CONGRESS OF THE UNITED STATES

CONGRESSIONAL BUDGET OFFICE

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Options for Taxing 

U.S. Multinational 

Corporations

JANUARY 2013
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Notes

Unless otherwise indicated, the years referred to in this report are federal fiscal years, 

which run from October 1 to September 30.

Numbers in the text and in tables may not add up to totals because of rounding.

Pub. No. 4150
Contents

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Summary 1

Current Federal Tax Treatment of U.S. Multinational Corporations 1

Policy Options 2

Two Basic Approaches to Taxing Multinational Corporations 3

Federal Tax Treatment of U.S. Multinational Corporations 4

The Federal Corporate Income Tax 4

U.S. Rules for Taxation of Income Earned Abroad 5

Effects of the Federal Tax Treatment of U.S. Multinational Corporations 11

Location of Investment 12

BOX: TAX HAVENS 13

Profit Shifting 14

Budgetary Effects of Decisions About Location and Profit Shifting 16

Policy Options 17

Move More Toward a Worldwide Approach 20

Move Toward a Territorial Approach 21

Other Options 24

Appendix: Corporate Tax Rates 29

List of Tables and Figures 32

About This Document 33
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Options for Taxing 

U.S. Multinational Corporations

Summary

In 2008, 12 percent of all federal revenues came from 

corporate income taxes; about half was paid by multinational corporations reporting income from foreign 

countries.1

 How the federal government taxes U.S. 

multinational corporations has consequences for the 

U.S. economy overall as well as for the federal budget. 

Tax policies influence businesses’ choices about how and 

where to invest, particularly as corporations assess 

whether it is more profitable to locate business operations 

in the United States or abroad. The tax laws also can 

create opportunities for tax avoidance by allowing multinational corporations to use accounting or other legal 

strategies to report income and expenses for their U.S. 

and foreign operations in ways that reduce their overall 

tax liability. U.S tax revenues decline when firms move 

investments abroad or when they strategically allocate 

income and expenses to avoid paying taxes here.

A country can take two general approaches to taxing the 

income of corporations that operate both domestically 

and abroad: 

 Under a worldwide approach, the home country 

considers all of the income of its multinational corporations to be taxable, regardless of where that income 

is earned. But to avoid taxing income twice—in the 

home country and in the country where it is earned—

a country would generally allow multinational 

corporations to claim a foreign tax credit against 

domestic tax liability for taxes paid elsewhere. 

 Under a territorial approach, the home country taxes 

only the income earned within its borders. 

No major developed country has adopted either approach 

entirely. Although many developed countries use a more 

territorial approach, the system in the United States 

leans toward a worldwide approach, but one that allows 

multinational corporations to defer or, in some cases, 

completely avoid paying U.S. taxes on some income they 

earn abroad. 

This study examines policy options that could move the 

United States closer to one system or the other, along 

with several approaches to addressing particular concerns 

about the current system of taxation. All would affect 

multinational corporations’ investment strategies and 

reporting of income as well as U.S. revenues from 

corporate income taxes.

Current Federal Tax Treatment of 

U.S. Multinational Corporations

The U.S. government taxes both the domestic and the 

foreign income of businesses that are incorporated in the 

United States and that operate abroad. Often, such corporations also must pay income taxes to their foreign host 

countries. At the national level, the top corporate tax rate 

in the United States (the statutory tax rate on income in 

the highest bracket) is 35 percent. When combined 

with state and local corporate taxes, that rate rises to 

39 percent—higher than that in any of the other 34 

member countries of the Organisation for Economic 

Co-operation and Development (OECD). Weighted by 

gross domestic product (GDP), the average statutory rate 

among OECD countries in 2011, excluding the United 

States, was about 19 percent. 

1. That year is the most recent for which detailed data are available. 

Since then, receipts from corporate income taxes have accounted 

for a smaller share of federal revenues—ranging from 7 percent in 

2009 to 10 percent in 2012.
2 OPTIONS FOR TAXING U.S. MULTINATIONAL CORPORATIONS JANUARY 2013

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Although the U.S. system is generally more worldwide 

than territorial, two important features of its tax system 

depart from the worldwide approach. First, a purely 

worldwide tax system would ensure that firms faced the 

same tax rate no matter where they operated. If the 

United States were to have such a system, it would not 

limit the credit granted to firms for the total taxes paid 

abroad, regardless of whether those taxes exceeded the 

domestic liability on the income. Under the U.S. system, 

however, the largest credit a corporation may take is one 

that matches the amount the firm would pay in U.S. 

taxes on the same income. Thus, U.S. corporations that 

operate in countries that tax at a higher rate than the 

United States does must pay the foreign tax rate on that 

income. Second, companies can defer U.S. taxes on 

income earned abroad by their subsidiaries until that 

income is remitted (or “repatriated”) to the U.S. parent 

company, thus allowing some foreign income to escape 

U.S. taxation—at least temporarily. 

Those features of the U.S. tax system affect U.S. multinationals’ decisions about whether and how to invest at 

home and abroad. The current tax system provides incentives for U.S. firms to locate their production facilities in 

countries with low taxes as a way to reduce their tax liability at home. Those responses to the tax system reduce 

economic efficiency because the firms are not allocating 

resources to their most productive use. Those responses 

also reduce the income of shareholders and employees in 

the United States and they lead to a loss of federal 

tax revenue. In addition, those investment decisions may 

initially result in more unemployment in this country. 

Over time, however, as the economy adjusts, other jobs 

are created and total employment would not be significantly affected. But as a result of such decisions, in the 

long run, total compensation for U.S. workers is lower, 

and employment may be concentrated in different 

industries and regions.

The current system also creates incentives to shift 

reported income to low-tax countries without changing 

actual investment decisions. Such profit shifting erodes 

the corporate tax base and leads to wasted resources for 

tax planning.

Policy Options

The options presented in this report are targeted at 

several areas of concern about the effects of the U.S. tax 

system on the flow of investment outside the United 

States and the reporting of U.S. corporate profits. Some 

options are broad, designed generally to address the flows 

of U.S. investment to other countries. Other options are 

narrower, addressing tax avoidance by U.S. firms that 

strategically allocate reported income and expenses 

between their U.S. and foreign operations. Some options 

would result in a more efficient allocation of resources 

among countries and also would impede the ability of 

corporations to avoid paying U.S. taxes; others would 

achieve just one of those two goals and could in fact make 

it more difficult to achieve the other.

A Worldwide System. Options that would move the 

United States closer to a purely worldwide tax system—

by eliminating or curtailing deferral of U.S. taxes on 

income earned abroad—would dampen incentives to 

shift investment or reported income on the basis of concerns about tax liability. As a result, those options would 

generally lead to more economically efficient business 

investment and increase corporate tax revenues from 

firms that remained incorporated in the United States. 

But moving closer to a purely worldwide system also 

would strengthen the incentive for U.S. firms to incorporate, or register, abroad or to be acquired by or merge 

with foreign companies. Such a response probably would 

not increase the efficiency of investment decisions, and it 

would reduce the corporate tax base. On balance, however, eliminating deferral would boost both efficiency and 

tax revenues. In fact, eliminating deferral entirely would 

boost U.S. tax revenues by more than $100 billion over a 

10-year period, according to an estimate by the staff of 

the Joint Committee on Taxation (JCT); that would be 

the largest revenue increase attributable to any of the 

options discussed in this report. 

A Territorial System. Alternatively, the United States 

could move toward a territorial system—for example, 

by exempting some income earned abroad from U.S. 

taxation or by taxing domestic income only but using a 

formula that considered the location of a company’s 

activities to determine the sources of its income. Such 

policies could result in a less efficient allocation of 

resources among countries by increasing incentives to 

shift business operations and reported income to countries with lower tax rates. Nonetheless, some options for 

moving toward a territorial tax would increase U.S. tax 

revenues by restricting the ability of multinationals to 

shield some income from U.S. taxation and by preventing 

them from deducting costs incurred abroad from income 

earned in the United States.
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Other Options. Some options would restrict corporations’ 

ability to use excess foreign tax credits, which are generated by income earned in countries where taxes are higher 

than they are in the United States. Under current law, a 

business can use those credits to offset U.S. taxes on 

income that is repatriated from low-tax countries, effectively decreasing the U.S. taxes they pay on foreign 

income and increasing their incentive to invest abroad. 

Thus, restricting the use of excess credits could increase 

federal tax revenues and reduce the incentive to invest 

abroad. Such a restriction, however, might push some 

firms to take greater advantage of provisions that allow 

deferral of taxes on income that is earned—and 

retained—abroad. The net effects of such a restriction on 

investment and repatriation of income are unclear, but it 

could increase U.S. tax revenues.

Other options would produce more incremental changes, 

generally limiting opportunities for corporations to shift 

reported income abroad and thus increasing the amount 

they must pay in U.S. taxes. Those options would treat 

entities and recognize income in a more consistent way 

across jurisdictions. One disadvantage is that such 

options also would strengthen incentives for shifting 

investments instead of just shifting reported income. 

However, such options are fairly narrow, and the overall 

effect on the location of businesses’ investments would 

probably be small. 

Two Basic Approaches to Taxing 

Multinational Corporations

Multinational corporations are businesses that incorporate and operate in one country (in this report called 

the home country) but that also maintain operations of 

various kinds in other countries (called host countries). 

Multinational corporations operate abroad for many reasons, including favorable tax laws, but they also do so to 

gain access to foreign markets, to employ a less costly 

labor force, and to obtain materials that are less expensive 

than those available at home. 

There are two basic approaches to taxing the income of 

multinational corporations: the worldwide approach and 

the territorial approach. Under the first system, multinational corporations are taxed by the home country on 

their worldwide income without regard to where it is 

earned. Countries that adopt such an approach generally 

also provide for credits or deductions for taxes paid to 

host countries. At the other end of the spectrum, under 

the territorial approach, the home country taxes only the 

income that is earned within its borders, and it imposes 

no tax liability for any income earned abroad. 

Each approach has different implications for the tax rates 

multinational firms face on income earned in foreign 

countries. If a country adopted a worldwide tax system 

with no limits on the size of its foreign tax credit (even if 

the foreign taxes exceeded domestic tax liability on the 

income), then all corporations’ income—whether earned 

at home or from investments abroad—would be taxed at 

the home country’s rate. 

Under a territorial system, by contrast, multinational 

corporations’ tax liability would depend on the rate set 

by the host country, and the only way to ensure that all 

of a country’s multinational corporations faced the same 

tax rate—regardless of the source of their income—

would be to have a universal, territorial tax system under 

which all countries treated multinational firms the same 

way—that is, having the same tax base and rate structure. 

How a home country taxes foreign-earned income can 

affect businesses in a significant way: Because many other 

countries in which such firms operate also tax income 

earned within their borders, business managers must 

decide whether investing abroad would he worthwhile, 

given the prospect of paying additional U.S. taxes on that 

same income. 

Different countries take different approaches to and have 

different systems for taxing income earned abroad. No 

major developed country has adopted either a completely 

worldwide or a completely territorial tax system. Instead, 

many have developed what are essentially hybrid systems 

that incorporate significant aspects of both approaches. 

The U.S. tax system leans toward a worldwide approach; 

it imposes taxes on multinational corporations’ foreign 

income but allows those businesses to claim deductions 

or credits for the taxes they pay abroad. Multinational 

corporations also can defer or, in some cases, completely 

avoid paying U.S. taxes on some income earned abroad. 

Deferral and some other mechanisms make the U.S. 

system territorial in some respects.

In contrast, most member countries of the Organisation 

for Economic Co-operation and Development take a 

largely territorial approach by exempting certain 

foreign-earned income from taxation (by means of what 

is often called an exemption system). Some of those
4 OPTIONS FOR TAXING U.S. MULTINATIONAL CORPORATIONS JANUARY 2013

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Table 1.

Progressive Structure of U.S. 

Corporate Income Tax Rates, 2012

(Percent)

Source: Internal Revenue Service.

a. The excess tax offsets the benefit of rates below 34 percent for 

income in the range between zero and $75,000.

b. The excess tax offsets the benefit of rates below 35 percent for 

income below $10 million.

countries also have “anti-abuse” rules that govern the 

type and source of foreign income that can be exempted 

from taxation, reducing the ability of firms to take unfair 

advantage of a territorial tax system by shifting the 

location of income.2

 France, for example, disallows 

exemptions for income earned in countries whose corporate income tax rates are at least 50 percent below its own. 

Germany taxes income earned in any foreign country 

where the tax rate is less than 25 percent, and it taxes all 

foreign income from certain types of business activities. 

Under Italy’s anti-abuse rules, a “blacklist” prevents 

income earned by Italian multinational corporations 

in some countries from receiving an exemption from 

taxation at home. Strong anti-abuse rules can result in 

systems that effectively tax foreign income in a way that 

is much closer to a worldwide approach.

Federal Tax Treatment of 

U.S. Multinational Corporations 

The amount of taxes that U.S. multinational corporations pay depends on several factors. As is the case for 

domestic corporations, multinationals are assessed corporate income taxes on earnings that exceed their expenses. 

Although those expenses can include taxes, current law 

generally provides for a system of credits for taxes paid to 

foreign governments that allows those companies some 

relief from what would amount to double taxation of that 

income. 

The U.S. system allows multinational corporations to 

combine credits for taxes paid to more than one foreign 

country; in 2008, those credits amounted to about 

$100 billion. Moreover, payment of U.S. taxes on foreign 

income can be deferred until the income is repatriated to 

the United States. Because of such deferral, the corporation’s total tax liability is effectively reduced if the taxes 

paid to another country are less than the amount the 

United States would levy on the same income. 

