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76–892—PDF 2011

S. HRG. 112–645 

TAX REFORM OPTIONS: INTERNATIONAL ISSUES 

HEARING 

BEFORE THE

COMMITTEE ON FINANCE 

UNITED STATES SENATE 

ONE HUNDRED TWELFTH CONGRESS 

FIRST SESSION 

SEPTEMBER 8, 2011 

( 

Printed for the use of the Committee on Finance 

COMMITTEE ON FINANCE 

MAX BAUCUS, Montana, Chairman 

JOHN D. ROCKEFELLER IV, West Virginia 

KENT CONRAD, North Dakota 

JEFF BINGAMAN, New Mexico 

JOHN F. KERRY, Massachusetts 

RON WYDEN, Oregon 

CHARLES E. SCHUMER, New York 

DEBBIE STABENOW, Michigan 

MARIA CANTWELL, Washington 

BILL NELSON, Florida 

ROBERT MENENDEZ, New Jersey 

THOMAS R. CARPER, Delaware 

BENJAMIN L. CARDIN, Maryland 

ORRIN G. HATCH, Utah 

CHUCK GRASSLEY, Iowa 

OLYMPIA J. SNOWE, Maine 

JON KYL, Arizona 

MIKE CRAPO, Idaho 

PAT ROBERTS, Kansas 

MICHAEL B. ENZI, Wyoming 

JOHN CORNYN, Texas 

TOM COBURN, Oklahoma 

JOHN THUNE, South Dakota 

RICHARD BURR, North Carolina 

RUSSELL SULLIVAN, Staff Director 

CHRIS CAMPBELL, Republican Staff Director 

(II) 

C O N T E N T S 

OPENING STATEMENTS 

Page 

Baucus, Hon. Max, a U.S. Senator from Montana, chairman, Committee 

on Finance ............................................................................................................ 1 

Hatch, Hon. Orrin G., a U.S. Senator from Utah ................................................. 2 

WITNESSES 

West, Philip R., partner, Steptoe and Johnson LLP, Washington, DC ............... 5 

Hines, Dr. James R., Jr., L. Hart Wright collegiate professor of law, University of Michgan Law School, Ann Arbor, MI ...................................................... 7 

Naatjes, Scott, vice president and general tax counsel, Cargill Incorporated, 

Wayzata, MN ........................................................................................................ 8 

Avi-Yonah, Dr. Reuven S., Irwin I. Cohn professor of law, University of 

Michigan Law School, Ann Arbor, MI ................................................................ 10 

ALPHABETICAL LISTING AND APPENDIX MATERIAL 

Avi-Yonah, Dr. Reuven S.: 

Testimony .......................................................................................................... 10 

Prepared statement .......................................................................................... 29 

Baucus, Hon. Max: 

Opening statement ........................................................................................... 1 

Prepared statement .......................................................................................... 37 

Hatch, Hon. Orrin G.: 

Opening statement ........................................................................................... 2 

Prepared statement .......................................................................................... 39 

Hines, Dr. James R., Jr.: 

Testimony .......................................................................................................... 7 

Prepared statement .......................................................................................... 41 

Naatjes, Scott: 

Testimony .......................................................................................................... 8 

Prepared statement .......................................................................................... 52 

West, Philip R.: 

Testimony .......................................................................................................... 5 

Prepared statement with attachment ............................................................. 67 

COMMUNICATIONS

Center for Fiscal Equity .......................................................................................... 101 

Center for the Study of Mergers and Acquisitions ............................................... 107 

Investment Company Institute ............................................................................... 117 

National Small Business Association ..................................................................... 121 

Overseas Shipholding Group, Inc. (OSG) .............................................................. 131 

Working Group on Intangibles ............................................................................... 136 

(III) 

(1) 

TAX REFORM OPTIONS: 

INTERNATIONAL ISSUES 

THURSDAY, SEPTEMBER 8, 2011 

U.S. SENATE, COMMITTEE ON FINANCE, Washington, DC. 

The hearing was convened, pursuant to notice, at 9:39 a.m., in 

room SD–215, Dirksen Senate Office Building, Hon. Max Baucus, 

(chairman of the committee) presiding. 

Present: Senators Bingaman, Wyden, Stabenow, Nelson, Carper, 

Cardin, Hatch, Grassley, Snowe, Enzi, Cornyn, and Thune. 

Also present: Democratic Staff: Russ Sullivan, Staff Director; Lily 

Batchelder, Chief Tax Counsel; and Jeff VanderWolk, International 

Tax Counsel. Republican Staff: Chris Campbell, Staff Director; Jim 

Lyons, Tax Counsel; Theresa Pattara, Tax Counsel; and Maureen 

McLaughlin, Detailee. 

OPENING STATEMENT OF HON. MAX BAUCUS, A U.S. SENATOR 

FROM MONTANA, CHAIRMAN, COMMITTEE ON FINANCE 

The CHAIRMAN. The committee will come to order. 

The Roman poet Ovid wrote, ‘‘A horse never runs so fast as when 

it has other horses to catch up to and outpace.’’ Advances in technology have resulted in a world in which business is more global. 

Today, a local business in my home State of Montana competes not 

only with the shop down the street, but with a company across the 

world. We need to ensure that our international tax rules help U.S. 

businesses outpace their competitors and succeed in this global 

economy. This increased competition from around the world can, 

and must, lead us to be better. 

American businesses increasingly sell their goods and services 

overseas, and foreign-based businesses compete aggressively for a 

share of the American market. Today, U.S.-based multinational 

companies generate, on average, nearly half their income from foreign affiliates compared to just 17 percent in 1977. The United 

States’ exports have more than doubled as a percent of GDP since 

1960. 

Foreign investment in the U.S. and the continued success of 

American business in the global marketplace are both essential to 

the health of the U.S. economy. Over the past 10 years, foreign direct investment in the U.S. has totaled $1.7 trillion, supporting 5 

to 6 million American workers. 

Foreign markets like Brazil, China, and India all offer lucrative 

new opportunities for U.S. workers and businesses. From 1990 to 

2008, emerging economies grew at an average annual rate of 4.6 

2 

* For more information, see also, ‘‘Present Law and Issues in U.S. Taxation of Cross-Border 

Income,’’ Joint Committee on Taxation staff report, September 6, 2011 (JCX–42–11), http:// 

www.jct.gov/publications.html?func=startdown&id=4355. 

percent. We need to have an international tax system that helps 

U.S. businesses to take advantage of these opportunities to create 

more jobs here at home. 

The tax code should not deter potential foreign investment in the 

U.S., and it should not hamper American competitiveness overseas, 

nor should our tax code discourage companies from employing 

Americans abroad. In July, we heard from U.S. business leaders 

who urged us to make our tax system more like the territorial tax 

systems of some of our major trading partners. I look forward to 

hearing from our witnesses on that issue today. 

In addition, we have heard a great deal about U.S. multinational 

corporations avoiding taxation of their foreign earnings, often using 

tax havens. I hope our witnesses will be able to discuss ways to address that issue. 

No one doubts that our tax code should encourage economic 

growth and job creation. It should be fair, simple, efficient, and certain. This is particularly true in the international area, where the 

current rules are among the most complex, and the most uncertain. 

Right now we are confronting a massive debt problem, due in 

part to the 2008 financial crisis. As we work to emerge from that 

crisis, we must understand how our tax code affects international 

business and investment. We must make sure our tax code does 

not encourage American businesses to relocate jobs overseas. At the 

same time, the tax code must not put U.S. business at a disadvantage in foreign markets. 

So, let us work together to address these issues. Let us make our 

tax code more competitive and fair, helping our economy grow, and 

creating more jobs for Americans in the global economy. Let us find 

creative solutions to help American business men and women outpace the competition.* 

[The prepared statement of Chairman Baucus appears in the appendix.] 

Senator Hatch? 

OPENING STATEMENT OF HON. ORRIN G. HATCH, 

A U.S. SENATOR FROM UTAH 

Senator HATCH. Well, thank you, Mr. Chairman. I want to thank 

you for calling this hearing today. Working our way through 

the—— 

The CHAIRMAN. If I might just say, Senator, I apologize for interrupting. I apologize to the panel, to the witnesses, my colleagues. 

I have another meeting I must be present at at 10, and I’m going 

to have to leave early. But, when I do leave, as is our customary 

practice, Senator Hatch, you can take over. 

Senator HATCH. Well, thank you, Mr. Chairman. 

The CHAIRMAN. And I apologize for the interruption. 

Senator HATCH. To work our way through the international tax 

system is a critical step on the road toward comprehensive tax reform. The United States’ international tax system dates back to the 

period between 1918 and 1928. 

3 

As part of the Revenue Act of 1918, the United States became 

the first country to enact a system in which income taxes paid to 

a foreign country on income earned outside of the United States 

could be credited against U.S. income taxes. Ten years after that, 

in 1928, the League of Nations introduced draft model income tax 

treaties, the basis of which are still used today by the United 

States. 

Well, I have to say a lot has changed since the 1920s. At that 

time, the United States had been the world’s largest economy for 

only about 30 years, having surpassed Great Britain in 1894. 

Today, the United States still has the world’s largest economy, but 

just last year China supplanted Japan as the world’s secondlargest, with predictions that China’s economy will approach the 

size of the U.S. economy within 20 years. 

