changing international tax laws the U.S. can improve its competitiveness. Hufbauer believes the U.S. is losing economic ground to Europe and Japan, and that tax policy can assist in reversing this trend. He suggests a tax system that encourages multinational firms to locate their headquarter activities (especially research and development), and the production and export of high-technology goods and services, in the U.S.

Chapter I of the book presents statistics for Hufbauer's contention that the U.S. is becoming less competitive and briefly introduces his specific recommendations for tax reform. The remainder of the book discusses his rationales for reforms in detail.

Chapters 2 and 3, and a good part of the Appendix, outline the current system of U.S. taxation of international income, its evolution, and its underlying equity concepts. While perhaps useful to the noneconomist, many economists will find the discussions on equity too simplistic. Razin and Slemrod [1], for example, gives a richer treatment of the subject matter.

In Chapter 4 Hufbauer appeals to capital export neutrality to justify his first suggested reform: that the U.S. should switch to residence-based taxation of portfolio income flows. This is perhaps his most convincing recommendation, for unlike many of his other reforms, efficiency concerns guide his argument.

In Chapter 5 Hufbauer explains why the U.S. should promote the domestic location of multinational headquarters activity. As a reviewer cautious of market intervention, Hufbauer's appeal leaves me unconvinced. For instance, he states:

... headquarter's activities are highly desirable: they provide interesting, well-paying professional and technical jobs. Moreover, headquarters services are an incubator of human capital, and human capital is highly mobile, so the spillover effects are potentially large: key employees acquire the knowledge to start new firms and energize old ones [p. 92].

Yet he gives no evidence to back up these assertions. He then continues:

In this context, it is striking that the world's most affluent metropolitan areas are headquarters to a disproportionate number of the world's top 100 industrial corporations and top 50 banks [p. 92].

Hufbauer fails to mention that a well-developed infrastructure also might attract headquarter activities, implying a causality running in the opposite direction.

Chapter 6 discusses a variety of emerging problems with the current system of taxation in the U.S. Included in this section is Hufbauer's prescription for technology export neutrality, the analogue to capital export neutrality. This calls for the U.S. to use residence-based taxation and to tax royalty and fee income from domestic technology at the same rate whether used at home or abroad. Hufbauer correctly notes that current tax laws provide an incentive at the margin for U.S. multinationals to move their productive technology abroad. Chapter 6 also examines problems in the allocation-of-expense rules, transfer pricing rules, taxation of export income, and state taxation of international income.

In Chapter 7 Hufbauer identifies his suggested reforms aimed at increasing U.S. competitiveness. These are not reforms based upon efficiency criteria, as Hufbauer readily admits. Among the major reforms are:

(i) implementing territorial-based taxation of foreign corporate earnings (which also implies repeal of the foreign tax credit for businesses, since no income received from foreign direct investment would be taxed);

(ii) allowing the deduction of all headquarters expenses incurred in the U.S. against the headquarter's U.S.-source income as a means of promoting the location of headquarters activities in the U.S.;

(iii) implementing a ten-percent R&D tax credit for R&D performed in the U.S. (to offset the potential drop in returns to R&D creation from implementing technology export neutrality);

(iv) excluding from shareholder taxable income 30 percent of capital gains on equity investments in corporate shares held over five years, which is a second-best solution designed to bring the returns from debt and retained equity nearer to each other, and to allow convergence of the U.S. tax system with that of other countries;

(v) converging the tax base used by the U.S. and other developed countries; and

(vi) using binding arbitration in transfer pricing disputes and using wider use of advanced pricing agreements to reduce the cost of transfer price enforcement.

Finally, Hufbauer estimates that the U.S. would generate $12.3 billion annually in tax revenue from his reforms. However, many of the estimates are untenable. I feel that a best-case, worst-case scenario would have been more helpful. Additionally, Hufbauer's revenue gains include $12.8 billion generated by taxing portfolio income flows and another $6.0 billion obtained by closer scrutiny of transfer prices. Therefore, Hufbauer's reforms designed to promote U.S. competitiveness entail a loss of $6.5 billion annually. Hufbauer also neglects to acknowledge the very real possibility that a tax policy designed to promote U.S. competitiveness might invoke retaliation from other countries.

In conclusion, many readers may disagree with the stance that tax laws should promote U.S. competitiveness, and many more readers may disagree with Hufbauer's specific proposals. Nevertheless, Hufbauer's experience at the U.S. Treasury allows for both pragmatic and detailed recommendations seldom found in the economic literature. As such, his book is worthwhile reading for those interested in international tax policy.


[1.] Blaug, Mark. Economic Theory in Retrospect. Cambridge University Press, 1985.
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Author:Heimert, A. Michael
Publication:Southern Economic Journal
Article Type:Book Review
Date:Jul 1, 1993
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