The Federal Corporate Income Tax 

The U.S. corporate tax system defines income broadly to 

include revenues from sales, interest, dividends, capital 

gains, royalties, and rents. To compute taxable income, 

corporations subtract business expenses (including the 

costs of goods sold, depreciation, advertising expenses, 

and interest payments) from their total income. Although 

corporations are allowed to deduct the interest they 

pay to bondholders, they cannot deduct dividends paid 

to shareholders; such dividends are subject to the 

individual income tax as well. 

In general, corporations’ federal income tax liability is 

computed according to a progressive structure starting at 

15 percent for the first $50,000 of taxable income 

and rising to 35 percent on income above $10 million 

(see Table 1). Income between $100,000 and $335,000 

is subject to an additional tax of 5 percent (raising the 

effective rate from 34 percent to 39 percent), and an 

additional 3 percent tax is assessed on income between 

$15 million and $18.3 million (raising the effective rate 

from 35 percent to 38 percent). For corporations with 

income in those ranges, such “excess taxes” effectively 

offset the benefit of the three lower tax rates. Although 

the excess taxes yield a higher tax rate over some income 

ranges, most corporations’ income is taxed at the 35 percent rate (the statutory rate that applies to income in the 

highest tax bracket). 

It is often noted that the top rate set by U.S. law—

35 percent (or 39 percent, on average, once state and 

local corporate taxes are included)—is among the highest 

for developed countries. However, other features of the 

2. Such rules are sometimes called CFC rules because they apply to 

income from controlled foreign corporations. For a comparison of 

various national tax systems, see Joint Committee on Taxation, 

Background and Selected Issues Related to the U.S. International 

Tax System and Systems That Exempt Foreign Business Income, 

JCX-33-11 (May 20, 2011), http://go.usa.gov/gPrJ. 

Over But Not Over

0 50,000 15 0 15

50,000 75,000 25 0 25

75,000 100,000 34 0 34

100,000 335,000 34 5 a 39

335,000 10,000,000 34 0 34

10,000,000 15,000,000 35 0 35

15,000,000 18,333,333 35 3 b 38

18,333,333 — 35 0 35

Income Range (Dollars) Corporate

Tax Rate

Excess Total

Tax Rate

Statutory
JANUARY 2013 OPTIONS FOR TAXING U.S. MULTINATIONAL CORPORATIONS 5

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U.S. tax code, such as credits and preferential rates, effectively lower the tax rates. (The appendix describes U.S. 

corporate tax rates and compares them with those of 

other countries.)

U.S. Rules for Taxation of Income Earned Abroad 

Two important features affect the U.S. tax treatment of 

foreign income. First, the foreign tax credit is limited to 

the amount of U.S. taxes a corporation would pay here 

on its income from foreign sources; a corporation may 

not take a credit on its foreign income that is larger, in 

the aggregate, than its U.S. tax liability is for that income. 

Second, payment of U.S. taxes on income earned—and 

kept—abroad can be deferred until the income is 

returned to a U.S. parent corporation. That feature adds 

a territorial aspect to the U.S. tax system in that foreign 

income receives preferential treatment. Other provisions 

and regulations (discussed later in this report) also 

contribute to a partially territorial approach.3

Under the U.S. system, taxation of foreign income is 

affected by a corporation’s structure. In some cases, multinationals operate abroad through branches that act as 

extensions of their U.S. parent companies; their foreignearned income is considered the legal income of the U.S. 

parent company and thus is taxed as it is earned. In other 

cases, corporations establish subsidiaries that incorporate 

as separate entities abroad. For those businesses, the parent corporation owns shares in the subsidiary and receives 

income in the form of dividends, which are not subject 

to U.S. taxation until the money is returned to the U.S. 

parent. A common type of subsidiary, the controlled foreign corporation (CFC), is incorporated abroad and has a 

majority of its stock owned by U.S. shareholders.4

Limits on Foreign Tax Credits. When the corporate 

income tax was established in 1909, lawmakers allowed 

businesses to claim a deduction for taxes paid on income 

earned abroad. A tax deduction, however, only offsets a 

share of foreign taxes.5

 That tax deduction was later 

converted to a tax credit, with no limits on the amount 

received, ensuring that income from foreign operations 

would not be taxed twice. With an unlimited credit, 

businesses that operated in countries where tax rates were 

higher than those of the United States received a tax 

credit that exceeded the U.S. tax on their foreign income 

and thus could use the excess credit to offset the U.S. tax 

on their domestic income. By comparison, businesses 

operating in low-tax countries paid the full U.S. tax on 

their domestic income. An unconstrained credit also provided an implicit U.S. subsidy of foreign governments: A 

portion of the taxes paid to those governments was in 

effect paid by the U.S. government in the form of forgone revenues. In response to those concerns, in 1921, 

lawmakers capped the foreign tax credit. 

Under current law, the credit cannot exceed the amount 

of taxes that a company would pay under the U.S. tax 

code. That limit ensures that the United States does not 

subsidize other countries by extending credits in excess of 

what it collects in taxes. As an example, suppose a multinational corporation earns $100 million in before-tax 

income in its domestic operations in the United States 

and an equal amount, currently subject to U.S. taxes, 

from the operation of its subsidiaries in other countries 

(see Table 2). Under U.S. tax law, the combined income 

is subject to a 35 percent rate—and the firm owes 

$70 million in corporate income taxes (before allowing 

for credits). Suppose the other countries tax corporate 

income earned within their borders at a rate of 40 percent. The firm therefore would pay $40 million in taxes 

to the foreign countries (40 percent on the $100 million 

earned there). Under U.S. law, the firm can then claim a 

credit up to the amount it owes the United States on the 

same income—in this case, $35 million (35 percent of 

the $100 million). In this example, the firm pays 

$75 million in taxes—$35 million to the United States 

(after taking the credit) and $40 million to the other 

countries—$5 million more than it would if there was no 

limit on the amount of the credit. 

The credit that can be taken for paying foreign taxes has 

changed. Initially, there was an overall limit (as in the 

simple example above). From 1932 to 1976, the foreign 

tax credit was calculated separately for each country as a

3. See Edward Kleinbard, “Stateless Income’s Challenge to Tax 

Policy,” Tax Notes (September 5, 2011), pp. 1021–1042.

4. Although each U.S. shareholder of a given CFC must own at least 

10 percent of the stock, it is common for 100 percent of the stock 

in a CFC to be owned by a U.S. corporation. 

5. A deduction is an expense or an amount of money that reduces a 

taxpayer’s taxable income, thus reducing the tax liability by the 

amount of the deduction multiplied by the applicable tax rate. A 

credit, by contrast, is a dollar-for-dollar reduction in the amount 

the taxpayer owes.
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Table 2.

Illustrative Effect of Limiting the Foreign Tax Credit on the Tax Liability of a 

U.S. Multinational Corporation

Source: Congressional Budget Office.

way to limit the ability of businesses to “cross credit” (that 

is, to use taxes paid to high-tax countries to reduce the 

U.S. tax on income from low-tax countries). Over time, 

the per-country limit has been replaced with separate limits for different categories (or “baskets”) of income; the 

income from all countries is combined within each basket. Before 2007, businesses were required to calculate 

separate limits for nine different baskets. The American 

Jobs Creation Act of 2004 reduced that number, moving 

certain items, such as income from financial services, into 

a general-income category. There are now just two main 

categories—general income (largely, active income) and 

passive income.6

Deferral of Taxes on Foreign Income. Since the enactment of the corporate income tax in 1909, the United 

States has allowed firms to defer U.S. taxes on the income 

of foreign subsidiaries until that money is repatriated to 

the U.S. parent company. An early justification held that 

no income should be taxed before it is available for use by 

the taxpayer (just as taxes are deferred on capital gains 

realizations or pension income until those funds are 

received). Over time, concern over the ability of businesses to manipulate their foreign income led to proposals to restrict or eliminate deferral of taxes. Advocates 

defended deferral as a way to protect firms’ ability to 

compete with foreign businesses in countries with lower 

tax rates or a territorial approach to taxation. Those 

competing concerns have led to a deferral system that is 

somewhat constrained by limits on its use. (Those limits 

are discussed later in this report in the section “Limits on 

Deferral.”)

Under current law, U.S. multinational corporations are 

taxed only on the income of subsidiaries that are incorporated abroad to the extent that the income from those 

U.S. Income 100 100

Repatriated Foreign Income 100 100 ___ ___

Total Income 200 200

U.S. Taxes Before Foreign Tax Credit

Rate (Percent) 35 35

Liability (Millions of dollars) 70 70

Foreign Taxes

Rate (Percent) 40 40

Liability (Millions of dollars) 40 40

Foreign Tax Credit (Millions of dollars) 40 35

U.S. Taxes 30 35

Foreign Taxes 40 40

__ __

Total Taxes 70 75

U.S. and Foreign Tax Liability After the Credit (Millions of dollars)

No Limit on Tax Credit Foreign Income Is Subject to U.S. Taxes

Tax Credit Limited to Amount Owed If 

U.S. and Foreign Tax Liability and the Foreign Tax Credit

Before-Tax Income (Millions of dollars)

If There Were

Current Law:

6. Active and passive income are discussed in more detail later in this 

report. The tax code identifies two other categories for special 

treatment. The first consists of income from investments in 

countries with which the United States does not have diplomatic 

relations and from countries that support terrorism: Income in 

that category is not eligible for a tax credit. The other category 

consists of income that is sourced (that is, attributed) to foreign 

countries by treaty; corporations must compute the foreign tax 

credit separately for that income.
JANUARY 2013 OPTIONS FOR TAXING U.S. MULTINATIONAL CORPORATIONS 7

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Table 3.

Illustrative Effect of Deferral on the Tax Liability of a 

U.S. Multinational Corporation

Source: Congressional Budget Office.

a. Credit is allowed for foreign taxes attributable to the repatriated foreign income.

operations is repatriated to the U.S. parent in the form of 

dividends. (Income earned by a branch, by contrast, is 

taxed as it is earned because branches are treated as legal 

extensions of the U.S. parent corporation.) 

In the previous example (shown in Table 2), the limit on 

the foreign tax credit reduced the appeal of investing in a 

high-tax country. By contrast, the ability to defer U.S. 

taxes on income that is not repatriated increases the 

appeal of investing in lower-tax countries. Consider again 

a U.S. parent company that earns $200 million in beforetax income (see Table 3). Suppose $100 million of that 

income is earned from a wholly owned subsidiary in a 

host country with a tax rate of 15 percent. The multinational corporation in this instance reinvests half of the 

dividends in its foreign subsidiary and repatriates the 

rest to the U.S. parent. Without deferral, all foreign earnings would be subject to U.S. taxes. However, under the 

current rules, the multinational does not pay U.S. taxes 

on the $50 million of the foreign earnings that remain 

abroad. Only the $50 million paid to the U.S. parent 

company is taxed at 20 percent, the amount by which the 

U.S. tax rate exceeds the foreign tax rate. Thus, deferral 

reduces the company’s U.S. tax liability by $10 million. 

If the multinational repatriates the income in some future 

year, it will owe U.S. taxes on that income. The firm still 

benefits, however, by deferring tax liability—and having 

the use of that money—until that future time.

Using Excess Credits to Shelter Income Repatriated from 

Low-Tax Countries. Because a firm’s foreign tax credit is 

limited to its U.S. tax liability, income that is repatriated 

from a country with a higher tax rate than the U.S. rate 

generates “excess credits” (that is, potential credits from 

foreign tax liabilities that cannot be used because they 

U.S. Income 100 100

Foreign Income Before Foreign Taxes

Taxable income repatriated to the parent company 50 50

Income reinvested abroad 50 50 ___ _____

Total Income 200 200

Income Subject to U.S. Taxes 200 150

U.S. Taxes Before Foreign Tax Credit

Rate (Percent) 35 35

Liability (Millions of dollars) 70 52.5

Foreign Taxes

Rate (Percent) 15 15

Liability (Millions of dollars) 15 15

Foreign Tax Credit (Millions of dollars) 15 7.5 a

U.S. Taxes 55 45

Foreign Taxes 15 15

__ ____

Total Taxes 70 60

If There Were No Deferral Current Law: Deferral

U.S. and Foreign Tax Liability and the Foreign Tax Credit

U.S. and Foreign Tax Liability After the Credit (Millions of dollars) 

Before-Tax Income (Millions of dollars)
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Table 4.

Illustrative Effect of Cross Crediting Under the Foreign Tax Credit on the 

Tax Liability of a U.S. Multinational Corporation

Source: Congressional Budget Office.

Note: n.a. = not applicable.

a. Per-country credits are shown for illustration only and are not calculated separately for U.S. tax purposes.

b. The potential credit is the foreign taxes paid on repatriated income.

c. The allowed tax credit is the smaller of the potential credit or the U.S. tax liability due on repatriated foreign income.

exceed the amount owed to the United States). A firm 

that repatriates income from a country with a lower tax 

rate would receive a credit that was not enough to offset 

the entire U.S. tax owed on that income, and the firm 

would face a residual tax in the United States. U.S. tax 

law, however, allows firms to combine the income and 

credits from high- and low-tax-rate countries on income 

tax returns. The excess credits attributed to the taxes paid 

on income earned in a high-tax country can be cross 

credited and applied to the income repatriated from the 

low-tax country, effectively offsetting some or all of 

the U.S. tax liability on income from the low-tax host 

country. 