Throughout the 1920s, the U.S. was running budget surpluses. 

Today, of course, the U.S. is running huge budget deficits. In the 

1920s, in the aftermath of World War I, the United States was a 

net creditor Nation. By the mid-1980s, the United States became 

a net debtor nation, a status that it retains today. During the 

1920s, Federal revenues averaged about 4 percent of GDP. In recent history, from 1971 to 2010, revenues have averaged about 18 

percent of GDP. 

Yet, despite the changes that have taken place in the United 

States and around the world since the 1920s, the basics of our 

international tax system have pretty much remained the same now 

for over 80 years. 

In any discussion of international tax reform, the fundamental 

issue remains unchanged. When income is earned in one country 

by a resident of another country, both the country where the income is earned and the country where the resident resides have legitimate claims to tax the income. Some tax scholars have referred 

to this issue as ‘‘the essential dilemma of international taxation.’’ 

Arguably, one of the basic goals of an international tax system 

is to resolve the competing claims of the source country and the 

residence country in order to avoid the double taxation that can result when both countries exercise their taxing powers. 

In the 1960s, the competing international tax theories of capital 

export neutrality and capital import neutrality were developed. 

Capital export neutrality occurs when the overall burden of taxation on capital owned by residents of a particular country is the 

same whether that capital is invested at home or abroad. Capital 

export neutrality has generally been associated with worldwide 

taxation, coupled with a credit for foreign income taxes. 

In contrast, the theory of capital import neutrality holds that the 

international tax system should have equal tax treatment for all 

capital investment within a particular country, regardless of the 

residence of the investor. Capital import neutrality has generally 

been associated with territoriality, the idea that a particular country, as a general rule, should only tax income earned within its borders. 

Other international tax treaties have developed over time, including the theory of national neutrality, emphasizing the importance of American economic well-being in tax policy, and more reVerDate Nov 24 2008 21:13 Dec 07, 2012 Jkt 000000 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 R:\DOCS\76892.000 TIMD
4 

cently the theory of capital ownership neutrality, the goal of which 

is to have tax rules that do not distort ownership patterns. 

Today we are reading and hearing about some of the tax issues 

that U.S. multinational corporations face when doing business 

abroad—issues that many believe are due to our outdated international tax system. 

To illustrate, many U.S. multinational corporations earn money 

overseas and typically want to bring that money back home to the 

United States. However, our current international tax system discourages and, some would say, penalizes U.S. multinational corporations from repatriating foreign earnings by imposing a 35- 

percent residual U.S. tax at the time of repatriation. As a result, 

several high-profile U.S. multinational corporations are sitting on 

large piles of cash earned from foreign operations, yet these same 

corporations are actually borrowing money. 

One of the reasons for this borrowing is that their cash is 

trapped offshore, and these corporations will be subject to a 35- 

percent U.S. tax for repatriating their cash back to the United 

States. One way of alleviating the problem of cash that is trapped 

offshore is for the U.S. to reform its international tax rules by, for 

example, adopting a territorial tax system. 

Now, I am very interested to hear what our witnesses have to 

say today with regard to our international tax system and how reform of the system will advance the goals of simplicity, fairness, 

and economic growth, while increasing the competitiveness of U.S. 

companies. 

In the modern global economy, we simply cannot afford to perpetuate policies that put our companies at a competitive disadvantage. 

We need to recognize that the world has changed, and we need to 

institute a tax system that will encourage companies to locate in 

our great Nation. We certainly do not need to place those that do 

so at a competitive disadvantage. 

Again, Chairman Baucus, thank you very much for this important hearing, the latest in a series of critical discussions about tax 

reform, and I think one of the more important hearings we are 

going to have this year. 

The CHAIRMAN. Thank you, Senator, very much. 

[The prepared statement of Senator Hatch appears in the appendix.] 

The CHAIRMAN. I would like to introduce the witnesses now. 

Our first witness is Mr. Phil West. Mr. West is chair of the tax 

practice and a partner in the Washington office of Steptoe and 

Johnson. He previously served for 4 years as the Treasury Department’s International Tax Counsel. 

Second, Dr. James Hines. Dr. Hines is a professor of law and economics at the University of Michigan. He also serves as the research director of the Office of Tax Policy Research at Michigan’s 

Ross School of Business. 

Our next witness is Mr. Scott Naatjes. Is that correct? Thank 

you. He is vice president of tax and general counsel at Cargill Corporation. In his position, he is responsible for Cargill’s worldwide 

tax planning, audit, and compliance functions. 

5 

Finally, we have Dr. Reuven Avi-Yonah. Dr. Avi-Yonah is professor of law at the University of Michigan Law School, where he 

specializes in corporate and international taxation. 

Thank you all for coming. I think our colleague from Michigan 

would like to say a few words of introduction about some of the 

witnesses as well. 

Senator STABENOW. Well, thank you, Mr. Chairman. I just wanted to say, I know this is going to be an extraordinary panel because 

we have two people from the University of Michigan on the panel. 

Dr. Avi-Yonah and Dr. Hines, welcome to both of you. I think it 

is important to note they will have different perspectives, which is 

what this debate is all about. I look forward to hearing from both 

of them. But, Mr. Chairman, we just thank you and your staff for 

your wisdom in recognizing talent. So, thank you. 

Senator HATCH. Is that typical of the University of Michigan? 

Senator STABENOW. We have free thinkers. We are open and believe in free thinking and free speech. 

Senator HATCH. We have noticed that about you as well. [Laughter.] 

Senator STABENOW. Well, thank you. 

The CHAIRMAN. Thank you very much. 

Mr. West, why don’t you begin? 

STATEMENT OF PHILIP R. WEST, PARTNER, 

STEPTOE AND JOHNSON, LLP, WASHINGTON, DC 

Mr. WEST. Thank you, Chairman Baucus, Ranking Member 

Hatch, and distinguished members of the committee. My name is 

Philip R. West, and I am chair of the tax practice and a partner 

at Steptoe and Johnson. I have practiced tax law for over 25 years, 

predominantly in the international tax area. As the chairman said, 

I served as the Treasury Department’s International Tax Counsel 

in the late 1990s. 

I appear before you today on my own behalf, not on behalf of my 

firm, or any client. I appreciate the opportunity to testify. I would 

ask that my full written statement be included in the record. 

[The prepared statement of Mr. West appears in the appendix.] 

Mr. WEST. A tax system that raises little revenue but imposes 

high compliance and administrative burdens on taxpayers and the 

IRS is the very definition of a bad tax system. Unfortunately, that 

is the international tax system we have: it raises little revenue, 

with high compliance and administrative burdens. 

When considering whether to change the rules to improve the 

system, we should compare the current system to the proposed 

rules on five grounds: revenue raising, fairness, economic efficiency, 

simplicity, and competitiveness. Our current international tax rules 

do not score well. We can do better. The question is, how? 

In our current economic environment, a core issue is the impact 

of any reform proposal on job creation. If the government cannot 

create jobs directly, the private sector must do so. If the private 

sector needs additional incentives, in my view those incentives 

should be provided. In the international tax world, perhaps the 

most significant incentive would be to move to a territorial tax system. 

6 

But will this push jobs abroad? In my experience, most tax planning involves shifting income abroad, not shifting jobs abroad. That 

is a crucial distinction. Job location decisions are made primarily 

for non-tax reasons. When tax is a factor in job location decisions, 

it is primarily because the U.S. tax is higher than the tax in the 

other jurisdiction, although we could eliminate this differential by 

repealing our anti-deferral rules and taxing all foreign income currently in the United States. 

In my opinion, that would adversely affect a multinational’s appetite for taking on the risk of hiring additional workers in an uncertain economic climate. Therefore, moving to a territorial system 

is not likely to adversely affect U.S. job creation compared to where 

we stand today, while a repeal of deferral might. 

Will moving to a territorial system increase the deficit? Shifting 

to a territorial system can raise or lose revenue depending on the 

system’s design. But a system that reduces tax burdens and therefore loses revenue could incentivize corporations to hire, while a 

system that increases taxes and raises revenue would not. 

Despite a potential revenue loss, I agree with those who favor 

stimulus now—this can be viewed as a form of stimulus—and disagree that austerity is the right answer for a recession economy. 

But, if there is no political appetite for tax reform that loses revenue, there are numerous offsets that could be found in the corporate area, and also an increase in the individual tax rates, especially on higher-income earners, and I include myself among them. 

Compared to historic standards, our individual tax rates today 

are low, and raising them would move our tax system closer to 

those other economic systems, those other economies that have historically been the best performers. They have lower corporate rates, 

lower rates on mobile capital, and they have higher individual 

rates. If you look around the world, that characterizes many of the 

more successful economies. Therefore, moving to a territorial system does not have to increase the deficit, and, if it does, we should 

be willing to live with that in the short term. 

I would like to close by mentioning two related sets of international tax rules that highlight the extraordinary compliance burdens that our system can impose. The rules, collectively known as 

the Foreign Account Tax Compliance Act (FATCA), were enacted to 

help the United States fight tax evasions, but they are imposing 

huge compliance costs, even where the opportunities for tax evasion are remote. In a cruel irony, FATCA is causing much of that 

money to be spent outside the United States, not here where we 

need the jobs. 

Lastly, the United States’ unique system of taxing U.S. citizens 

on a worldwide basis, even if they have very few contacts with the 

United States, ought to be reconsidered. 