Suppose a firm repatriates $100 million from a country 

with a 40 percent tax rate and $20 million from a country 

with a 10 percent tax rate (see Table 4). Without cross 

crediting, the firm could claim a credit of $35 million on 

Foreign Income 100 100 200

Taxable Foreign Income Repatriated to the

Parent Company 100 20 120

U.S. Taxes

Rate (Percent) 35 35 35

Liability (Millions of dollars) 35 7 42

Foreign Taxes

Rate (Percent) 40 10 n.a.

Liability (Millions of dollars) 40 10 50

Foreign Tax Credita

Potentialb 40 2 42

Allowedc 35 2 37

U.S. Taxes 0 5 5

Foreign Taxes 40 10 50

__ __ __

Total Taxes 40 15 55

Foreign Tax Credita

Potentialb 40 2 42

Allowedc 35 7 42

U.S. Taxes 0 0 0

Foreign Taxes 40 10 50 __ __ __

Total Taxes 40 10 50

Country

Before-Tax Income (Millions of dollars)

Total

U.S. and Foreign Tax Liability After the Foreign Tax Credit, with Cross Crediting

U.S. and Foreign Tax Liability After the Foreign Tax Credit, with No Cross Crediting

Country

U.S. and Foreign Tax Liability Before the Foreign Tax Credit

(Millions of dollars)

(Millions of dollars)

High-Tax Low-Tax 
JANUARY 2013 OPTIONS FOR TAXING U.S. MULTINATIONAL CORPORATIONS 9

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its income from the high-tax country, the amount it owes 

under U.S. tax law on $100 million of earnings. The firm 

also could claim another credit for $2 million—the 

amount owed to the low-tax country on the $20 million 

repatriated from that country. However, under current 

law, that firm has excess credits of $5 million—the 

difference between the potential credit ($40 million) and 

the allowed credit ($35 million) from the taxes paid to 

the country with the higher tax rate. The U.S. firm 

can still apply the excess credit of $5 million against the 

amount due in U.S. taxes on income earned in the 

low-tax country. 

The advantages of cross crediting increase as fewer restrictions are placed on the foreign tax credit.7

 The current 

system’s smaller number of baskets eases the way for firms 

to use cross crediting, and thereby increases the use of 

that mechanism.8

Combining Deferral and Excess Credits. Corporations 

can increase their after-tax income by retaining some 

earnings abroad in low-tax countries and using excess 

credits from high-tax countries to shelter income repatriated from low-tax countries. Such actions allow them to 

avoid paying the U.S. taxes that would have been due on 

some of their income from low-tax countries. Consider 

again a firm that initially earns $100 million in the 

United States and $100 million in a country with a 

15 percent tax rate. If the company does not defer any 

income, it would have a U.S. tax liability of $70 million, 

less a foreign tax credit of $15 million, and thus would 

owe $55 million in U.S. taxes; its total tax payments 

would amount to $70 million (see the first column in 

Table 3 on page 7). Deferral, by itself, would reduce those 

taxes by $10 million (see the second column in Table 3).

Alternatively, the firm could rearrange its investments 

and use the combination of deferral and cross crediting to 

reduce its total tax liabilities even more—and eliminate 

its U.S. tax liability. For example, say the firm moves its 

domestic and foreign investments to two foreign countries—one with a rate that is higher (40 percent) and the 

other with a rate that is lower (10 percent) than the U.S. 

tax rate (the example shown in Table 4).9

 If it repatriates 

$100 million from the country with the higher tax rate 

and $20 million from the country with the low tax rate, 

the company can use cross crediting to take the full credit 

of $40 million—the amount paid to the high-tax country—to eliminate the domestic tax due on income it 

repatriates from the low-tax country. Thus, by moving 

investments overseas, retaining some earnings abroad, 

and using cross crediting, the company could reduce its 

net U.S. tax liability from $55 million to zero and its 

total tax payments from $70 million to $50 million.

Deductions for Expenses. Another feature of the tax code 

that can affect the use of excess credits is the treatment of 

certain expenses incurred by the parent firm in the course 

of its general business activities. Such expenses include 

interest on loans, spending on research and development, 

and overhead. The foreign tax credit is limited to the U.S. 

tax liability on repatriated income, net of those expenses 

incurred in earning the income. Deducting the expenses 

reduces the allowable credit for firms affected by that 

limit. However, the lower limit could be used to generate 

additional excess credits from high-tax countries to shield 

income repatriated from low-tax countries from U.S. tax 

liability, thus encouraging some firms to allocate more 

expenses to their foreign earnings.

Although deductions for expenses related to doing business abroad can reduce the foreign tax credit, those 

expenses can nevertheless be used in other ways to lower 

the company’s U.S. tax liability. When determining that 

liability before tax credits, firms need not differentiate 

between domestic and foreign expenses; all foreign 

expenses can be deducted entirely against U.S. taxable 

income to reduce total U.S. tax liability. Thus, expenses 

from foreign operations reduce U.S. tax liability, even 

before the application of the foreign tax credit. Moreover, 

the parent firm can take deductions for expenses it incurs 

for its foreign operations in the year that those expenses 

7. See Kimberly Clausing, “Tax Holidays (and Other Escapes) in the 

American Jobs Creation Act,” National Tax Journal, vol. 58, no. 3 

(September 2005), pp. 331–346.

8. See Harry Grubert and Rosanne Altshuler, “Corporate Taxes in 

a World Economy: Reforming the Taxation of Cross-Border 

Income,” in John W. Diamond and George Zodrow, eds., 

Fundamental Tax Reform: Issues, Choices and Implications (MIT 

Press, 2008).

9. Under both scenarios, the firm would face the same underlying 

tax rate on the new investments (before accounting for foreign tax 

credits, deferrals, and other adjustments). In the previous example 

(see Table 3), the firm faced an underlying tax rate of 25 percent 

($35 million in U.S. taxes and $15 million in foreign taxes on 

$200 million of before-tax income). In this example (see Table 4), 

it also faces an underlying tax rate of 25 percent ($40 million in 

taxes in the high-tax country and $10 million in taxes in the 

low-tax country on $200 million of before-tax income).
10 OPTIONS FOR TAXING U.S. MULTINATIONAL CORPORATIONS JANUARY 2013

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are incurred—even if the related foreign income is not 

repatriated until a later year.

Limits on Deferral. Income is taxed differently according 

to how it is earned (that is, whether it is passive or active 

income) and whether it is retained abroad or paid within 

the tax year to a U.S. parent company. Passive income is 

derived from businesses that a firm owns but for which 

the firm has minimal or no involvement in operations. 

For example, income from the sales of foreign property to 

related parties would be considered passive.10 Passive 

income, often called subpart F income because of the 

portion of the tax code that specifies its treatment, is 

taxed as it is earned. Active income is generated by the 

firm in the management of its business, and it is taxed 

only when it is returned to the U.S. parent company.11

For example, active dividends are taxed only when they 

are paid out to the U.S. parent. Additionally, some forms 

of income, such as interest, rents, and royalties, are taxed 

currently, regardless of whether they are earned passively 

or actively, because the money is paid immediately to the 

U.S. earner. 

Because government tax administrators cannot readily 

identify the source of passive income, it is easier to make 

financial arrangements to shift passive income to low-tax 

countries and escape U.S. taxation than it is to do the 

same with active income. If passive income was not taxed 

when earned, it would be possible for U.S. multinational 

corporations to defer paying taxes on all investment 

income, including that from U.S. businesses, by investing 

through foreign entities. That is not possible under 

subpart F because investment in U.S. property by 

U.S.-controlled foreign corporations is subject to tax. 

The subpart F rules limit the ability of businesses to 

shelter from U.S. taxation any passive income, including 

dividends from stock holdings. The separate limits on 

foreign tax credits for active and passive income reduce 

the impetus for corporations to use foreign tax credits 

related to active dividends that are subject to high foreign 

taxes as a way to shelter passive income associated with 

low-tax jurisdictions. 

Impact of Foreign Tax Credits and Deferrals on Federal 

Revenues. In 2008—the latest year for which detailed 

data are available—12 percent of federal revenues came 

from corporate income taxes, and about half of that 

amount was from multinational corporations claiming 

credits for taxes paid to foreign governments (see 

Table 5). Although those 7,242 companies represented 

only four-tenths of one percent of all U.S. corporations, 

they earned about 70 percent of total taxable corporate 

income. In all, U.S. multinational corporations claimed 

about $100 billion in foreign tax credits on almost 

$700 billion in worldwide taxable income (including 

domestic income and foreign income repatriated to the 

United States). The credits reduced those corporations’ 

income tax liability by about 40 percent.12

Almost three-quarters of the foreign tax credits were 

claimed by corporations in the manufacturing sector, 

and those credits reduced their U.S. tax liability by 

55 percent. Total foreign repatriated income is almost 

60 percent of worldwide taxable income of the corporations claiming a foreign tax credit (comparing totals on 

Tables 5 and 6). About 10 percent of repatriated income 

came from the United Kingdom—a major U.S. trading 

partner (see Table 6)—and Canada accounted for 

another 8 percent. More than 9 percent was repatriated 

from countries often considered to be tax havens for 

U.S. corporate income because of their low tax rates: 

Bermuda, Luxembourg, the Cayman Islands, and the 

Bahamas (see Box 1 on page 13). 

Measuring the impact of deferral is more challenging 

because multinational corporations are not required to 

report the amount of foreign income that is not 

repatriated.13 The Bureau of Economic Analysis of the 

Department of Commerce has reported that earnings of 

U.S. foreign affiliates were, on net, about $900 billion in 

2009 (that total does not include the foreign-branch 

10. Specifically, if a U.S. CFC purchased foreign property and sold it 

to another foreign subsidiary that was controlled by that CFC—a 

related party—that income would be deemed passive.

11. 26 U.S.C. §951 et seq. (2006 & Supp.).

12. Some firms can take a deduction for foreign taxes in lieu of the 

credit. Such deductions are estimated to have resulted in forgone 

revenues of $0.2 billion in 2011 and are expected to reduce federal 

revenues by $1.2 billion over the 2011–2015 period. See Joint 

Committee on Taxation, Estimates of Federal Tax Expenditures 

for Fiscal Years 2011–2015, JCS-1-12 (January 17, 2012), 

http://go.usa.gov/flW.

13. Information is available from several sources. For example, data on 

foreign and domestic income are available from financial statements and, with less detail, on the Internal Revenue Service’s 

Schedule M3; data on distributions from CFCs are available on 

the information returns of those corporations; and repatriated 

income is reported on the tax form that corporations use to claim 

foreign tax credits. Still, comparisons involving repatriated income 

are difficult because the available data sources measure income differently and report income from different types of entities that are 

not easily linked.
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Table 5.

Use of the Foreign Tax Credit, by U.S. Industry, 2008

(Billions of dollars)

Source: Congressional Budget Office based on data from the Internal Revenue Service.

Note: * = less than $50 million.

a. Total income, consisting of domestic and repatriated foreign income that is subject to U.S. taxes.

b. The general business credit combines many of the available business credits, such as the research and development credit and investment 

credits. Combining the credits provides a uniform method for determining limits on their amounts.

c. Including additional credits that are not reported separately.

income of U.S. parent companies).14 Estimates of the cost 

of deferral use data on, or assumptions about, the distribution of U.S. corporate income among countries with 

different tax rates and assumptions about how corporations might respond to changes in tax policy. Some analysts estimate, on the basis of a review of the financial 

data from 880 companies, that as of May 2011, unrepatriated foreign income totaled $1.4 trillion.15 JCT estimates that forgone revenues attributable to deferral 

totaled about $16 billion in fiscal year 2012 and that they 

will amount to a total of $87 billion from 2011 through 

2015, making deferral of taxes on foreign income the 

largest corporate tax expenditure.16

Effects of the Federal Tax Treatment of 

U.S. Multinational Corporations

The current U.S. tax treatment of multinational corporations affects their behavior in ways that have an impact 

on U.S. tax revenues: 

 The different treatment of foreign and domestic 

operations influences decisions about how much and 

where companies invest. Economic efficiency—the 

extent to which resources are allocated in a manner 

that maximizes their value—is reduced if firms forgo 

more productive investments because they are 

avoiding taxation. 

 The current U.S. tax code encourages firms to 

artificially shift reported income abroad and between 

foreign counties. 

 When firms choose to shift either their investments 

or their reported income abroad, U.S. revenues from 

corporate income taxes decline. 

Industry

Manufacturing 1,268 384.0 134.4 73.5 4.4 56.1

Services 2,600 68.2 23.9 7.3 2.1 14.3

Mining 109 38.7 13.6 6.8 * 6.5

Information 253 52.4 18.3 4.8 0.8 12.5

Finance, Insurance, Real Estate, and

Rental and Leasing 1,769 66.7 24.1 4.3 0.3 19.2

Wholesale and Retail Trade 570 73.1 25.6 2.9 0.6 22.0

Other 673 13.4 4.7 0.7 0.1 3.8 _____ _____ _____ _____ ___ _____

Total 7,242 696.4 244.6 100.4 8.4 134.4

U.S.

After

Worldwide 

Before 

Credits Income Tax 

Returns

Number of 

Incomea 

Taxable 

Credits

Income Tax 

Tax

Foreign General 

Creditsc

U.S.