I see my time is up. Thank you for the opportunity to testify 

today, and I look forward to answering your questions. 

Senator HATCH. Well, thank you so much. We appreciate you. 

Dr. Hines, we will turn to you. 

7 

STATEMENT OF DR. JAMES R. HINES, JR., L. HART WRIGHT 

COLLEGIATE PROFESSOR OF LAW, UNIVERSITY OF MICHIGAN LAW SCHOOL, ANN ARBOR, MI 

Dr. HINES. Thank you, Senator. 

There are three goals that many of us share and are thought to 

be in conflict in thinking about the design of the tax system in general and its international provisions in particular. What are these 

goals? We want the tax system to help promote the well-being of 

American workers, we want the tax system to help promote the 

competitiveness of American industry, and we want the tax system 

to generate revenue. 

Well, these three goals are not in conflict. If you adopt an efficient tax system, it simultaneously advances all three of these. The 

question is, what constitutes an efficient system in the modern 

world, in 2011? An efficient tax system is one that would not tax 

the active foreign business income earned by resident companies. 

That is the system that is adopted by virtually every high-income 

country in the world other than the United States, and every significant capital-exporting nation in the world other than the United 

States. It is also known as the territorial system. 

Why is that an efficient system? It is efficient because, if you are 

in a competitive business environment, then it is a mistake to 

think in terms of just what the tax rules do only to American companies. You have to think about what they are doing as well to the 

foreign competitors, to the companies from other countries, all of 

whom virtually are coming from countries that do not tax active 

foreign business income. 

As a result of the United States having a very different system 

than the rest of the world, we have put American companies at a 

comparative disadvantage and made it burdensome for them to 

own productive assets in foreign countries, particularly in lower tax 

rate foreign countries. 

Is that a problem? Yes, it is a problem because it impedes the 

efficiency of the way in which American firms conduct their operations. As a result of that, it makes all of their productive factors 

less productive, including American workers whom these companies employ in the United States. 

If you want to help American workers, you have to adopt policies 

that make them more productive, and you certainly want to avoid 

policies that make them less productive because, in a market economy like ours, workers are paid their wage according to their productivity. So, things that we can do that make them more productive will enhance their wages and improve job prospects. 

In order for workers to be fully productive, the firms that employ 

them have to do so in an efficient manner, and so we all have an 

interest in these firms being efficient, and what ‘‘efficient’’ means 

in the modern era is to be competitive. 

In order to be competitive, you have to operate on a playing field 

that is commensurate with the playing fields that your competitors 

are operating on, and that is not the current U.S. situation. We 

have a burdensome system of taxing foreign income. It does not 

generate very much revenue. It does cause a lot of distortion to 

business activities. As a result, we have made our firms less productive and our workers less desirable for firms because they are 

8 

less productive as a consequence of distorting the ownership patterns of international assets. 

If we were to adopt a territorial system of a type that other countries have adopted, what would be the consequences? We would 

have more rational allocation of business assets, it would increase 

productivity of factors that are located in the United States, primarily labor. Should we be concerned that business would flow 

abroad, that firms, instead of hiring American workers, would hire 

foreign workers? We should not be concerned about that. 

Here is why we should not be concerned about that. Anything 

that improves the efficiency, the operations of domestic business 

activity, and in particular the hiring of domestic workers, if we improve the efficiency of that, it is going to be better for American 

workers. The evidence that we have indicates that, when American 

multinational firms, and other countries’ multinational firms, when 

they expand abroad, expand their foreign business operations, that 

is accompanied by expanding their domestic business operations. 

For the United States, firms that increase by 10 percent their 

foreign workforces increase their domestic workforces at the same 

time by 3.7 percent. That is because so much of the world’s economic activity is foreign these days, so much of the profit opportunity is foreign. In order for American workers to have the best 

prospects, they have to be associated with businesses that are highly profitable and that are exploiting their U.S. operations in order 

to generate foreign profits. 

Prosperity is not automatic. We have to adopt policies that encourage prosperity. We are so out of step with the rest of the world 

right now, it is important for us to adopt a territorial tax system. 

Senator HATCH. Well, thank you so much. 

[The prepared statement of Dr. Hines appears in the appendix.] 

Senator HATCH. Mr. Naatjes, we will take you now. 

STATEMENT OF SCOTT NAATJES, VICE PRESIDENT AND GENERAL TAX COUNSEL, CARGILL, INCORPORATED, WAYZATA, 

MN 

Mr. NAATJES. Ranking Member Hatch and members of the committee, thank you for inviting me to testify today. I am Cargill’s 

general tax counsel and vice president of tax. 

Cargill is a U.S. corporation with global sales in excess of $120 

billion. Roughly 60 percent of those sales are from active business 

operations outside of the U.S. We employ over 130,000 people in 63 

countries; nearly 50,000 reside in the U.S., including close to 5,000 

who work in our headquarters in Minnesota. Cargill builds plants 

and facilities around the globe. We compete for opportunities to 

serve suppliers, customers, and markets. We build infrastructure to 

support our investments and enhance the communities where we 

do business. 

The world has changed since the U.S. adopted its international 

tax system. Strong foreign companies with access to global capital 

markets now challenge us in virtually every market we serve. The 

vast majority of our competitors are organized in jurisdictions with 

territorial tax systems that allow them to compete in any country, 

unfettered by possible home country tax costs. 

9 

With more than $200 trillion of capital traded in global capital markets today and $70 trillion held in funds, every competitive 

project in the world will be funded by someone. If a foreign country 

is the optimal location for any particular investment, capital markets will ensure that the investment is eventually going to be made 

there. U.S. tax policy cannot prevent the investment from happening, it can only stop U.S. companies from participating. 

Much is at stake for our Nation. The knowledge gleaned from 

managing business in all corners of the world provides us with the 

business intelligence we need to compete and win. Enhanced competitiveness attracts capital. Management of that capital at U.S. 

headquarters creates high-paying knowledge-based jobs. It also creates support jobs and businesses, all of which strengthen our economy and country. These employees and companies pay a lot of the 

taxes that sustain our Federal, State, and local governments. Income tax collections from Cargill’s 5,000-person headquarters all by 

itself can equal several hundred million dollars in a single year. 

The U.S. now stands nearly alone as the last developed Nation 

trying to impose tax on the active foreign income of its resident 

companies. We add to it nearly 100 pages of convoluted expense allocation rules that often cause real U.S. expenses to become economically non-deductible. With these added burdens, U.S. companies have to be that much better than their foreign competitors to 

succeed. Some academics have questioned their disadvantage, but 

no tax advisor would ever allow a new global enterprise to have a 

U.S. parent company. 

Many of America’s largest and most important global companies 

are trapped in a system that no advisor would choose and for 

which there are many good alternatives. In response, some have 

proposed trying to bring foreign multinationals into the U.S. tax 

net by taxing them based on place of management. But this would 

only put at risk highly mobile headquarters jobs and all the economic benefits they create for our Nation. We need to invite, rather 

than repel, headquarters jobs from multinationals. 

Some have worried that a territorial system will motivate U.S. 

companies to locate jobs and income overseas to chase lower tax 

rates, but the foreign capital investment and economic growth will 

happen with or without us. We can only attract a strong U.S. investment base through our system of taxing U.S. domestic income, 

not foreign income. 

Academics and policymakers question whether overseas investment by U.S. companies helps or hurts U.S. investment in jobs. 

The answer is interesting, but it is the wrong question. The only 

question is, who gets to manage the capital? It will always be better for American workers when that investment opportunity is won 

and managed by our market-leading U.S. companies. When American companies win, their domestic and global footprint grows and 

our Nation gains a greater share of global income. 

The pace of global development and growth is staggering. Even 

Japan and the U.K. have moved to a territorial tax system to allow 

their people to participate in this growth. Nearly one-third of the 

500 largest companies in the world change every 4 years. We cannot afford to delay. Our Nation needs long-term tax policy that is 

competitive and favorable to both capital deployed here, and to capVerDate Nov 24 2008 21:13 Dec 07, 2012 Jkt 000000 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 R:\DOCS\76892.000 TIMD
10 

ital deployed abroad but managed here. Both types of capital create 

U.S. jobs and growth. 

Congress should adopt a territorial system that is consistent with 

international norms, and, while we figure out overall reform, Congress should extend the controlled foreign corporation (CFC) lookthrough rules and other expiring provisions of our international tax 

laws now to ensure we do not become even less competitive. 

The idea of revenue-neutral corporate income tax reform should 

not be our goal. The burden of corporate tax is borne by some combination of capital providers, customers, and labor, all of whom are 

in the end real-life, flesh-and-blood individuals. Since people bear 

all the tax burdens, the objective for corporate and business tax reform should be distributional equality for Americans as a whole. 

Our tax system should maximize the economic pie that we as a Nation all share. We can then achieve our vision of fairness within 

that system. Thank you. 

Senator HATCH. Thank you, Mr. Naatjes. 

[The prepared statement of Mr. Naatjes appears in the appendix.] 

Senator HATCH. Dr. Avi-Yonah? 

STATEMENT OF DR. REUVEN S. AVI-YONAH, IRWIN I. COHN 

PROFESSOR OF LAW, UNIVERSITY OF MICHIGAN LAW 

SCHOOL, ANN ARBOR, MI 

Dr. AVI-YONAH. Thank you very much, Senator Hatch, and thank 

you, members of the committee. 

I am sorry to have to disagree, but I do not believe that we 

should go to a territorial system. As you pointed out in your opening statement, the United States has traditionally been the leader, 

not the follower, in international tax matters. We were the first one 

to adopt the foreign tax credit; we were the first one to adopt the 

CFC rules. I think we should continue to lead. 

I do not think there is any evidence that U.S. multinationals are 

significantly hampered in their competitiveness by our current set 

of rules. U.S. multinationals have been doing extremely well, both 

recently and before, despite the fact that they now have more global competitors. 

The main reason for that is that, if you look not at our nominal 

rate but rather at an effective rate, U.S. multinationals pay about 

the same effective rate as do our major competitors, and they typically pay a much lower effective rate on the foreign-source income 

than our major competitors, despite the fact that it is true that our 

major competitors have a so-called territorial system and we do 

not. 

The reason for that is that our major competitors’ CFC rules, 

such as subpart F, are much tougher than our subpart F. For example, Japan, which has been mentioned, taxes automatically, with 

few exceptions, every income in a foreign country that is earned by 

a CFC of a Japanese multinational. It is subject to an effective tax 

rate of less than 20 percent. If that rule applied to Cargill or any 

other U.S. multinational, then they would pay much more U.S. tax 

on the foreign-source income. They do not. 

Now, it is true that there is a problem with the particular issue 

of repatriation that has been mentioned repeatedly. U.S. multinaVerDate Nov 24 2008 21:13 Dec 07, 2012 Jkt 000000 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 R:\DOCS\76892.000 TIMD
11 

tionals have a lot of income that is trapped overseas, $1.4 trillion 

according to one estimate, and that might be back on-shore if we 

did not have the 35-percent tax on dividends from active business 

income. 

I think that that is a real problem that is evidenced by the fact 

that they do not bring it back. However, territoriality is not the 

only solution to that. There is another solution, and the solution is 

that we should tax currently all income of all U.S. multinationals 

from the CFCs at the same time that we reduce our corporate tax 

rate dramatically by about 10 percentage points. 

If we do that, then that means that our multinationals will be 

able to compete because they will still face the same overall effective tax rates that our foreign competitors do, except that our foreign competitors pay their 25-percent effective tax rate on the foreign income as well as the domestic income, and others pay 35 percent on domestic income and much less than 25 on foreign income. 

All I am trying to do here is level the playing field. 

In the end, this issue of repatriation has nothing to do with competitiveness. There is no evidence whatsoever that the tax on repatriation affects U.S. multinationals’ competitiveness for the simple 

reason that they do not repatriate. A tax that you do not pay cannot affect competitiveness. Competitiveness is affected by taxes 

that you do pay, and the taxes that you do pay are not higher than 

that of our trading partners. 

Now, just to say a little bit about inbound taxation, which has 

been mentioned. You also mentioned in your opening statement 

that the U.S. now is the world’s leading capital importer. I think 

we do need to pay more attention to inbound taxation. I think 

there is a lot of evidence that foreign multinationals operating in 

the United States underpaid their taxes for access to the American 

market. 

That is because of a variety of reasons. Our earnings stripping 

rules are too lax, we allow full deduction of royalties, we do not tax 

capital gains even in large participations, and our treaty policy is 

even more residence-oriented than the OECD ones. For example, 

we do not have withholding on interest, whereas the OECD model 

does. I think it is high time that we focus more resources on this. 

I think we should amend our inbound rules to, for example, have 

tougher rules on the deductibility of royalties. We should tax capital gains in large participations, such as the sale of T-Mobile by 

Deutsche Telecom to AT&T, which is not taxed either in Germany 

or in the United States under current rules. We should also enhance enforcement of transfer pricing, and, if we abolish the deferral as I suggested before, we could focus all the IRS transfer pricing resources on inbound transfer pricing. 

Finally, I should mention that we should, in my opinion, police 

the line between foreign and domestic multinationals better by 

adopting a management and control standard, which is the general 

standard in the rest of the world. With all due respect to the other 

witnesses, I do not think that this would lead to significant movement of headquarters. If that were true, then under the current 

system all of our competitors should move their headquarters to 

the United States, because currently we do not tax based on management and control, and the other countries do. 

12 

But they do not, and the reason for that is, with all due respect 

to the tax function, normally companies will not put their headquarters where they do based on taxes, they put them based on 

many, many other factors. I do not see any evidence that U.S.- 

based headquarters are not being established because of tax reasons, and I think that, if we do that, then at least we should not 

have this problem, which is the famous double Irish sandwich, 

which has two completely empty companies. That is the way in 

which Google underpays taxes on its foreign operations, and I 

think we should at least deal with that. 

Thank you very much. 

Senator HATCH. Well, thank you. 

[The prepared statement of Dr. Avi-Yonah appears in the appendix.] 

Senator HATCH. Let me ask a question for the entire panel. Now, 

some have raised concerns that moving to a territorial system 

would risk exacerbating transfer pricing issues, which would thereby potentially shift profits and jobs overseas. But it seems that substantially reducing our corporate tax rate, at the same time, would 

go a long way towards mitigating those concerns. 

I mean, presumably, if the U.S. corporate tax rate was more competitive with other countries, there would be less incentive to 

forum shop due to tax rates. Now, I would just like to hear the 

panel’s thoughts on this. Should any change to a territorial system 

be linked to a reduction in the corporate tax rate? 

We will start with you, Mr. West. 

Mr. WEST. Well, there is no question that, if you reduce the U.S. 

rate, you are reducing the incentive to avoid the U.S. tax. That is 

pure logic and common sense as well. Insofar as transfer pricing 

is concerned, our system is a mess. No one likes it. The IRS does 

not like it; taxpayers do not like it. They may not like it for different reasons. Taxpayers may not like it for compliance and administrative reasons, while the IRS does not like it because they 

cannot enforce it well, and the Treasury does not like it because 

they do not think the rules are adequate. 

So I think it is worth rethinking those rules. It is worth revisiting them, and we ought to do that. A territorial system may put 

more pressure on those rules. I do not think we should make the 

perfect the enemy of the good and fail to enact reform because it 

might exacerbate a transfer pricing concern. As you have observed, 

reducing the rate would take pressure off that concern. Would it 

eliminate it? No. Is it still worth looking at those rules? Yes. That 

is my response. 

Senator HATCH. Thanks. 

Dr. Hines? 

Dr. HINES. A lower statutory corporate tax rate would certainly 

reduce the pressures on transfer pricing. I think everybody agrees 

on that. If the question is, is it necessary to have a lower corporate 

tax rate to accompany a move to territorial taxation, I believe the 

answer is no. That is, if it is not possible to lower the corporate 

rate, even though lowering the corporate rate would be a good idea, 

but, if it is not possible to lower the corporate rate, we should nonetheless embrace a territorial tax system, even though it would put 

a little more pressure on the transfer pricing issue. 

13 

We should be wary of letting the transfer pricing tail wag the tax 

policy dog in this context. We should adopt the tax policy that is 

the most sensible. We have sensible transfer pricing rules. The difficulty is that, in application, it is very challenging, and that is why 

there is a problem. If that is the problem, we could adopt a territorial system and increase enforcement at the IRS. It would be 

much better than fearing to adopt a territorial system because of 

potential problems associated with it. 

Senator HATCH. Well, thank you. 

Mr. Naatjes? 

Mr. NAATJES. Yes. Two thoughts on that. First, we have to separate in our minds our domestic system for taxing domestic source 

income and the system for taxing foreign income. The rates we 

choose to implement here, the deductions we allow in our overall 

tax footprint, deal with our competitiveness to attract capital here 

for investment and base investment here. The second tax system 

is for whether or not we can compete abroad in managing the capital abroad. Both have to be competitive, both are important; you 

should separate them in your mind. Both can be done right. 

Now, regarding transfer pricing and the rate differential, we will 

never be able to successfully chase low rates around the world, so 

there is always going to be a difference between foreign tax rates 

in some country and U.S. tax rates. Multinational planning opportunities are vast. 

The question we have to answer is, whom do we want to have 

a transfer pricing battle against? There will always be multinationals. The question is, will they be foreign or U.S. multinationals? If 

our system is non-competitive, we will increasingly see foreign multinationals where we will be the satellite jurisdiction for a subsidiary. 

Foreign multinationals rarely keep their intellectual property 

here, they rarely keep their headquarters here, and most of the 

brains and backbone of the business are kept offshore. Transfer 

pricing rules that follow an arm’s-length standard, at the end of 

the day, will follow where the economics lie, and, if you want to 

have the greatest possible shot at the overall economics, and therefore the most income, you want to have the most multinationals. 

So, having a territorial system gives us the hub and capacity to 

stay strong as a multinational corporate headquarters’ jurisdiction 

and, in the end, will be better for us for transfer pricing disputes. 

Think only of one small thing: just how you get information to have 

a transfer pricing battle. A U.S. multinational has its officers, its 

books and records, all of its foreign companies, subject to all the 

reporting here. All the information you need to engage in the dispute, you have. Matching that abroad would not be easy. 

Senator HATCH. Dr. Avi-Yonah? 