Businessb

14. See Bureau of Economic Analysis, “U.S. Direct Investment 

Abroad: Financial and Operating Data for U.S. Multinational 

Companies” (November 19, 2012), http://go.usa.gov/fTf. 

15. Dane Mott and Amy Schmidt, “Accounting Issues: Show Us the 

Foreign Cash!” North American Equity Research (September 12, 

2011). 

16. See Joint Committee on Taxation, Estimates of Federal Tax 

Expenditures for Fiscal Years 2011–2015, JCS-1-12 (January 17, 

2012), http://go.usa.gov/flW. Tax expenditures are defined by the 

Congressional Budget and Impoundment Control Act of 1974 

as “revenue losses attributable to provisions of the Federal tax laws 

which allow a special exclusion, exemption, or deduction from 

gross income or which provide a special credit, a preferential rate 

of tax, or a deferral of tax liability.” Estimates of tax expenditures, 

unlike those for revenues, do not reflect any changes in taxpayers’ 

behavior in response to changes in the tax code.
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Table 6.

Foreign Taxes Paid by and Foreign Taxable Income Repatriated to 

U.S. Parent Companies for Selected Countries, 2008

Source: Congressional Budget Office analysis of data on foreign tax credits from the Internal Revenue Service.

Note: n.a. = not applicable.

a. The number of returns for each country is the number on which that country is listed; a single return filed by a U.S. parent company can 

list more than one country.

b. The total number of returns for all countries is the total filed by U.S. parent companies claiming a foreign tax credit.

Location of Investment 

The current U.S. tax system encourages firms to consider 

tax advantages as they choose whether to invest in the 

United States or in some foreign country: 

 The limit on foreign tax credits encourages 

corporations to avoid investing in countries where tax 

rates are higher than they are in the United States,

 The ability to defer foreign income encourages firms 

to invest and retain earnings in low-tax foreign 

jurisdictions rather than in the United States to avoid 

paying higher taxes here, and 

 The practice of cross crediting provides a further 

incentive for corporations to make foreign 

investments on the basis of their potential tax 

liabilities rather than their other business interests. 

A tax system that combines those three features yields a 

less efficient allocation of worldwide capital among 

domestic and foreign jurisdictions because companies can 

move capital from country to country in part to reduce 

their tax liabilities. Under the current U.S. tax system, a 

firm—faced with a choice between a project in the 

United States and a less productive investment in another 

country with lower taxes—might select the foreign 

investment because it yields a higher after-tax return.

The system also leads to an inefficient deployment of 

U.S. capital, thereby reducing the income of U.S. 

shareholders and employees. To the extent that firms are 

able to exploit market power (that is, to earn profits that

United Kingdom 1,142 10.3 39.3 9.5

Canada 2,430 11.0 32.8 7.9

Netherlands 709 7.8 21.5 5.2

Ireland 304 1.7 21.2 5.1

Switzerland 392 2.8 14.5 3.5

Japan 942 3.4 14.1 3.4

Bermuda 224 3.6 13.2 3.2

Luxembourg 202 2.6 10.9 2.6

Singapore 514 0.6 9.3 2.2

Cayman Islands (British) 227 1.3 8.8 2.1

Germany 645 2.1 8.7 2.1

China 590 1.1 8.0 1.9

France 638 2.4 7.5 1.8

Bahamas 116 2.1 6.3 1.5

Hong Kong 434 0.5 4.7 1.1

India 501 1.0 3.6 0.9

Italy 475 1.2 3.5 0.8

British Virgin Islands 82 0.2 1.1 0.3 _____ ____ _____ ____

Total for Selected Countries n.a. 55.6 228.8 55.4

Memorandum:

Total for All Countriesb 7,242 121.2 413.3 100

Percentage of Total

Foreign Taxable Income Repatriated 

Returnsa (Billions of dollars)

Foreign Taxes Paid

(Billions of dollars)

Number of 
JANUARY 2013 OPTIONS FOR TAXING U.S. MULTINATIONAL CORPORATIONS 13

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are greater than the normal market return) in foreign 

jurisdictions, that profitability could benefit the U.S. 

economy. However, that benefit is unlikely to override 

the negative consequences (such as the loss of income to 

shareholders and employees) of inefficient allocation of 

U.S. capital.17

Concerns about tax-motivated decisions by U.S. multinationals to invest in foreign countries sometimes reflect 

the fear that the United States is losing jobs to other 

countries where tax rates are lower than they are here. 

However, the Congressional Budget Office anticipates 

that, apart from periods of general economic weakness—

like the recent severe recession and slow recovery—jobs 

lost in that way tend to be replaced by others, perhaps in 

other industries, in other locations, and at different 

wages. Specifically, a shift of investment by U.S. multinationals to foreign markets can cause a loss of particular 

U.S. jobs (because a manufacturing plant is closed, for 

Box 1.

Tax Havens

The term tax haven is often applied to countries that 

do not assess income taxes or that appear to set taxes 

purposely low to attract investment or income from 

foreign businesses or individuals. More formal definitions, however, have changed over time and vary 

among international organizations and governments. 

Factors other than tax rates are sometimes used to 

determine whether to call a particular country a tax 

haven. 

The Organisation for Economic Co-operation and 

Development (OECD), for example, originally identified countries as tax havens if they levied minimal 

taxes or none at all and if they prevented exchanges of 

information with foreign tax authorities, exhibited a 

lack of transparency, and did not require corporations 

to establish substantial local business activity. In 

2000, the OECD identified 35 such countries on the 

basis of those criteria.1

 Since then, the OECD has 

classified countries on the basis of their commitment—or lack of a commitment—to developing 

information exchanges with foreign tax authorities, 

and it assigns nations to what are known as the white, 

gray, and black lists. 

As of May 2012, the OECD had listed three countries that had not substantially implemented information exchanges (Nauru, Niue, and Guatemala); none 

were black-listed as uncooperative tax havens. On the 

basis of its current criteria, the OECD does not designate as tax havens many countries that have low tax 

rates and that do not require corporations to have 

domestic business operations.

The Government Accountability Office has identified 50 countries as tax havens.2

 That list includes 

countries that had been identified by the OECD in 

the past as tax havens and others that also have had 

low tax rates for businesses or that offer financial privacy and that, as a result, are considered tax havens by 

other sources.3

1. Organisation for Economic Co-operation and Development, 

Towards Global Tax Co-operation: Report to the 2000 Ministerial Council Meeting and Recommendations by the Committee 

on Fiscal Affairs, Progress in Identifying and Eliminating 

Harmful Tax Practices (2000), www.oecd.org/document/43/

0,3746,en_2649_33745_36153067_1_1_1_1,00.html.

2. Government Accountability Office, International Taxation: 

Large U.S. Corporations and Federal Contractors with Subsidiaries in Jurisdictions Listed as Tax Havens or Financial Privacy 

Jurisdictions, GAO-09-157 (December 2008), 

http://go.usa.gov/f1K.

3. See Dhammika Dharmapala and James R. Hines Jr., Which 

Countries Become Tax Havens? Working Paper 12802 

(National Bureau of Economic Research, December 2006), 

www.nber.org/papers/w12802; and James R. Hines Jr. and 

Eric M. Rice, Fiscal Paradise: Foreign Tax Havens and American Business, Working Paper 3477 (National Bureau of 

Economic Research, April 1994), www.nber.org/papers/

w3477. Hines and Rice initially developed the criteria used 

by Dharmapala and Hines to identify 41 countries and 

territories as tax havens. 

17. In seeking to exploit market power, it is more likely that a corporation would use the many methods of manipulating returns on 

intangible assets, including licensing or franchising a brand name, 

that do not require a change in the location of an investment.
14 OPTIONS FOR TAXING U.S. MULTINATIONAL CORPORATIONS JANUARY 2013

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example, or a new one is not built). But over the long 

term, the economy as a whole generates enough jobs to 

compensate for those losses. 

Still, the replacement jobs may be in different locations 

and for workers with different skills and experience. 

Moreover, unless that shift of investment is replaced by 

additional investment in the United States from other 

sources, less capital investment in this country will lead to 

lower overall wages and incomes for U.S. residents.

It bears emphasis that, although tax considerations matter, many other considerations, such as the quality of a 

country’s labor force and infrastructure, its regulatory 

environment, and its legal and political institutions, play 

a role in decisions about where to invest.

The incentives to invest abroad would be different under 

a worldwide tax system with unlimited foreign tax credits: Firms would face the same tax rate regardless of where 

they invested because they would receive a credit for all 

taxes paid abroad whether or not those taxes exceeded the 

U.S. tax liability on that income. As a consequence, 

U.S. firms’ investments, or capital, would no longer be 

inefficiently allocated because of tax considerations.18

Departures from that system yield different tax rates for 

different investment locations, and economic efficiency is 

reduced to the extent that companies attempt to respond 

to those different rates. 

Several researchers have tried to estimate how corporate 

taxes affect corporate investment behavior. One analysis 

showed that a 1 percentage-point increase in the U.S. tax 

rate relative to the tax rate in a foreign country increased 

U.S. multinational corporations’ employment and sales 

in that foreign country by 1.6 percent and 2.9 percent, 

respectively. However, both the assets and the gross 

income of U.S. corporations in that country increased 

even more, suggesting that firms respond to differences 

in tax rates by shifting reported profits as well as by 

relocating business activities.19

Profit Shifting

Shifting investments to other countries can be quite 

costly, especially if the investment and the demand for 

skilled labor must be moved from a high-tax developed 

country to a low-tax jurisdiction that lacks an appropriate 

infrastructure or labor force and if goods that are 

produced abroad must be shipped to distant markets. 

Many of the tax advantages associated with relocating 

investment can be achieved—at a lower cost—by profit 

shifting, which allows businesses to maintain their actual 

investments in high-tax countries while reporting profits 

in low-tax jurisdictions.20 Some profit-shifting methods 

are controversial, and government tax administrators and 

corporations find themselves at odds over the legality 

of such financial transactions between U.S. parent 

corporations and their foreign subsidiaries. 

How do firms shift profits from one country to another? 

Some take advantage of the different tax treatment of 

entities and income in various jurisdictions, in some cases 

using rules that allow corporations to disregard, or ignore 

for tax purposes, income from certain subsidiaries. 

Another common way to reduce a company’s tax burden 

is for a business to take advantage of transfer pricing—

that is, how it sets prices on transfers of property, 

particularly intangible property (such as licenses to use 

intellectual property), among related businesses in 

different countries. 

Differing Treatment of Entities and Income. U.S. parent 

corporations can—for tax purposes—transform their foreign subsidiaries into hybrid entities that shelter income 

from U.S. and foreign taxes. In a standard hybrid structure, a subsidiary of a CFC is treated as a corporation by 

the foreign jurisdiction but as what is known as a passthrough entity (for example, a branch of a CFC) under 

U.S. tax law. That arrangement allows the firm to take 

deductions in the foreign jurisdiction, but it also allows 

the income of the subsidiary to pass through to—that is, 

to be attributed to—the controlled foreign corporation. 

Thus, transactions between the two entities can be disregarded in calculating U.S. taxes, thereby avoiding U.S. 

taxes on such transactions. This feature of the U.S. tax 

system encourages companies to shift investments—and 

reported profits—abroad.

18. That efficiency also could be achieved if every country had the 

same territorial tax system and thus identical effective tax rates on 

all foreign investments. Allowing unlimited credits also would 

amount to a U.S. subsidy for foreign governments.

19. See Kimberly A. Clausing, “Multinational Firm Tax Avoidance 

and Tax Policy,” National Tax Journal, vol. 62, no. 4 (December 

2009), pp. 703–705. 

20. Profit shifting also imposes costs because it requires the use of 

resources for tax planning.
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Such an intercompany transaction occurs, for example, 

when a subsidiary that is incorporated in a low-tax 

jurisdiction lends money to a subsidiary incorporated in 

a high-tax jurisdiction, effectively shifting income to the 

low-tax country in the form of interest payments. The 

borrowing subsidiary deducts, at the high tax rate, 

the interest payments made to the lending subsidiary. For 

U.S. tax purposes, however, the borrowing subsidiary can 

be treated as a branch of the lending subsidiary, and the 

income of the borrowing subsidiary is considered 

the legal income of the lending subsidiary. Therefore, 

the parent corporation can shield the passive income (the 

interest the borrowing entity has paid to the lending 

entity) from the taxation that normally would occur 

under the U.S. system. By allowing the company to 

disregard, for tax purposes, the passive income of the 

hybrid entity in the year it is earned, the tax code effectively defers the repatriation of the income and therefore 

the tax that will be owed on it. 

Under “check-the-box” rules, a business can elect to treat 

a subsidiary as a separate corporation, a partnership, or a 

“disregarded entity” that is not treated as separate from its 

owner.21 Those rules allow a corporation to remove a 

wholly owned subsidiary incorporated abroad from recognition by the U.S. tax system or to treat a partnership 

as a corporation for tax purposes. The rules were 

intended to simplify the classification of business entities 

by allowing multinational corporations to identify the 

status of an entity on its income tax forms.22 But the rules 

also enhance the ability of U.S. parent companies to 

make use of differences in tax laws to generate tax credits 

on unrepatriated income or to shield passive income from 

U.S. taxation.23

A separate provision enacted in 2006 created the “lookthrough” rule, which instituted specific classifications of 

certain types of intercompany payments of CFCs. The 

look-through rule allows those intercompany payments 

to escape taxation, permitting much of what check-thebox rules also allow.24 The provision originally was 

scheduled to expire at the end of 2008 but was extended 

through 2013. If the look-through rule is extended again, 

eliminating the check-the-box rules would not be 

sufficient to restrict the use of hybrid entities to avoid 

U.S. taxes. 