Dr. AVI-YONAH. Well, in this case, I agree with a couple of you 

at least. I agree with Mr. Naatjes that I do not think we can chase 

rates overseas. I mean, the basic problem is, even if we reduce the 

corporate tax rate to, let us say, 20 percent, which is going to be 

very hard, we are dealing with jurisdictions where the corporate 

rates are at zero. There still will be a significant incentive. 

If you look at this structure, as I mentioned before, it is entirely 

built around reducing the shifting of profits from Ireland where the 

14 

tax rate is 12.5 percent, to Bermuda where the tax rate is zero. So 

reducing our tax rate will not eliminate transfer pricing problems. 

I do think, with all due respect, that transfer pricing is the key to 

the issue because, if we adopt territoriality, there will be a significant tendency—not necessarily to shift jobs, as Mr. West says, but 

to shift profits overseas, because, at the moment, the only disincentive to shift more profits overseas is the fact that they cannot be 

brought back home easily without having to pay tax. If we adopt 

territoriality, there would be a significantly increased incentive to 

shift those profits overseas. Thank you. 

Senator HATCH. Thank you so much. My time is up. 

Senator Bingaman? 

Senator BINGAMAN. Thank you all very much. Let me just focus 

on this suggestion that Dr. Avi-Yonah has made here that, regardless of what we wind up doing or not doing in shifting to a territorial system, we should modify the definition of residence for domestic corporations, the suggestion being that that on its own at 

least would be a step forward and would avoid or eliminate some 

of the tax avoidance that currently exists. I would be interested in 

your view on that, Mr. West, and the rest of you as well. 

Mr. WEST. Sure. There is no question that basing the distinction 

between worldwide taxation and source taxation on where you are 

organized is arbitrary. It does not make a whole lot of sense. So, 

the fact that a U.S. corporation happens to have been born here, 

filed its organizational documents here, and is taxed so differently 

than other corporations, seems pretty arbitrary. But we have to assess what the alternative is. 

What is the point of a managed and controlled test? Well, it is 

somewhat less arbitrary, but it is also somewhat manipulable. 

When we think about the three things it is going to do, it was proposed to address initially inversion transactions in which U.S. corporations move outside the U.S. and set up headquarters in Bermuda or Ireland or Switzerland. Those transactions have effectively died because of legislation passed by the Congress, section 

7874, and before that section 367. You do not see a lot of inversion 

transactions any more. It is also aimed at hedge funds and offshore 

funds. 

Our historic tax policy has been to encourage offshore collective 

investment vehicles to invest in the United States and to be managed in the United States. To say now that we want to flip that, 

and, if they are managed in the United States, we want to tax 

those pools of capital, it is really a reversal of our historic posture 

towards those pools of capital, and I would suggest not one that we 

should undertake. 

The third impact of a managed and controlled test would be on, 

as Mr. Naatjes said, large multinational corporations that base significant management here in the United States. If you have a large 

foreign-based multinational that has a large management component here in the United States and that corporation becomes at 

risk of U.S. taxation because their management contingent is too 

large, they are not going to locate those high-value management 

jobs here. I am not sure that is something we want to pursue. So 

is the current rule bad? It is. Is the alternative better? I am not 

sure. 

15 

Senator BINGAMAN. Dr. Hines, did you have a thought on this? 

Dr. HINES. Yes, I do. I think the alternative of adopting a management and control criterion for residency is a bad idea, for two 

reasons, the first of which has been mentioned. The first reason is, 

we should be concerned, if we were to adopt such a system, that 

we would lose management and control jobs, that management and 

control would flee to other countries. Would that happen? There is 

evidence in the case of Great Britain that, when they announced 

a proposal to tighten their CFC rules, British companies began expatriating to Switzerland their management jobs, because they 

have management and control, and to Ireland. 

Britain wound up backing off of the proposed tightening of the 

CFC rules as a consequence. Would that happen in the United 

States? Surely it would. Would that be a quantitatively large phenomenon? There is no evidence that it would be a large phenomenon, but there is no evidence it would be a small one either. 

But that is only the first concern. The second concern is, even if 

no management job moved as a result of adopting this system, so 

all the managers wound up staying put where they are currently, 

it still would be problematic because the companies that were managed in the United States, as a result of adopting the system, 

would wind up smaller and less productive than they would be otherwise. 

The reason is that those companies, if their site of incorporation 

is currently outside the United States but they are managed within 

the United States, would then be subject to U.S. international tax 

rules and, as a result, would be subject to all the problems and distortions we have been talking about today. 

I think it is a mistake to think about the management and control option simply in terms of, will management jobs move. You 

also have to think about, what will be the character of the management jobs that stay in the United States, and will they be managing smaller, less productive companies if you adopt that system? 

The answer is yes, so that is why we should not do it. 

Senator BINGAMAN. I think my time is about up. Mr. Naatjes, did 

you want to make a comment on this? 

Mr. NAATJES. I will just say it is outside international norms. 

Other companies that do management and control, vest that control in a board of directors, and the test is easy to manage. It has 

no teeth, so it would not be consistent with international law for 

us to have a system that was based on who does the operational 

activities of a business day to day. We operate overseas in lots of 

these jurisdictions and know how the rules work. 

Senator BINGAMAN. Thank you, Mr. Chairman. 

Senator HATCH. Senator Grassley? 

Senator GRASSLEY. Mr. Naatjes and Mr. West, financial accounting and tax accounting have two different goals. Financial accounting principles focus on the proper matching of income and expenses 

to provide the most accurate, and generally most conservative, picture of the company’s financial health. 

In contrast, tax accounting generally focuses on reducing the 

company’s tax costs and improving cash flow. I refer to Mr. 

Naatjes’s highlighting the discussion about how effective tax rates 

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16 

ing and tax accounting. Some differences result from a book tax, 

differences in accounting, and for inventory and capital costs. 

I understand that the companies, and countries that have adopted international financial reporting standards are not permitted to 

use LIFO inventory accounting methods. Separately, a reduction in 

tax rates may lead to significant financial statement adjustments. 

So to you two, I would like your thoughts on whether financial 

accounting principles create any disincentives for tax reform, also, 

what, if any, international accounting standards should be considered as we consider tax reform. 

Mr. WEST. Thank you, Senator. A couple of things. As you have 

observed, it is correct that financial accounting tries to achieve a 

different objective than tax accounting, and in many instances 

those two objectives are inconsistent with each other. Financial reporting attempts to conservatively estimate income tax reporting, 

not understate income, and in many cases maximize the amount of 

revenue that is appropriately reported. 

So your ultimate question is, does a calculation based on accounting income accurately reflect taxable income? In many instances it 

would not. We are working with a group of companies—and full 

disclosure, Mr. Naatjes’s is one of those companies—on the question of figuring out what the right measures of income are for this 

public debate. Is it the marginal effective tax rate? Is it the effective tax rate? Is it the statutory rate? We have some academic 

work under way to try to assist, or potentially assist, participants 

in the debate on that question. 

Senator GRASSLEY. Mr. Naatjes? 

Mr. NAATJES. Some have alleged that U.S. taxpayers operating 

abroad do not have a higher effective tax rate, and part of it is, 

what is missed in the data? You have to know a company really 

well to understand its ETR. Another flaw of looking at ETR, when 

looking at international tax reform, is that companies cannot take 

their average rate and use it to compete on a marginal basis. You 

would never go out and buy a municipal bond, and then a regular 

priced bond, and believe that you are getting a blended rate on 

your regular bond. If you stayed in business that way, you would 

go out of business. 

So when I compete in China, the fact that I get a tax incentive 

in Thailand or a section 199 deduction in the U.S. does not make 

me competitive in China. China has to rise or fall on its own competitiveness for Cargill and any investment when you go to make 

it there. So the idea that an overall ETR means you do not have 

a burden is simply a logical mistake. 

Beyond that, for U.S multinationals, because of the Accounting 

Principals Board opinion number 23—which allows us, if we do not 

have a plan to repatriate, to not accrue the U.S. tax—this means 

in some ways our ETRs are always, always understated because we 

bear significant risk of losing that deferral if the rules change, if 

subpart F gets worse, if business exigencies change. All of that is 

contingent. 

Foreign multinationals have a low ETR that is permanent, and 

we can do a lot of work to defend that rate. The idea that the system is not burdensome, I told you before, nobody, no advisor could 

keep their job who would allow a multinational company to form 

17 

a U.S. parent company. There is no tougher jurisdiction to do foreign tax planning in, and saying anything to the contrary means 

you have not been in tax practice. 

So the ETR, it matters. It is evidence of something. It shows 

overall efficiency, but it should not be mistaken for competitiveness 

in any particular country, and it should not be believed that a U.S. 

multinationals’s ETR is the same as a foreign multinational’s ETR. 

Senator GRASSLEY. Thank you, Mr. Chairman. 

Senator HATCH. Senator Cardin? 

Senator CARDIN. Thank you, Mr. Chairman. I appreciate that, 

and I appreciate our witnesses and their views. I also understand 

the strong preference for a territorial tax structure. 

Let me, though, bring us back to some of the considerations that 

this Congress may in fact be looking at. We have seen recommendations come in from Simpson-Bowles and from others that are 

suggesting trying to, within the corporate tax, reduce the rates and 

spread the tax burden, given the fact that we have high marginal 

rates but the effective tax rates are significantly lower. But because 

of the high marginal rates, it acts as a disincentive to American 

companies. 

So, Mr. West, if I could start with you, when you take a look at 

tax expenditures within the corporate code—and we are looking 

solely within the corporate code to flatten things out—do you have 

any suggestions of where we might be able to flatten this code out 

in order to get revenue to reduce rates? 

When I look at the largest tax expenditures, I see section 199, 

which seems to be a very popular provision. Accelerated depreciation—another popular provision—the R&D credit. Do you have any 

suggestions that might be used in order to try to reduce the rates 

by flattening the tax? 

Mr. WEST. Senator Cardin, from the perspective of any particular 

taxpayer, whether reducing the rates in exchange for eliminating 

expenditures is a good or bad idea, of course, depends on what 

those expenditures are, and how they use them, and what the impact is on their particular tax position. As a general proposition, as 

you know, the best tax policy is one that has low rates and a broad 

base, with fewest tax expenditures, the fewest exemptions. 

So, if you wanted to start from a clean slate and say, let us get 

the rate as low as possible and eliminate all the expenditures, and 

you did not shift the burden with respect to a particular company, 

what you would have done is, you would have hewed more closely 

to good tax policy, and you would have simplified the code. Those 

are both laudable objectives. 

Whether, beyond that, you effect competitiveness or revenue raising or economic efficiency depends on whether you are going to 

raise or lose revenue, and whether a particular taxpayer’s taxes are 

going to go up or down. That, of course, is a function of where you 

stand, it is a function of where you sit, and where any particular 

taxpayer is on that can be a function of whether their bill is going 

up or down, to state the obvious. 

Senator CARDIN. Well, I think you sufficiently dodged the question. We are where we are. We are not going to rewrite the corporate tax code and pretend it did not exist before the reform. I 

would just be curious if there are any parts of the tax expenditure 

18 

areas that could produce enough revenue to make a significant reduction in the rates that could get consensus within the business 

community as being something that could help U.S. competitiveness and create jobs. 

Yes, sir? 

Dr. HINES. I cannot speak to what would generate consensus in 

the business community, but coming from the academic community, two of the provisions that you mentioned, the section 199 domestic production activities deduction and the accelerated depreciation that we currently have, are viewed with skepticism. That is if, 

in return for lowering the statutory rate, one were to repeal section 

199 and to repeal the bonus depreciation provisions we currently 

have for large companies investing in equipment, that would be an 

appealing combination. 

Senator CARDIN. Mr. Naatjes, one second. I want to bring you 

into this discussion, because section 199 actually was passed as a 

way to try to deal with the fact that our business taxes were not 

border-adjusted, whereas Europe and Asia have the consumption 

taxes that are border-adjusted. With your experience, would we 

avoid many of these problems if we considered either reducing or 

eliminating our corporate income tax and instead use a consumption-based tax? 

Mr. NAATJES. There is no question that I think almost every 

economist would prefer some form of consumption tax over more income taxes. The effect on an economy of an income tax is almost 

always viewed as negative by economists, so the general proposition that more consumption tax and less income tax is a good 

thing, is true. 

With regard to broadening the base, I have sat with many tax 

directors, and the special provisions that we pass are calculated 

after the year ends in back offices by CPAs for months on end, and 

they hardly motivate anything in corporate board rooms. What 

they do is spawn an industry to capture them, another one to lobby 

for more, and at the end of the day they are not as effective as low 

rates. 

Senator CARDIN. Thank you. 

Dr. Avi-Yonah, I have about 15 seconds. You can take it and respond. 

Dr. AVI-YONAH. Well, I mean, I think if we do the 199 depreciation and abolish deferral and let the Bush tax cuts expire, we could 

reduce the tax rate by 12 points, and that is significant. 

Senator CARDIN. Thank you, Mr. Chairman. 

Senator HATCH. Thank you, Senator Cardin. 

Senator Enzi? 

Senator ENZI. Thank you, Mr. Chairman. A question for Dr. 

Hines and Mr. Naatjes, primarily. Tax reform could have a significant impact on the organizational structure and operations of both 

small and large U.S. multinationals as well as a potentially significant financial statement impact. Given this, it seems prudent to include appropriate transition rules in any tax reform effort. In your 

view, what should this committee take into consideration as part 

of a potential transition plan if we go to the international tax reform? 

19 

Dr. HINES. It depends on the nature of the international tax reform what sort of transition rules you want to adopt, of course. 

There have been various proposals, if we were to move to a territorial system, to think about, how are we going to treat the income 

that has currently accumulated abroad by American companies, 

that was accumulated under the current system where there was 

a reasonable expectation that there would be a heavy tax burden 

upon repatriation. 

The question is, should that currently accumulated income be 

subject to some kind of a tax when repatriated, or perhaps even 

subject to a tax prior to repatriation? One of the difficulties that 

the transition rules encounter is that now you are relying on years 

and years of past tax returns and earnings and profits calculations 

and spreadsheets that go back many decades in some cases. It becomes extremely difficult to apply a transition rule to that income. 

It is not impossible, but it is extremely difficult and challenging. 

I urge the committee to be wary of such proposals. Part of the reason is the difficulty of enforcement, the other reason is that it is 

extremely hard to know exactly what tax burden taxpayers anticipate currently, given their ability to pool income and use worldwide 

averaging. 

So one possibility is to do what other countries have done when 

they have moved to territorial systems, which is just not to have 

transition rules at all, just adopt the territorial system. Many other 

countries have done that. Their fiscs have not fallen apart as a result, and it does seem the most practical alternative. 

Senator ENZI. Thank you. 

Mr. Naatjes? 

Mr. NAATJES. Yes, a couple of thoughts. Number one, I think it 

needs to be tied, whatever we do if we shift to a territorial system, 

the recognition of any U.S. tax on the offshore income has to be 

tied to a recognition event. To simply impose tax on static business 

activity, I do not think, would be fair, and could cause huge economic distortions. 

I think, second, that every other country that I am aware of, 

when they went territorial, simply stopped the system: no more 

credits, no more tax on foreign income, and they just transitioned. 

Today we have to pool our income and credits from 1987 until 

today to try to understand the tax credits attached to a single dividend. The bookkeeping and recordkeeping are unbelievable. 

The adjustments in a little tiny company over a more than 20- 

year period are a huge burden, and to create another layer or another pool would be yet another burden on corporate America. 

Again, I understand the incentive to not let the low taxpayers get 

away Scott-free, but it is a difficult thing to make a transition rule 

that no other country has done. 

Senator ENZI. Thank you. 

I will throw out another question here just for anyone. Several 

countries recently revised their tax systems to provide a preferential tax rate on certain royalty and/or intangible property income. These jurisdictions have referred to this tax incentive as a 

patent box or innovation box regime. 

Would the United States be well-served to implement such a regime to incentivize the exploitation of intangible assets from the 

20 

United States? Would this help to alleviate the transfer pricing 

pressures that some have indicated might result from a movement 

to a territorial tax regime? Do countries that have patent box regimes also have research and development incentives like the R&D 

tax credit? Mr. Naatjes, you are making a lot of notes there. 

Mr. NAATJES. Yes. I think what other foreign countries have seen 

is that, if you do not allow a regular low tax rate on income earned 

in a different foreign country, what you are going to do is motivate 

structuring, and you are not going to collect the tax anyway. 

What they said is, you know what? We understand that we have 

granted the right to country X outside of us to decide how much 

to withhold on or give a deduction for a royalty payment or interest; to try to then capture the excess tax on that is chasing something you will never catch. They said, you know what? Let us instead leave it here. Do not move the intellectual property jobs offshore, do not move the management offshore, do not move the marketing offshore. Leave it here, and we will give you the kind of rate 

you could get abroad so you can keep the jobs. That has been the 

direction of the U.K., the Netherlands, and many countries. 

Senator ENZI. My time has expired. Thank you. 

Senator HATCH. Well, thank you, Senator. 

Senator Wyden? 

Senator WYDEN. Thank you, Mr. Chairman. This has been an excellent panel, and I want to thank all of you. 

Dr. Avi-Yonah, I just want to make sure that I am reading correctly something that you offer up in your testimony. It is at page 

4, and it seems to me what your testimony there is saying is that 

the effective tax rate of many U.S. multinationals on their foreign 

income is lower than that of their multinational competitors. Is 

that correct? 

Dr. AVI-YONAH. That is right. 

Senator WYDEN. All right. So given that—and I think that is exceptionally important—would it be fair to say that, if the Senate 

were to significantly alter deferral, or abolish it as Senator Gregg, 

Senator Coates, and I have done over the last 5 years, that it 

would be possible to use that money to dramatically slash rates for 

all American businesses, multinationals, small businesses, all of 

our businesses. Is that correct? 

Dr. AVI-YONAH. That is exactly what I mean. I think that would 

be an excellent move. I think we should not really favor our businesses that operate offshore against the businesses that operate 

primarily domestically at the moment. Our corporate tax rate is extremely high, and the effective rate on businesses that operate primarily on-shore, that is domestic business, is very, very high as a 

result of that, and we could significantly lower the tax rate for everybody if we tax both of them. 

Senator WYDEN. And in doing so, approaching it that way, we 

could finally set aside all of these gaming kinds of questions, how 

you game the system with transfer pricing. I think all three of you 

who discussed territorial taxation, I have great respect for your 

views. I have always said I am open on this question of a territorial 

system. 