Other features of the U.S. tax code also foster misalignments between deductions and income. U.S. 

corporations can deduct interest expenses from taxable 

income, regardless of the expenses’ source. Therefore, a 

firm can claim the deduction for interest expenses related 

to foreign operations even if the income from those 

operations is never repatriated. That aspect of the U.S. 

tax code allows corporations to reduce the amount of 

income subject to U.S. taxation by deducting expenses 

for operations abroad without currently, or maybe ever, 

paying taxes on the income from those operations. This 

misalignment between deductions and taxation is attributable to the ability of firms to defer paying taxes on 

income earned abroad.

Transfer Pricing. U.S. firms also can shift income 

between countries through intercompany transfer 

pricing, a method of setting prices for the transfer of 

property, both real and intangible, between related parties, such as from a parent corporation to a subsidiary. 

Under Treasury regulations, that price should be determined by the “arm’s length” standard—the price two 

unrelated parties would agree upon in the open market. 

However, for intellectual property of various kinds or 

for intangible assets, such as patents for production techniques, it is difficult to determine what an open-market 

21. Most corporate filers do not actually check a box; the classification

form includes some automatic classifications that depend on the 

number of owners and their liability status. For example, an entity 

is automatically disregarded for taxation if it has a single owner 

without limited liability, and it is classified as a partnership by 

default if it has multiple owners, at least one of which does not 

have limited liability. 

22. Although those rules were enacted to simplify the process of 

classifying and structuring business arrangements, any gain is 

diminished by the use of such complicated hybrid tax strategies 

as the “Double Irish” and “Dutch Sandwich” approaches. See 

Jesse Drucker, “Google 2.4% Rate Shows How $60 Billion 

Lost to Tax Loopholes,” Bloomberg News (October 21, 2010), 

www.bloomberg.com/news/2010-10-21/google-2-4-rate-showshow-60-billion-u-s-revenue-lost-to-tax-loopholes.html. Some 

observers assert that check-the-box rules add complexity by 

encouraging corporations to compute taxes under different 

scenarios to determine which entity status will yield the smallest 

tax liability. See American Bar Association Tax Section, Task 

Force on International Tax Reform, “Report of the Task Force 

on International Tax Reform,” Tax Lawyer, vol. 59, no. 3 (2006), 

pp. 649–743.

23. Similarly, foreign parent corporations can use differences between 

U.S. tax laws and those of other countries to shield income from 

taxation at home.

24. For a comparison of check-the-box and look-through rules, see 

David R. Sicular, “The New Look-Through Rule: W(h)ither 

Subpart F?” Tax Notes (April 23, 2007), pp. 349–378. 
16 OPTIONS FOR TAXING U.S. MULTINATIONAL CORPORATIONS JANUARY 2013

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price would be, and companies and tax authorities sometimes engage in costly disputes over the correct pricing. 

Companies have an incentive to underprice the transfer 

of assets to subsidiaries in low-tax countries and to overprice sales from affiliates in low-tax countries to those in 

high-tax countries. 

A simple example of transfer pricing might involve a 

U.S. parent corporation’s sale or lease of patent rights on 

a production innovation to a foreign subsidiary located 

in a low-tax jurisdiction.25 Suppose the parent company 

developed the idea in the United States, where the 

research costs could be deducted from the company’s taxable income at the U.S. corporate income tax rate. Then, 

suppose the patent right is sold by the parent company to 

a subsidiary in a low-tax country. Thereafter, the income 

from sales of the resulting product (net of production 

costs) is allocated to the patent holder in the low-tax 

country, and if production costs are low, most of 

the receipts will be attributable to that subsidiary. If 

the transfer price for the patent right is set below the 

open-market price, the parent company benefits by 

reducing its reported income in the United States while 

allocating most of the income generated from use of the 

patent to the patent-holding subsidiary in the lower-tax 

country. By reinvesting earnings in the low-tax subsidiary 

and not repatriating that income to the United States, the 

company avoids paying U.S. taxes associated with the 

U.S. invention. 

Estimates of Profit Shifting. One study, noted earlier, 

showed that multinationals increased both real investment and reported profits in a country when its tax rate 

declined relative to the U.S. rate.26 The analysis showed 

that a 1 percentage-point increase in the U.S. tax rate relative to the tax rate in a foreign country can increase U.S. 

multinational corporations’ assets (including financial 

assets that may be unrelated to investment) and gross 

income (which are related to reported profits) in that 

country by 4.8 percent and 5.2 percent respectively, 

whereas employment and sales (which are indicators of 

real investments) in the host country increased much less. 

Those results suggest that profit shifting increases more 

than investment as a result of increases in the relative tax 

rate. 

Other studies present indirect evidence of profit shifting. 

Firms can relocate the legal home of their headquarters by 

merging with a foreign firm or by reincorporating 

abroad. If the firm relocates its legal headquarters to a 

low-tax jurisdiction, investments by the corporation are 

no longer subject to U.S. taxeseven though the firm has 

made no changes to the location of capital. One report 

showed that an increase in the tax on repatriated income 

in the home country—assuming nothing else changes—

increases the likelihood that a corporation will legally 

relocate, suggesting that the prospect of paying more in 

taxes can encourage firms to use accounting or other 

methods to change the location of the profits they 

report.27

Some studies show that U.S. business income in low-tax 

countries is high relative to the actual presence of U.S. 

businesses in those countries.28 Other research has shown 

disproportionately large ratios of profits earned by U.S. 

firms relative to GDP in low-tax countries.29 Recent 

research has shown that firms’ shares of income abroad 

are increasing but that their share of sales is not.30 Those 

findings provide further evidence that firms are more 

likely to shift profits than to relocate investment in 

response to an increase in the U.S. tax rate relative to 

rates in other countries.

Budgetary Effects of Decisions About 

Location and Profit Shifting

Both the movement of investment abroad and the 

shifting of reported profits reduce income subject to 

U.S. corporate taxes. Several researchers have attempted 

25. For a discussion of other ways to transfer income, see Joint 

Committee on Taxation, Present Law and Background Related to 

Possible Income Shifting and Transfer Pricing, JCX-37-10 (July 20, 

2010), http://go.usa.gov/fiw.

26. See Kimberly A. Clausing, “Multinational Firm Tax Avoidance 

and Tax Policy,” National Tax Journal, vol. 62, no. 4 (December 

2009), pp. 703–725.

27. Johannes Voget, Headquarter Relocations and International Taxation, Working Paper 1008 (Oxford University Centre for Business 

Taxation, April 2010).

28. Melissa Costa and Jennifer Gravelle, “U.S. Multinational Corporations: Effective Tax Rates and Business Locations,” in National 

Tax Association, Proceedings of the 103rd Annual Conference

(Chicago, 2010), www.ntanet.org/publications/nta-proceedings/

222.html. 

29. Jane Gravelle, Tax Havens: International Tax Avoidance and 

Evasion, CRS Report for Congress R40623 (Congressional 

Research Service, September 3, 2010). 

30. Harry Grubert, “Foreign Taxes and the Growing Share of U.S. 

Multinational Company Income Abroad: Profits, Not Sales, are 

Being Globalized,” National Tax Journal, vol. 64, no. 2 (2012), 

pp. 247–281.
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to estimate how much tax revenue is lost to the U.S. 

Treasury through various accounting or other strategies 

that corporations use to reduce their tax liability on 

income earned from international transactions. The estimates vary widely—from a low of $10 billion to a high of 

$90 billion per year. 

The difference in those estimates is partly the result 

of what type of avoidance is analyzed, but the choice of 

research methodology also affects the outcome.31 For 

example, some studies used data on differences in countries’ rates of returns, but that method accounts only for 

profit shifting by U.S. multinationals. In contrast, regression analyses that estimate profit shifting encompass 

shifts by foreign firms to the United States and by U.S. 

firms to foreign countries. Those studies yielded the 

highest estimates of revenue losses. Other studies assess 

the impact of policy changes on revenue losses, but their 

results apply only to the specific activity affected by that 

change. 

Policy Options

Among the avenues policymakers and analysts have 

suggested for changing—fundamentally or incrementally—the way the U.S. tax code treats multinational 

corporations are the following: 

 Move significantly toward a purely worldwide system 

that limits or eliminates deferral,

 Move significantly toward a territorial system that 

exempts foreign income from domestic corporate 

taxation, or

 Prevent multinational corporations from avoiding 

taxes under the current system, for example, by 

restructuring the foreign tax credit or by treating 

entities and income consistently. 

This report discusses some policy options in each of 

those categories.32 Because the U.S. tax system affects 

multinationals’ decisions about where to invest and how 

to report profits, those choices have consequences for 

economic efficiency and U.S. tax revenues—key criteria 

for evaluating trade-offs between tax policy options. This 

assessment of each policy option considers its potential 

effects on the following: 

 Firms’ decisions about where to invest, 

 Firms’ decisions about shifting profits from one 

country to another, and 

 U.S. tax revenues.

Some options would dampen incentives to shift capital or 

profits abroad, thereby increasing economic efficiency 

and producing more tax revenue, others would bolster 

those incentives, and a third set could yield conflicting 

effects on efficiency and revenues (see Table 7). All of the 

options could be structured to boost U.S. corporate tax 

revenues, which could be used to reduce the deficit, pay 

for additional spending, finance reductions in corporate 

tax rates or other tax changes, or implement some combination of those actions. The economic and budgetary 

effects of the options would depend greatly on how they 

were structured. 

One important consideration in choosing among options 

involves firms’ responses to different tax rates. For example, if multinational corporations are more likely to 

artificially shift reported profits than they are to adjust 

their investment behavior in response to lower tax rates 

abroad, options designed to limit such behavior may be 

preferable. Such options would restrict those corporations’ ability to use various accounting methods to avoid 

paying taxes, and they might or might not impede efficient allocation of investments. Alternatively, if firms 

are more likely to adjust their investment behavior, tax 

31. See, for example, Kimberly A. Clausing, “The Revenue Effects of 

Multinational Firm Income Shifting,” Tax Notes (March 28, 

2011), pp. 1580–1586, and “Multinational Firm Tax Avoidance 

and Tax Policy,” National Tax Journal, vol. 62, no. 4 (December 

2009), pp. 703–725; Martin Sullivan, “U.S. Multinationals Shifting Profits Out of the United States,” Tax Notes (March 10, 2008), 

pp. 1078–1082, and “Shifting Profits Offshore Costs U.S. Treasury $10 Billion or More,” Tax Notes (September 27, 2004), 

pp. 1477–1481; and Charles W. Christian and Thomas D. 

Schultz, “ROA-Based Estimates of Income Shifting by U.S. 

Multinational Corporations,” in James Dalton and Beth Kilss, 

eds., IRS Research Bulletin: Recent Research on Tax Administration 

and Compliance—Proceedings of the 2005 IRS Research Conference, 

Publication 1500 (Washington, D.C., 2005), pp. 57–72, 

http://go.usa.gov/gP2R.

32. For estimates of the revenues that would accrue from adopting 

some of those options, see Joint Committee on Taxation, Estimated Budget Effects of the Revenue Provisions Contained in the President’s Fiscal Year 2013 Budget Proposal, JCX-27-12 (March 14, 

2012), http://go.usa.gov/gPrA; and Congressional Budget Office, 

Reducing the Deficit: Spending and Revenue Options (March 2011). 
18 OPTIONS FOR TAXING U.S. MULTINATIONAL CORPORATIONS JANUARY 2013

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Table 7.

Policy Options for the Tax Treatment of U.S. Multinational Corporations

Continued

policies that ensure economic efficiency could be more 

appropriate. However, it is difficult to distinguish 

between actual changes in investment behavior and those 

that are purely changes in accounting for profits. 

Although there is some evidence that firms’ investment 

decisions are affected by changes in the U.S. corporate tax 

rate, research findings suggest that firms respond more by 

artificially shifting their reported profits abroad. 

The options presented here specifically address the 

taxation of foreign income earned by multinational corporations. Although this report does not discuss ways to 

change the treatment of U.S. corporations’ domestic 

Change in 

U.S. Tax Revenue, 

2012–2021

(Billions of dollars)

Effect on Decisions About:

Policy Description Investment Profit Shifting

Move More Toward a Worldwide Approach

Eliminate Deferral Subject all income earned 

by foreign subsidiaries of 

U.S. corporations to U.S. 

taxes but maintain 

foreign tax credit

Would reduce investment 

in low-tax countries and 

could boost investment in 

high-tax countries

Would reduce shifting of 

income to low-tax 

countries

114

Eliminate Deferral For 

Certain Countries

Eliminate deferral of 

income from countries 

with low or no corporate 

income tax

Would reduce investment 

in those countries; some 

firms might shift 

investment to other 

countries for which 

deferral was still allowed

Would reduce shifting 

of income to those 

countries; some firms 

might shift income to 

other countries for which 

deferral was still allowed

Uncertain

Eliminate Deferral 

Related to Goods 

Produced Abroad

Eliminate deferral of 

income earned from the 

sale of certain goods 

produced abroad

Would reduce investment 

in the affected countries 

Would have little effect 

on profit shifting

Potentially a small 

increase

Move Toward a Territorial Approach

Exempt Active Dividends 

Earned Abroad from 

U.S. Taxation

Exempt dividend 

income earned from 

investments abroad from 

U.S. corporate taxes; 

eliminate deduction for 

overhead expenses 

allocated to foreign 

operations

Would increase 

incentives to invest in 

low-tax countries

Would increase 

incentives to shift income 

to low-tax countries; 

would create incentives 

to characterize payments 

from foreign subsidiaries 

as active dividends

76

Apportion U.S. and 

Foreign Income by 

Formula

Allocate total income 

among the United States 

and other countries on 

the basis of the fraction 

of assets, sales, 

employment, and payroll 

in each country

Would increase 

incentives to invest in 

low-tax countries; the 

effects might be small

Would reduce the 

incentive for firms to shift 

income

Probable increase
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Table 7. Continued

Policy Options for the Tax Treatment of U.S. Multinational Corporations

Sources: Congressional Budget Office and the staff of the Joint Committee on Taxation.

a. The projected change in U.S. tax revenues for this option is for fiscal years 2013 to 2022. It includes the effects of interactions with other 

proposals in the President’s fiscal year 2013 budget.

operations, the options presented could be combined 

with other, broader changes to the U.S. corporate tax 

system. For example, changes in the taxation of multinational firms could be combined with a reduction in 

the corporate tax rate. One proposal, presented in the 

2010 report of the National Commission on Fiscal 

Responsibility and Reform (often called the Simpson–

Bowles commission), would combine a territorial tax 

system with a reduction of the top corporate tax rate from 

35 percent to a rate between 23 percent and 29 percent.33

Although a territorial system would strengthen the incentive for firms to move operations and reported income 

abroad, the reduction in the corporate tax rate could 

Change in 

U.S. Tax Revenue, 

2012–2021

(Billions of dollars)

Effect on Decisions About:

Policy Description Investment Profit Shifting

Restructure the Foreign Tax Credit

Determine Foreign Tax 

Credits on a Pooling 

Basis 

Base the total foreign tax 

credit on the share of 

aggregate earnings 

repatriated from each 

country

Would increase 

incentives to invest in 

low-tax countries, 

although with little effect

Would increase 

incentives to keep 

profits abroad to avoid 

U.S. taxes on income from 

subsidiaries in low-tax 

countries and would 

reduce shifting of income

57a

Determine Foreign 

Tax Credits with a 

Per-Country Limit

Disallow cross crediting 

by limiting the amount of 

foreign tax credits 

allowed from each 

country

Would increase 

incentives to invest in 

low-tax countries, 

although with little effect

Would increase shifting 

of income from high-tax 

to low-tax countries

Potentially small 

increase

Treat Entities and Income Consistently

Eliminate Check-the-Box 

Rules

Allow income from 

foreign entities to be 

untaxed only if the 

entity’s sole owner is 

legally organized or 

established within the 

same country

Would reduce incentives 

to invest abroad

Would reduce shifting of 

income from high-tax to 

low-tax countries 

Increase

Defer Interest 

Deductions Related to 

Deferred Income

Defer the deduction of 

interest expenses so that 

the share of total foreign 

expenses that is allowed 

to be deducted is the 

same as the ratio of 

repatriated income to 

total foreign income

Would indirectly increase 

incentives to invest 

abroad, although with 

little effect 

Would reduce shifting of 

income 

60a

33. See National Committee on Fiscal Responsibility and Reform, 

The Moment of Truth: Report of the National Commission on Fiscal 

Responsibility and Reform (December 2010), http://go.usa.gov/

fO7. 
20 OPTIONS FOR TAXING U.S. MULTINATIONAL CORPORATIONS JANUARY 2013

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offset those incentives and encourage firms to operate in 

and report their income in the United States. 

Other broad proposals involve combining reductions in 

the corporate tax rate with provisions that would move 

the tax system toward a more worldwide taxation structure. The President’s fiscal year 2013 budget proposal, 

for example, called for reducing the top corporate tax rate 

from 35 percent to 28 percent and instituting a minimum tax on income retained in low-tax countries.34

Reducing the corporate tax rate could dampen the incentive for multinational corporations to invest abroad or 

to change the location of reported income as a way to 

minimize their tax liability. However, as long as some 

countries have low corporate income tax rates or none at 

all, such incentives will never be completely overcome by 

reducing U.S. tax rates.

Move More Toward a Worldwide Approach

Because the U.S. tax system taxes income earned abroad, 

it leans toward a worldwide approach. However, deferral 

of taxes on unrepatriated foreign income gives the tax 

system some characteristics of a territorial approach. 

Options that would eliminate or reduce the ability of 

multinational corporations to defer taxes on foreign 

income would move the U.S. tax system closer to a purely 

worldwide system. Some options would prevent U.S. 

firms from deferring U.S. taxes on foreign income; all 

income earned by those businesses would be taxed as it is 

earned. Other options would maintain deferral but limit 

the types of income that could be deferred as a way to 

boost economic efficiency and increase revenues by 

removing incentives to shift income to low-tax jurisdictions or to invest in low-tax jurisdictions solely to avoid 

paying U.S. taxes.35

Eliminate Deferral. Under this option, all income earned 

by foreign subsidiaries of U.S. corporations—regardless 

of whether the income had been repatriated—would be 

subject to U.S. taxes. To prevent double taxation of foreign income, the foreign tax credit would remain in force, 

but, as under current law, that credit could not exceed the 

U.S. tax liability on foreign income. Because all income 

would be treated identically and taxed concurrently, however, the U.S. parent corporation’s overhead expenses 

would no longer be allocated between domestic and 

foreign activities for determining the foreign tax credit. 

Eliminating deferral would reduce the movement of capital and reported income to low-tax countries. Income 

earned abroad would generally be subject to the U.S. tax 

rate, thus reducing incentives to shift investment or 

reported income to countries with low taxes. With deferral, firms have an incentive to bring back only as much 

income from low-tax countries as can be sheltered by the 

excess credits generated from paying taxes in high-tax 

countries. Without deferral, the tax advantage of retaining income in a low-tax country would be diminished: 

All of a corporation’s income would now be taxed currently at U.S. rates. Removing that advantage would 

reduce tax-based motivations to retain income in low-tax 

countries and encourage companies to redirect those 

resources to more efficient uses.

Although this option generally would dampen the incentive to shift investment and reported income to low-tax 

countries, in some circumstances, corporations might still 

find an advantage in doing so. Deferral might be eliminated, but the rules governing foreign tax credits would 

not change and the amount of the credit would still be 

limited to the U.S. tax liability on income earned abroad; 

firms investing in countries with tax rates above those 

in the United States would still be able to use cross crediting to avoid paying some tax. Thus, firms with excess 

foreign tax credits would still find it advantageous to shift 

investments or reported income from high-tax to low-tax 

countries. A variant of this option also would limit or 

eliminate cross crediting, further shrinking the incentive 

to shift investments to low-tax countries.

Revenue gains resulting from eliminating deferral 

might be diminished if, in response, corporations shifted 

investment or reported income from low-tax to high-tax 

countries. A business that had transferred its income to a 

low-tax country solely to cut its tax liability, for example, 

would no longer benefit from retaining income in the 

low-tax country and might shift that income back to one 

or more high-tax countries. Such a response could offset 

the revenue gains to the United States. However, if the 

option was paired with limits on cross crediting, the tax 

incentives to shift investments or income to high-tax 

countries would be reduced. 

34. See White House and Department of the Treasury, The 

President’s Framework for Business Tax Reform (February 2012), 

http://go.usa.gov/fOv. 

35. Eliminating deferral would remove the territorial features of the 

current tax system but would still not result in a purely worldwide 

tax system unless the limit on the foreign tax credit was eliminated 

as well. 
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Eliminating deferral also could increase the incentive corporations have to incorporate, or register, abroad or to 

merge with overseas firms, thus reducing U.S. revenue 

gains in the future. However, the current tax system 

penalizes U.S. firms that “invert,” or reincorporate 

abroad. A more worldwide system could encourage 

emerging businesses to choose foreign incorporation 

without fear of inversion penalties. (Under the current 

system, there seems to be little evidence that fledgling 

firms choose to start up abroad.)36

JCT estimates that eliminating deferral would raise, on 

net, about $50 billion between 2012 and 2016 and 

$114 billion over the 2012–2021 period.37

Eliminate Deferral for Certain Countries. This option 

would eliminate deferral of income earned in countries 

that are considered tax havens, giving corporations less 

incentive to invest in or shift income to those countries 

because all of the resulting income would be subject to 

U.S. taxation as it was earned. Those firms would still 

have an incentive to shift investment or reported income 

to other low-tax countries that are not considered tax 

havens. The net effects on investment and incomeshifting are uncertain and have not been estimated.

The effect on U.S. tax revenues also is not clear; it would 

depend on how firms responded to the new incentives for 

investment and income shifting. If the shift was from 

countries considered tax havens to high-tax countries, tax 

revenues attributable to repatriation could drop as firms 

relied more on cross crediting. Alternatively, if investment 

or income was moved to other low-tax countries and 

repatriated, U.S. tax revenues could rise. 

Eliminate Deferral Related to Goods Produced Abroad. 

This option would eliminate deferral of income from the 

sale of goods produced abroad and imported to the 

United States, thus discouraging investment in foreign 

countries. The option would discourage the building 

of “runaway plants,” which corporations use to shift 

production abroad while they either import the goods to 

the United States or export them to another country. In 

the absence of enforceable rules for tracing the path of 

goods from production to final consumers, U.S. multinational corporations can currently adjust the reported 

location of their sales, which may or may not require 

physical transfer of goods, to take advantage of deferral. 

For example, a firm might transfer goods or ownership of 

products to another country so that they could be 

imported back to the United States and the income from 

that sale would be deferrable. Because this option would 

target sales of goods abroad rather than transfers of 

reported income, it probably would have little effect on 

the shifting of income to low-tax countries. 

To the extent that this type of option is enforceable, U.S. 

tax revenues would probably increase because the option 

would limit the amount of income corporations could 

defer. However, the revenue gains could be minimal if the 

affected goods were produced in high-tax countries, 

where U.S. corporations can take larger foreign tax 

credits. 

Move Toward a Territorial Approach

The United States could move formally toward a territorial system of taxation in any of several ways, one of 

which would be to exempt some or all income earned 

abroad from the U.S. corporate income tax.38 Under one 

option, dividend income from investments abroad would 

be excluded from the U.S. tax base; in that case, by setting those dividends, multinational corporations would 

determine the amount of income earned abroad that 

would be excluded. Another option would require firms 

to use a formula, set by law, to distinguish foreign from 

domestic income. A formula approach is not necessarily 

limited to a purely territorial system; it could also be 

applied to a tax system, like the current one in the United 

States, that leans toward a worldwide system but has 

deferral.

Exempt Active Dividends Earned Abroad from U.S. 

Taxation. Exempting active foreign dividends from 

U.S. taxation would move the country toward a 

36. See Eric J. Allen and Susan C. Morse, “Firm Incorporation Outside the U.S.: No Exodus Yet” (unpublished paper, University of 

California, Hastings College of Law, October 2011), 

www.works.bepress.com/susanmorse/10.

37. That estimate differs from the tax expenditure for deferral because 

of adjustments made to account for firms’ behavioral responses 

(for example, choosing to restructure in favor of foreign branches 

rather than subsidiaries) in the estimates for policy options. See 

Congressional Budget Office, Reducing the Deficit: Spending and 

Revenue Options (March 2011), p. 186. 

38. For a comparison of options to eliminate deferral and exempt 

dividends, see Rosanne Altshuler and Harry Grubert, “Corporate 

Taxes in the World Economy: Reforming the Taxation of CrossBorder Income,” in John W. Diamond and George R. Zodrow, 

eds., Fundamental Tax Reform: Issues, Choices, and Implications

(MIT Press, 2008).
22 OPTIONS FOR TAXING U.S. MULTINATIONAL CORPORATIONS JANUARY 2013

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territorial tax system; active dividends from investments 

abroad would not be subject to domestic corporate taxes. 

All other forms of foreign income, including royalties, 

interest payments, and income from passive activities, 

would be taxed as they are under current law—as the 

income is earned.39 Under this option, overhead expenses 

that are allocated to foreign operations (such as interest 

expenses generated by foreign subsidiaries’ borrowing) 

would no longer be deductible because the income associated with those expenses would never be subject to 

U.S. taxation. 

Exempting active foreign dividends would tend to 

increase investment in and reported income from low-tax 

countries. The option would make investment behavior 

by U.S. firms less efficient by increasing incentives to 

invest in low-tax countries.40 Without a tax on repatriated 

dividends, U.S. multinational corporations would prefer 

to locate as much income as possible in the lowest-tax 

countries and would have more incentive to shift their 

reported income to such countries. Additionally, firms 

would have an incentive to characterize payments from 

foreign subsidiaries as active dividends because they 

would be exempt from U.S. taxation. 

In general, countries with territorial (or exemption) tax 

systems collect less revenue, all else being equal, than they 

would with worldwide tax systems.41 However, for two 

reasons, this option could raise revenues, despite the 

exemption of foreign dividends from taxable income: 

The option would restrict the ability of firms to deduct 

expenses associated with foreign operations, and it would 

more effectively tax income from royalties.42 Other methods of exempting dividends could result in revenue losses.

All expenses now are deductible regardless of their source. 

Under this option, overhead expenses allocated to foreign 

operations would no longer be deductible and a corporation’s taxable income would, according to JCT, increase 

enough to more than offset the Treasury’s loss from not 

taxing active foreign income. If firms were allowed to 

continue to deduct all overhead expenses, including those 

associated with foreign operations, this option would 

probably result in a significant revenue loss.