I will tell you, Senator Gregg and I probably spent a gajillion 

hours—and that is barely an exaggeration—trying to figure out 

21 

how to do this territorial question without the gaming, where 

someone generates a sale in one country and books the profit in another. We just could not figure out how to do it. I came away with 

the theory that competitive rates, which means lower rates, solve 

just about all the problems. 

I want to make it clear, I am open to you all in looking through 

these territorial questions, but I think Dr. Avi-Yonah has really, in 

effect, pulled the rock up to really show what is there underground. 

That is, his testimony and the figures that he offers at page 4 that 

show that the effective tax rate of many U.S. multinationals on 

their foreign income is lower than that of their competitors, (A) and 

(B), if we look at the fundamental question here, which is deferral, 

which is the big pot of money, boy, what an opportunity to lower 

rates for American business. Senator Coates and I have come in at 

25 percent. I think we could go lower. That was always the question in 1986. 

Now, there is one other question I wanted to ask of all four of 

you. One of the aspects of the tax debate that troubles me today 

is that virtually everything is temporary. The Wall Street Journal 

had a good piece the other day where they basically said, the only 

thing that is permanent about the American tax system is it is 

temporary. 

I would like to maybe just go down the row. How important, in 

your view, is it that this whole issue of the tax debate now move 

to permanent changes, so as to bring about some certainty and predictability? Because I think if we can get that idea across, even the 

super committee, recognizing that they are not going to be able to 

write a whole tax reform bill in a matter of 6 or 8 weeks, but they 

could get started on it and at least offer the underpinnings so that 

the Finance Committee could pick it up in a bipartisan way, we 

would make some headway if we accepted the importance of now 

making permanent changes. If we do not, my concern is we will 

have the same debate in the lame duck session of the 2012 Congress that we had in the 2010 Congress and talk about the Bush 

tax rates and back and forth, and the like. 

So I guess I have 20 seconds, and I can get this one in. The question of permanence, and how important that is, the certainty, and 

predictability for business investment. 

Mr. WEST. I can be brief: I agree. 

Senator WYDEN. Beautiful. I will quit while I am ahead. 

Dr. HINES. I agree also. One of the costs of the temporary stuff 

is that you are discouraging business activity and you are not generating any revenue. As a result, people are just worried about the 

future. 

Mr. NAATJES. It creates a lot of planning to decide how to react 

to things that may change or may not change, and it wastes corporate resources. It is a huge issue, but being fast and making it 

worse could be worse still. 

Senator WYDEN. Put me down as being against doing dumb 

things at any point. 

Dr. AVI-YONAH. I agree with all of the above. 

Senator WYDEN. All right. 

Thank you, Mr. Chairman. 

Senator HATCH. Thank you, Senator. 

22 

Senator Nelson? 

Senator NELSON. Thank you, Mr. Chairman. 

When trading partners such as China offer tax holidays, and 

some tax havens in the Caribbean basically do not tax multinational companies, is this a game that we can still play and win 

in which we have to compete on tax rates and incentives with 

places like the Cayman Islands, Monaco, and other tax havens? 

Yes, sir? 

Dr. AVI-YONAH. I do not think we can compete with the Cayman 

Islands. I do not think we should compete with the Cayman Islands. I do not think we offer the level of services that the Cayman 

Islands does. I do think we should compete with places like China, 

India, and Brazil. It is inaccurate to say that China offers a lot of 

tax holidays. China abolished most of the tax holidays. They tax 

their multinationals with CFC rules that are tougher than our 

rules. They have a significantly lower corporate tax rate than ours, 

and that is important. 

Brazil, on the other hand, has a higher rate than ours, and they 

do not have deferral at all, and they have been managing to grow 

very nicely. So does India. So, in that sense I think that those are 

our real competitors. I think that it would really be helpful if we 

reduced our corporate tax rate to more or less where the average 

rate now is, both in the OECD and in the large and growing developing countries. But we cannot compete with the Cayman Islands. 

Mr. NAATJES. We make a mistake when we think about tax burden in terms of income tax only. Every country extracts from every 

multinational and business what it needs to fund itself. Most countries rely on indirect taxes, and multinationals play a huge role in 

that and bear a heavy burden. 

So, when you see a tax holiday, you will also almost always see 

a major corporation building its own roads and bridges, being the 

withholding agent for the government, and bearing almost all the 

risk of doing everything correctly, or losing almost everything on 

audit. So, the burdens are large when you see an under-developed 

country with a tax holiday. You are not chasing rates, you are 

chasing growth. 

With regard to the Cayman Islands, people are not doing the active operations there, so the idea of a territorial system largely 

does not touch that. Multinationals today only use those as a place 

to block and defer U.S. taxation of already active earnings. 

So it is not that we are making money in the Caymans, it is the 

money that we made in China, Germany, and Brazil that is sitting 

in the Caymans, so U.S. tax is not collected on it. But we could just 

as easily use Spain, the Netherlands, Luxembourg, the U.K., Canada; all those holding company structures would also impose no 

tax. The point is, they have territorial regimes. The islands are 

simply easier than going to a country and having to incur more 

costs, but we could. 

Dr. HINES. Every time a foreign country offers an American company a tax holiday, I am happy. The reason I am happy is that it 

is a lower cost for Americans to do business in some place. We do 

not want foreigners to impose heavy taxes on Americans; we benefit if the taxes are lighter, because it makes companies more profVerDate Nov 24 2008 21:13 Dec 07, 2012 Jkt 000000 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 R:\DOCS\76892.000 TIMD
23 

itable and it lowers the foreign tax credits that they claim, and it 

is a big win for the United States. 

So, tax holidays, per se, as offered by foreign governments, are 

not a bad thing. The question, Senator, that you addressed is, how 

should we think about this in a competitive framework? The 

United States has to be competitive. We cannot ignore what the 

rest of the world is doing. A country like the Netherlands has a 

very competitive tax system, and as a consequence there are a lot 

of Dutch businesses doing competitive business around the world. 

Should we think in terms of, how is our tax system stacking up 

to that of the Netherlands, Canada, India, Brazil, and other countries? Absolutely, we should. We are always going to have a different system than these very small islands, like the Cayman Islands. It is just a totally different economy in a place like that. But 

from the standpoint of the United States, look over your shoulder 

at Canada and the Netherlands. Look at what they are doing. We 

need to think hard about that. 

Mr. WEST. We cannot, and should not, chase the Cayman Islands 

rate. But the question of how multinationals use tax havens, as alluded to by Mr. Naatjes, is a complex question, and largely they 

are not doing anything other than what the laws enacted by Congress allow them to do. It is dangerous to look at this issue simplistically. 

What we should do with the staffs, who are excellent, is to sit 

down and figure out how they are used, why they are used, and 

whether that is a problem, and, if it is a problem, how to address 

it. But, on the one hand, we should not be chasing their rate, and, 

on the other hand, I think there is a perception that, if a tax haven 

is there, something illicit and illegitimate is going on, and we need 

to look more closely at how they are used. 

Senator NELSON. Mr. Chairman, I have one second left, and I 

just want to get on the record the question that we should be concerned that we develop intellectual property in this country and 

then it is transferred in its ownership to wholly owned subsidiaries 

in tax havens of low-tax jurisdictions and what we should do about 

it. That is my question I want to put on the record. 

Senator HATCH. Well, thank you, Senator. 

Senator Thune, we will go to you. 

Senator THUNE. Thank you, Mr. Chairman. I want to thank our 

panel today for their good answers to some complicated questions. 

We obviously want to figure out how to get this right and move to 

a system that makes us competitive in the world, and I think that 

is the goal everybody has here. Obviously today I do not think we 

are. I think the tax systems of our competitors around the world 

have moved away from us and have put us at a competitive disadvantage. 

I want to direct this question to Mr. Naatjes, if I might. In your 

testimony, you described the global reach of a company like Cargill 

and the advantages that you bring to U.S. agricultural producers 

by being on the ground in markets around the world. Could you describe how your company helps farmers in places like South Dakota that produce large quantities of commodities such as wheat, 

soybeans, and corn, how what you are doing there helps them access global markets? 

24 

Mr. NAATJES. Cargill has a footprint wherever food is produced 

and consumed, and it is all over the world. Access to knowledge 

and intelligence related to that helps us understand global commodity markets. It helps us move all the commodities and goods 

that feed the world to the right place at the right time, to ensure 

that the cost of food is reasonable for people, and efficient. All that 

helps efficient farmers and great growers find markets for their 

commodities and crops and the food that comes from them. 

Senator THUNE. And what would a more favorable U.S. tax environment mean to these farmers? 

Mr. NAATJES. I think in every case where you see efficiency 

growing, where you see the best owners of foreign assets owning 

those assets of production, you will find greater efficiency for all 

players in the market. But what you are going to get with the right 

company owning the right investments globally is better economic 

outcomes for the globe, for producers, for consumers, for everybody 

who is touching those industries. 

Senator THUNE. As you know, our tax system, I think, was designed at a time for a world really where our U.S. companies were 

largely competing against other U.S. companies. Who are your 

major competitors today, and are they U.S. or foreign-based? What 

will a tax system that you describe as putting you at a competitive 

disadvantage in the global marketplace mean for Cargill over the 

long term? 