This option also could result in added federal tax revenues because receipts from taxes on royalty income would 

probably rise once dividends were exempted. Current law 

subjects income from royalties to U.S. taxation. However, 

firms are able to use excess foreign tax credits generated 

by dividends from high-tax countries to cross credit 

against U.S. taxes on royalty income, allowing much of 

that income to escape U.S. taxation. Under this option, 

those dividends—once exempted from U.S. taxation—

could not be used to generate excess foreign tax credits, 

thus increasing the likelihood that royalty income would 

become taxable.43

JCT has estimated that this option would increase revenues by about $32 billion from 2012 through 2016 and 

by $76 billion from 2012 through 2021.44

Apportion U.S. and Foreign Income by Formula. Another 

path to a territorial-type system would be to institute 

what is known as formula apportionment. Some observers consider this approach a simpler alternative to the 

current transfer-pricing rules, which require arm’s-length 

pricing that is difficult to enforce. Under formula apportionment, before-tax income would be allocated to the 

United States and other countries according to a formula 

that accounted for the fraction of assets, sales, employment, and payroll a corporation had in each country, 

rather than relying on the taxpayer’s reports of their 

income reflecting the transfer prices it had set.45 The 

39. Unlike dividends, other types of active income (such as interest 

payments, fees, or royalties) are taxed when they are earned 

because they flow directly to the parent company. All passive 

income is taxed as it is earned under subpart F of the Internal 

Revenue Code.

40. There could be efficiency gains for the U.S. economy to the extent 

that the overall tax on capital was reduced. Determining the net 

effect is difficult and depends on the details of the option. 

41. Territorial approaches are sometimes referred to as exemption 

systems because they exempt, subject to anti-abuse rules, foreign 

income from taxation.

42. Kimberly A. Clausing, “Corporate Tax Revenues in OECD 

Countries,” International Tax and Public Finance, vol. 14, no. 2 

(April 2007), pp. 115–133.

43. For discussion of the effects of exempting dividends, see Rosanne 

Altshuler and Harry Grubert, “Where Will They Go If We Go 

Territorial: Dividend Exemption and the Location Decisions of 

U.S. Multinational Corporations,” National Tax Journal, vol. 54, 

no. 3 (December 2001), pp. 787–809; and Harry Grubert, 

“Enacting Dividend Exemption and Tax Revenue,” National Tax 

Journal, vol. 54, no. 3 (December 2011), pp. 811–827. 

44. Congressional Budget Office, Reducing the Deficit: Spending and 

Revenue Options (March 2010), pp. 187–188.

45. Net income, rather than gross income, would be allocated, 

causing the deductions for expenses also to be allocated proportionately to foreign income. As a result, deductions against foreign 

income would be higher than they are under the current system.
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income allocated to the United States would then be 

subject to U.S. taxation. 

Another type of formula apportionment would separately 

address the allocation of income from intangible assets, 

such as patents and trademarks, because that allocation is 

not readily observable. Such an approach would assign 

normal returns from an investment—that is, the return 

that would be expected to cover the cost of investment—

to the country where the costs of producing the income 

are incurred and assign any remaining income (the 

income from intangible assets) on the basis of where the 

products are sold.46

With allocation on the basis of a formula, there would be 

fewer disputes between the tax authorities and taxpayers 

regarding the amounts that are reported as income. The 

formula would be statutory and based on actual business 

activity, so U.S. firms would find it more difficult to 

avoid taxes by moving reported income abroad. But 

because they would still have an incentive to locate real 

investment in countries with lower tax rates, this option 

would not reduce inefficiencies from decisions about 

where to locate investments. 

In the United States, some states have already adopted 

formulas that determine taxable corporate income by the 

fraction of the corporation’s sales, employment, or physical assets (or some weighted combination of each factor) 

within the state.47 The European Union has proposed a 

similar form of formula apportionment under which 

taxable income would be determined using a weighted 

fraction of the share of sales, payroll, employment, and 

assets in a given country.48

Some important practical considerations could hamper 

the adoption of an apportionment system, however. 

For example, other countries might retaliate if the 

United States were to implement such a system without 

renegotiating its tax treaties and trade agreements.49

Such concerns have led the European Union to limit its 

proposal for formula apportionment to its member 

countries.

Moreover, formula apportionment imposes an implicit 

tax on each factor used in the formula, which could 

reduce investment by discouraging companies from hiring workers or accumulating assets in high-tax countries 

(including the United States). As a result, those firms 

might shift their investments to low-tax countries, thus 

reducing U.S. tax revenues and increasing inefficiency. In 

addition, without coordination between countries, under 

this option some income could be taxed twice: Income 

would be treated as though derived from domestic 

sources and taxed in the United States, even though it 

was earned abroad and might be taxed by the host 

country as well. 

Possible inefficiencies stemming from multinationals’ 

incentives under the formula to change the location of 

investments would be mitigated by other factors that—

both under current law and under the option—restrict 

movement in real activity. For example, firms might find 

it costly to transport materials or could find themselves 

constrained by the need to locate in a country where 

demand for their goods or services is high. Because capital is more mobile than customers, a formula that gave 

greater weight to the fraction of sales in a given country 

also would reduce the incentive to move production to a 

country that did not have a significant consumer market 

for the product. 

This option would generally make it more difficult to 

shift reported income abroad because income would be 

allocated on the basis of relatively immobile factors, such 

as employment and sales. However, corporations could 

still take steps to minimize their taxes, especially if 

income was assigned in part according to the location of 

assets. For example, financial assets are relatively mobile 

and could be moved by firms trying to reduce their tax 

liability. The alternative approach, with separate allocations for income and intangible assets, would further 

46. For discussion of this approach, see Reuven S. Avi-Yonah, 

Kimberly A. Clausing, and Michael C. Durst, “Allocating Business Profits for Tax Purposes: A Proposal to Adopt a Formulary 

Profit Split,” Florida Tax Review, vol. 9, no. 5 (2009), pp. 497–

553. 

47. See Federation of Tax Administrators, “State Apportionment of 

Corporate Income” (May 2012), www.taxadmin.org/fta/rate/

tax_stru.html.

48. For a discussion of the consequences of such a change, see Michael 

Devereux and Simon Loretz, The Effects of EU Formula Apportionment on Corporate Tax Revenues, Working Paper WP 07/06 

(Oxford University Centre for Business Taxation, April 2007), 

www.sbs.ox.ac.uk/centres/tax/papers/Pages/paperWP0706.aspx. 

49. For a discussion of the complexity of implementing formula 

apportionment, see Joanne Martens Weiner, Formulary Apportionment and Group Taxation in the European Union: Insights from the 

United States and Canada, Taxation Papers, Working Paper 8 

(European Commission, 2005), http://ec.europa.eu/taxation

_customs/common/publications/services_papers/working

_papers/index_en.htm.
24 OPTIONS FOR TAXING U.S. MULTINATIONAL CORPORATIONS JANUARY 2013

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constrain income shifting by allocating income on the 

basis of production costs and sales and reducing corporations’ ability to strategically locate expenses and income 

in different countries.

By using measures of actual business activity to allocate 

income between domestic and foreign sources instead of 

allowing firms to identify sources of income, this option 

would probably increase U.S. tax revenues. Because 

it would primarily impede corporations’ efforts to shift 

reported profits as a way to avoid U.S. taxation, however, 

firms might respond by shifting their investments to lowtax countries, and the revenue gains from the option 

would be reduced. 

Other Options

Two other types of options would address tax avoidance 

as it is permitted under the current system: restructuring 

the foreign tax credit and providing a system of more 

consistent treatment of various entities and income. 

Restructure the Foreign Tax Credit. Although opportunities for cross crediting are limited because statutory 

corporate tax rates are generally higher in the United 

States than they are in other countries, some researchers 

still report significant use of cross crediting by U.S. 

multinational corporations.50 Those results suggest that 

effective corporate tax rates, which reflect both the statutory rates and other features of the tax system, are lower 

in the United States than in some other countries (see the 

appendix for a discussion of effective rates). 

Concern over corporations’ use of excess foreign tax credits to offset tax liabilities in low-tax countries has led to 

suggestions that the foreign tax credit should be restructured. Under one option, credits would be determined by 

“pooling”—limiting the total foreign tax credit according 

to the share of a firm’s total foreign income that is repatriated to the U.S. parent company. Another option would 

limit the foreign tax credit that a corporation could claim 

for every country separately. Both options would affect 

repatriation of income by corporations that amass an 

excess of credits to shield repatriated income from taxation in the United States. The effects of such provisions 

on U.S. tax revenues would depend on firms’ ability to 

adjust their repatriations or allocations of worldwide 

income. If modifications to the foreign tax credit were 

paired with an option that substantially reduced deferral 

or eliminated it altogether, those companies would be 

more likely to repatriate income, thus increasing U.S. tax 

receipts. 

Determine Credits on a Pooling Basis. Under this option, 

foreign tax credits would be determined by pooling the 

firm’s earnings from all foreign countries, and the total 

credit would be set according to the percentage of those 

aggregate earnings that are repatriated. 

In general, the option would reduce the foreign tax 

credit. As an example, consider a multinational corporation with gross earnings of $100 million from each of two 

subsidiaries—one in a country with a corporate tax rate 

of 12.5 percent and one in a country with a 40 percent 

tax rate (see Table 8). The firm pays a total of $52.5 million in foreign taxes. Suppose it repatriates all of its net 

earnings—$60 million—from the subsidiary in the 

high-tax country ($100 million in dividends minus the 

$40 million paid in taxes) but only $19.5 million from 

the subsidiary in the low-tax country ($22.3 million in 

dividends minus $2.8 million in taxes). In total, the firm 

pays $42.8 million in foreign taxes on the income repatriated to the United States. The foreign tax credit on the 

repatriated income also is $42.8 million—the top U.S. 

corporate rate of 35 percent applied to the repatriated 

gross income (that is, the income repatriated to the 

United States, including the foreign taxes that have been 

paid on that income, or $122.3 million). Thus, under 

current law the firm can take foreign tax credits equal to 

82 percent of the total foreign taxes it paid ($42.8 million 

divided by $52.5 million). Under this scenario, the parent company has repatriated enough income from the 

subsidiary in the low-tax country to use up the excess 

credits from the subsidiary in the high-tax country. 

Under the option, credits would be assigned according to 

the amount of pooled foreign income, and the computation of foreign taxes paid would differ from that under 

current law in two key regards. First, the computation 

would start with the total amount of taxes paid to foreign 

entities ($52.5 million, in the example). Then, that total 

would be allocated among countries based on the share of 

total before-tax foreign earnings repatriated from each 

country. 

50. Harry Grubert and Rosanne Altshuler, “Corporate Taxes in a 

World Economy: Reforming the Taxation of Cross-Border 

Income,” in John W. Diamond and George Zodrow, eds., 

Fundamental Tax Reform: Issues, Choices and Implications

(MIT Press, 2008).
JANUARY 2013 OPTIONS FOR TAXING U.S. MULTINATIONAL CORPORATIONS 25

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Table 8.

Example of Pooling to Determine Credits

(Millions of dollars)

Source: Congressional Budget Office.

a. Amount is the average tax rate across the two countries.

b. Repatriated income is “grossed up” to include the amount of taxes paid on that income to the foreign country; the value of the repatriated 

income is divided by one minus the tax rate of the country from which the income is repatriated.

c. Per-country credits are shown for illustration only and are not calculated separately for U.S. tax purposes.

d. Amount is the difference between grossed-up dividends and repatriated dividends.

e. Amount is the product of total foreign taxes paid in both countries and grossed-up dividends in a particular country as a percentage of 

before-tax earnings in both countries.

In the example, the subsidiary in the low-tax country 

repatriated about 11 percent of the $200 million that the 

corporation earned through its operations in both foreign 

countries, and the subsidiary in the high-tax country 

repatriated 50 percent. The share of foreign taxes attributed to the low-tax subsidiary would be $5.9 million 

(11 percent of $52.5 million) and the share attributed 

to the high-tax subsidiary would be $26.3 million 

(50 percent of $52.5 million). The total would be 

$32.1 million and, under the pooling option, the foreign 

tax credit also would be $32.1 million. Thus, under the 

pooling option, the firm can take foreign tax credits only 

to the extent that those credits equal 61 percent of foreign 

taxes. 

The foreign tax credit is smaller under the pooling 

option—in this example, it is reduced by $10.7 million—because the firm repatriated just 61 percent of its 

foreign income, and the credit would be limited to that 

share of the total foreign taxes the firm had paid. Under 

current law, the firm can claim a credit for more foreign 

taxes by repatriating more from high-tax countries than 

from low-tax countries. The pooling provision would 

reduce the amount of the credit because it would require 

a shared allocation. 