Mr. NAATJES. Cargill has a tremendous global footprint and 

great know-how. We compete well with our burdens. I model our 

burdens deal by deal, country by country as we spread around the 

world. I have a 240-person tax department, very sophisticated lawyers and accountants who try to figure out the U.S. burden for the 

expense allocation rules, and our deferral. I am telling you, it costs 

a lot of money. Everywhere we go, we have a major impediment to 

how we compete. 

Companies have sprung up in places like Asia that did not exist 

only 20 years ago, that are larger than us today, in their overall 

footprint. Are we competing still and winning sometimes? Yes. But 

to give you a sense of some of our competitors: Wilmar, organized 

in Singapore; Bunge, organized in Bermuda; Glencore, organized in 

Switzerland; Noble, organized in Hong Kong; and Tate and Lyle, 

organized in the U.K. with a territorial system. We also have ADM 

organized here, and Unilever. So we have competitors. Some are 

still in worldwide systems, but for the most part they are territorial, and they have very low effective tax rates. 

Senator THUNE. If investments are going to be made in developing economies in order to capture the growth in these markets, 

why does it matter if these investments are made by U.S. or foreign companies? 

Mr. NAATJES. It makes a huge difference. So, if you imagine the 

difference between Cargill’s footprint and Cargill’s headquarters, 

and, if we grow and spread—I told you we have 5,000 people in our 

headquarters offices. The charities they sustain, the taxes they pay, 

the society they develop is what builds places like Minnesota and 

the surrounding communities; the people they hire, the people that 

support them, it makes the economy thrive. 

25 

Winning around the world gives us the intelligence to compete in 

other places and grows our synergies. So, if we are the best owner 

for a crush plant in Paraguay to harvest and help bring the soybeans to market from Paraguay, then you want Cargill there. 

Nothing could be better for America than having us do it rather 

than a company organized in a different place without the headquarters here and without the jobs. 

Senator THUNE. Yes. 

Mr. Hines, in your testimony you made some interesting points 

about who really bears the burden of high U.S. corporate tax rates. 

You stated that in today’s economy where capital is very mobile, 

it is labor that actually feels the burden of taxation the most. You 

also state that workers benefit the most from a system that taxes 

businesses efficiently. Could you just expand upon that a little bit? 

Dr. HINES. Sure. The reason that works is that, because capital 

is so mobile internationally, not just American capital, but German, French, Dutch, everybody’s, the capital is going to get its rate 

of return regardless of where it invests. If the United States has 

a really high tax rate, there will be less investment in the U.S. to 

the point where capital can earn its necessary rate of return. But 

the consequence of less investment to the United States is that 

workers will be less productive, and their wages will fall. 

The thing that makes up the difference for the companies, the 

thing that keeps any investment in a high-tax place, is that wages 

wind up falling as a result and therefore businesses can break even 

or turn a small profit. But the theory clearly states that, in an environment of mobile international capital, workers wind up bearing 

the burden of business taxes. There is as well empirical evidence 

to support that. 

Senator THUNE. Thank you. 

Thank you, Mr. Chairman. 

Senator HATCH. Thank you, Senator. 

Senator Carper? 

Senator CARPER. Thank you, Mr. Chairman. 

Gentlemen, welcome. Thanks for being here today and sharing 

your thoughts with all of us. I missed your testimony. We have 

been having a separate—we call it a mark-up—on the Environment 

and Public Works Committee on an extension of the transportation 

program for our country, so I missed what you had to say. I gather 

that there are some things you agree on, and maybe some things 

you do not. 

One of the things that I look to on a panel like the one assembled 

here is, we have smart people who have some good ideas to share 

with us. I always look to see where you agree, and are there some 

major points of agreement on which there is unanimity? If so, what 

are they? 

Dr. AVI-YONAH. I think we all agree that we should reduce the 

corporate tax in the United States. The 35-percent rate is too high 

by international norms. I do not think anybody on the panel would 

disagree with that. 

Senator CARPER. All right. Thank you. Well, that is a good starting point. 

Mr. NAATJES. I think everyone is agreed as well that flattening, 

again, the basic base and making sure that special exemptions are 

26 

out and making the rate as low as possible actually provides the 

greatest business motivation and does the best good for America 

and its workers. 

Senator CARPER. All right. 

Dr. HINES. I am hopeful that in time we will come to agree that 

a territorial system is the best system, but we have not agreed on 

that yet today. 

Mr. WEST. A little commercial announcement. I would refer you 

to an article which I published recently in which I have probably 

15 or 20 points that I think are generally broadly agreed on. The 

problem is, they conflict with each other in many cases. But they 

are broad areas of agreement, and I will send you a copy of the article so you have it, Senator. 

[The article appears in the appendix on p. 74.] 

Senator CARPER. All right. Thanks. 

I understand that my wingman here, Senator Cardin, spoke earlier to maybe ask you a question regarding a value-added tax, 

which he has some interest in. Professor Graetz who sat, I think, 

right about where you are sitting this morning, he was here a couple of months ago and spoke in favor of moving in that direction 

and called for lowering corporate and individual rates, but also trying to make sure that there is some progressivity that remains, at 

least on the individual income side. 

Senator Cardin may have asked you to share your views on that 

approach. I would ask you, whether you did or not, about the compatibility of that approach embraced by Dr. Graetz with the territorial approach. Are they compatible, incompatible? How can they 

be reconciled? 

Dr. AVI-YONAH. It seems to me that they are separate issues, because certainly I am in favor of the value-added tax. I think every 

other developed country—most other developing countries in the 

world—have the VAT. We are really the only OECD member that 

is left without one. It is a very efficient tax. It is a great tool of 

revenue collection, and it would enable us to reduce the burden on 

businesses and on individuals. 

It has been suggested, for example, that if we had a 15-percent 

rate VAT, we could reduce the corporate and individual top tax 

rates to 15 percent altogether, which is a pretty radical move. That 

would be even better than the 1986 Tax Reform Act. But I think 

that it is a separate issue than this question of a territorial tax system, although, in my opinion, if we had a 15-percent corporate income tax rate, nobody would seriously argue that we are not competitive, even if we taxed worldwide income of our multinationals, 

and that would be a significantly simplifying move. 

Senator CARPER. All right. Thanks. 

Others, please? 

Mr. NAATJES. Again, international norms would dictate that you 

have a territorial system and a VAT, so they are consistent. It has 

been done by many. Economists support a VAT for all the reasons 

you have heard from Professor Graetz. I think it is consistent with 

what our trading partners do, so it equalizes the tax burdens our 

goods bear when they cross borders. Overall for the economy, 

again, it is the way foreign countries collect tax and defend their 

27 

tax base. They do not tend to worry about the income taxes much; 

it is a much smaller revenue source for them. 

When you deal with new U.S. lawyers and send them into a big, 

multinational company, they have this tragic flaw of always doing 

income tax planning. But it is the VAT that is most of the burden, 

and most of the rate, and most of the issues going on around the 

world everywhere else. 

Senator CARPER. All right. Thank you. 

Dr. HINES. A VAT has enormous appeal. More than 140 countries 

have value-added taxes; of course the United States does not. We 

are the only—— 

Senator CARPER. Why do you suppose not? 

Dr. HINES. Well, that is because we have not legislated one, and 

we should. There were no VATs until the late 1950s, and, depending on your definition, the mid-1960s. We just have not caught up 

with the times, and we need to. The VAT and territorial taxation, 

I agree with Dr. Avi-Yonah, are conceptually separate, however 

they share the feature that they are both the kind of tax that a 

country that is worried about competitiveness would adopt. If you 

are worried about competitiveness, you want a value-added tax and 

you also want a territorial system, but you could have one without 

the other. 

Senator CARPER. All right. Thank you. 

Please? 

Mr. WEST. I agree with what everyone has said. At some risk, 

when you ask why we do not have one, I think it was Professor 

Graetz who made the observation that we do not have one because 

Democrats think it is regressive and Republicans think it is a tax 

increase, and we will get one when Democrats realize it is a tax 

increase and Republicans realize it is regressive. 

Senator CARPER. That is a good note to end on. Thank you. 

Senator HATCH. Well, I can tell you why I do not want it: it is 

because it just becomes a big government money spending machine, that is why. But I am very interested. I would be happy to 

read materials from any of you who would care to tell me why a 

value-added tax should work better than tax reductions and 

spreading the base and keeping revenue neutral and so forth. But 

I am not very enthusiastic about value-added taxes, to be honest 

with you. I am very interested that these experts are, so maybe I 

am missing something here. 

Senator CARPER. When people this smart actually agree on something, we ought to drill down on it and listen to them. 

Senator HATCH. Well, I know a lot of smart people do not agree, 

too. 

Senator CARPER. I am sure that is true. 

Senator HATCH. With that statement, I think we will end this 

hearing. Thank all of you for excellent testimony here today. I really have enjoyed listening to all of you. Each of you deserves a lot 

of credit for the intelligence that you have, and the ability to explain these matters to us lesser mortals up here on the committee. 

Thank you so much for being here, and we appreciate your testimony. 

We will keep the record open for questions to be submitted and 

for anything you would care to submit to the committee that would 

28 

help us to understand these matters better. I have certainly enjoyed all of you and appreciate what you have done. Thanks so 

much. 

With that, we will recess until further notice. 

[Whereupon, at 11:02 a.m., the hearing was concluded.] 

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