The net effect on corporations’ investment is not clear 

but probably would be small. Limiting the ability to cross 

credit could shift investment from high-tax to low-tax 

countries because corporations would not benefit as 

Before-Tax Earnings 100.0 100.0 200.0

Foreign Tax Rate (Percent) 12.5 40.0 26.3 a

Foreign Taxes Paid on All Earnings 12.5 40.0 52.5

Repatriated Income 19.5 60.0 79.5

Repatriated Income Before Foreign Taxes 

Millions of dollarsb 22.3 100.0 122.3

As a percentage of total before-tax 

earnings in both countries 11.1 50.0 61.1

U.S. Taxes Before Foreign Tax Credit 7.8 35.0 42.8

Foreign Taxes Paid on Repatriated Incomed 2.8 40.0 42.8

Foreign Tax Credit with Cross Crediting 7.8 35.0 42.8

U.S. Taxes After Foreign Tax Credit 0 0 0

U.S. Taxes Before Foreign Tax Credit 7.8 35.0 42.8

Foreign Taxes Deemed Paid on Repatriated Incomee 5.9 26.3 32.1

Foreign Tax Credit 5.9 26.3 32.1

U.S. Taxes After Foreign Tax Credit 1.9 8.7 10.7

Low-Tax Country High-Tax Country Total

Taxes Under Current Lawc

Taxes Under a Pooling Option

Foreign Income
26 OPTIONS FOR TAXING U.S. MULTINATIONAL CORPORATIONS JANUARY 2013

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much from the larger tax credits. Firms also might 

respond to the higher taxes on repatriated income by 

increasing investment abroad and retaining more of the 

resulting earnings. The effects probably would be small, 

however, because the additional tax benefits would be 

insufficient to compensate for the barriers to moving 

investments abroad. 

Nevertheless, determining foreign tax credits by pooling 

would have implications for the way firms allocate their 

income. As the example above shows, this option would 

restrict firms’ ability to use excess credits from countries 

with high taxes to offset the U.S. corporate tax on income 

from countries with low taxes. It would thereby reduce 

the incentive to shift reported profits strategically 

between high-tax and low-tax countries to take advantage 

of cross crediting and deferral. 

Some income from subsidiaries in high-tax jurisdictions 

would be taxed at a substantially higher rate under the 

option than would be the case under current law. (In this 

example, the firm would pay the $40 million in taxes to 

the high-tax country, both under current law and with 

pooling, but the pooling option would require the firm 

to pay U.S. tax of $8.7 million in excess of the allowable 

foreign tax credit). That effect would be mitigated 

somewhat by the higher foreign tax credit imputed to 

the income repatriated from the lower-tax country 

($5.9 million, compared with $2.8 million permitted 

under current law). 

Corporations generally would no longer have an incentive to strategically choose individual subsidiaries from 

which to repatriate income because taxes would be proportionately assigned to each country and would not be 

linked to the individual subsidiary. In general, however, 

firms would still have an incentive to keep profits abroad 

to avoid paying U.S. taxes on income from subsidiaries in 

low-tax jurisdictions. Indeed, that incentive would be 

stronger because of the decline in the potential value of 

the foreign tax credit. 

JCT estimates that adopting this option (the same as that 

proposed in the President’s 2013 budget) would increase 

revenue by $25 billion between fiscal years 2013 and 

2017 and by $57 billion between fiscal years 2013 and 

2022.51

Determine Credits with a Per-Country Limit. Another 

option would disallow cross crediting by limiting the 

amount of credits allowed from each country. By requiring firms to compute a separate foreign tax credit for 

income earned in each country, a per-country limit, like 

that in effect in the United States between 1932 and 

1976, would prevent firms from using repatriated income 

from a high-tax country to shield income from a low-tax 

country. 

By eliminating the ability of firms to cross credit by combining the income from high-tax and low-tax countries, 

this option would bolster the incentive to reinvest income 

in low-tax countries rather than repatriate it. Firms also 

would have an incentive to shift income from high-tax 

to low-tax countries. However, to the extent that income 

in low-tax countries is derived from passive activities, 

those firms could no longer shield the income from U.S. 

taxation through the use of excess foreign tax credits. It is 

not clear whether net repatriated income would decline as 

a result, but if repatriation responses were small, U.S. tax 

revenues would increase. 

A disadvantage of the option is its complexity. Firms 

would have to report the sources of income and calculate 

credits separately for each country instead of combining 

income from all countries under an aggregate credit as 

they do under current law. Large multinational corporations with multiple tiers of subsidiaries in different 

countries would face an especially large additional filing 

burden.

Treat Entities and Income Consistently. Another 

approach would be to incrementally change the taxation 

of U.S. multinational corporations by treating different 

forms of business entities and income more consistently 

than current law does. One option would repeal the 

check-the-box rules that allow U.S. multinationals to 

treat subsidiaries differently for U.S. tax purposes than 

they are treated by foreign jurisdictions. Another would 

preclude U.S. corporations from claiming interest deductions related to foreign income that stays abroad and out 

of reach of U.S. taxation. Both options generally would 

increase U.S. tax revenues because they would constrain 

the ability of firms to shift reported income from the 

United States to low-tax countries. However, they also 

could reduce economic efficiency if corporations

51. Joint Committee on Taxation, Estimated Budget Effects of the Revenue Provisions Contained in the President’s Fiscal Year 2013 Budget 

Proposal, JCX-27-12 (March 14, 2012), http://go.usa.gov/gPrA. 
JANUARY 2013 OPTIONS FOR TAXING U.S. MULTINATIONAL CORPORATIONS 27

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Figure 1.

Effect of Check-the-Box Rules Under Current Law and If Eliminated

Source: Congressional Budget Office.

responded by moving their investments to low-tax 

countries.

Eliminate Check-the-Box Rules. U.S. parent corporations 

currently can choose to shield the passive income of certain solely owned foreign subsidiaries from U.S. taxation 

by checking a box on their tax returns. (Under normal 

circumstances, the income would be subject to U.S. 

taxation under the subpart F rules that govern passive 

income.) Check-the-box rules allow multinational corporations to create and use hybrid business entities, which 

are treated differently by foreign tax authorities than they 

are by the United States. In a simple case, a parent company owns a Subsidiary A, which it has incorporated in a 

high-tax country. Subsidiary A wholly owns Subsidiary B, 

which is located in a low-tax country (see Figure 1). 

Subsidiary A borrows $100 million from Subsidiary B, 

and because Subsidiary B is a separate corporation, 

Subsidiary A is allowed to deduct its interest payments 

on the loan from its income on its tax return in the 

high-tax country. But Subsidiary B is treated as a 

branch of Subsidiary A for U.S. tax purposes under the 

check-the-box rules, and the U.S. tax code considers the 

income received by a branch (B, in this example) to be 

the legal income of the parent (A, in this example). Thus, 

under U.S. tax law, the interest payment, in effect, is 

treated as an internal transaction within Subsidiary A. As 

a result, the interest income received by Subsidiary B 

escapes U.S. taxation.

Those rules facilitate shifting income from high-tax 

countries to low-tax countries by multinational corporations and encourage firms to shift investment and 

reported profits abroad to avoid paying U.S. taxes. 

By making interest payments to subsidiaries in lowtax countries and deducting those payments in high-tax 

countries, the firms effectively shift that income from 

subsidiaries in high-tax countries to subsidiaries in lowtax countries. Furthermore, those payments, which 

would be considered passive income and subject to U.S. 

taxation, are shielded from U.S. taxes by the check-boxrule that allows Subsidiary B to be treated as part of 

Subsidiary A. As a result, the interest payments are not 

considered income under current U.S. tax law.

Current Check-the-Box Rules Elimination of Check-the-Box Rules

U.S. parent corporation chooses to treat

Subsidiary B as a branch of Subsidiary A

U.S. parent corporation must treat

Subsidiary B as a separate incorporated entity

Subsidiary A

U.S. Parent Corporation

Subsidiary B

Subsidiary B’s

interest income 

is not subject to 

U.S. taxation as 

passive income

of the U.S. parent

corporation

U.S

TAX XRETURN

Owns Subsidiary A

Located in high-tax country

Owns Subsidiary B

Pays interest income to Subsidiary B

Located in low-tax country

Deducts

interest

income on

tax return of

high-tax

country

U.S

TAX

RETURN

Subsidiary B’s

interest income 

is subject to 

U.S. taxation as

passive income

of the U.S. parent

corporation

;

Interest

Interest Subsidiary B

Located in low-tax country
28 OPTIONS FOR TAXING U.S. MULTINATIONAL CORPORATIONS JANUARY 2013

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This option would require that income from foreign entities be excluded from taxable income only if that entity’s 

sole owner is legally organized or established within the 

same country. That restriction would constrain U.S. parent corporations’ ability to shift income from high-tax to 

low-tax countries through payments of passive income 

that currently escape taxation under subpart F. Passive 

income payments made between two entities could still 

be excluded from taxable income as long as both were in 

the same country.

The advantages of investing abroad would decline under 

this option because firms would lose the ability to shield 

certain income from those investments. There would be 

no advantage to shifting income because payments would 

be taxed at the same time and at the same rates as the 

corresponding deductions. Moreover, U.S. tax revenues 

would increase because passive income from solely owned 

subsidiaries would not be shielded from U.S. taxation. 

(However, if the look-through rule provision was 

extended beyond 2013, eliminating check-the-box rules 

would not prevent firms from shielding intercompany 

payments from U.S. taxation.)

Defer Interest Deductions Related to Deferred Income. U.S. 

multinational corporations can deduct interest expenses 

from their taxable income. Those expenses are not allocated between foreign and U.S. sources for purposes of 

determining deductions against gross income that is subject to U.S. taxation. However, for determining the limit 

on the foreign tax credit, interest expenses are allocated to 

foreign and domestic sources in proportion to the ratio of 

foreign assets to total assets. 

This option would defer the deduction of interest 

expenses allocated to foreign income that is not currently 

subject to U.S. taxation. The proportion of all foreignrelated deductions allowed would be the same as the ratio 

of taxable foreign income to total foreign income. The 

foreign tax credit would still be determined by allocating 

all expenses according to the share of a company’s total 

assets in each country. 

In general, requiring interest deductions to be deferred 

until the associated income is repatriated would provide 

an incentive for corporations to accelerate repatriation. 

Still, increased repatriation could come from countries 

with higher taxes, and firms could still use cross crediting 

to shield income repatriated from low-tax countries 

under this option. 

By making it more costly for corporations to shift income 

abroad, this option might cause firms to respond by 

adjusting their investments to avoid an increase in tax liability. Nevertheless, the targeted nature of this option 

would probably produce little change in investment. The 

incentives to shift income would decline, because firms 

could no longer immediately claim deductions for 

expenses associated with foreign operations when taxes 

on the income earned from those activities was deferred. 

JCT estimates that adopting this option (which was 

proposed in the President’s 2013 budget) would increase 

revenue by $28 billion between fiscal years 2013 and 

2017 and by $60 billion between fiscal years 2013 

and 2022.52

52. Joint Committee on Taxation, Estimated Budget Effects of the Revenue Provisions Contained in the President’s Fiscal Year 2013 Budget

Proposal, JCX-27-12 (March 14, 2012), http://go.usa.gov/gPrA.
CBO

Appendix: 

Corporate Tax Rates

Corporate income tax rates are specified by the tax 

code. However, the actual tax rates that a firm faces differ 

from the rates in the tax code—the statutory tax rate—

because of other provisions in the code that affect its tax 

liability. Both the statutory rates and those that the firm 

actually pays can be compared among countries to analyze the tax burdens firms face in different countries. 

Statutory Corporate Income Tax Rates

Most developed countries—including all members of the 

Organisation for European Co-operation and Development (OECD)—tax corporate income, typically at the 

national and the subnational (state or province, for example) levels. Statutory tax rates on corporate income differ 

from one country to another. In 2011, the top rates 

among the 34 members of the OECD ranged from 

12.5 percent in Ireland to 39.5 percent in Japan (see 

Figure A-1). Those rates combined the top national statutory corporate tax rate—that is, the tax rate that applies 

to income in the highest tax bracket—in each country 

with the average corporate tax rate set at the subnational 

level of government.1

 In 2011, the top U.S. federal 

statutory rate on business income that was subject to the 

corporate income tax was 35 percent, and the average top 

statutory rate imposed on that income by states was 

about 6 percent—for a combined top statutory rate of 

39.1 percent (after accounting for the fact that state taxes 

are deductible from federal taxable income).

Weighted by gross domestic product, the average combined tax rate for current OECD countries, excluding the 

United States, was 19.1 percent in 2011. (That average 

probably declined in 2012 because Japan cut its top corporate tax rate—at the national level—in April from 

30 percent to 25.5 percent, making the statutory U.S. tax 

rate the highest among OECD member countries.)2

Although the majority of OECD countries have a top 

corporate tax rate of at least 25 percent, some countries 

have rates that are so low (sometimes zero) that they are 

considered tax havens, attracting both investment by and 

reported income from multinational corporations (see 

Box 1 on page 13). 

Average Tax Rates

Statutory rates may not represent the tax rate that multinational corporations actually face. Because of the 

graduated rate structure, deductions, credits, and other 

business tax provisions (such as favorable depreciation 

allowances and credits for certain activities), the average 

tax rates that corporations pay—the ratio of total taxes to 

aggregate income—are generally below the top statutory 

rates. For example, the average rate faced by U.S. domestic firms with no foreign operations between 2005 and 

2009 was about 10 percentage points lower than the 

statutory rate. 3

1. For each country in which subnational corporate taxes are 

deductible from national taxes, as in the United States, the combined statutory tax rate is the sum of the national and subnational 

tax rates minus the product of the national and subnational 

statutory rates, which amounts to the value of the deduction. 

2. Japan added a 10 percent surtax for three years, raising the rate to 

28.01 percent (excluding local taxes).

3. For a comparison of the average U.S. tax rate with that of selected 

other countries, including major trading partners, see Kevin 

Markle and Douglas Shackelford, Cross Country Comparisons of 

Corporate Income Taxes, Working Paper 16839 (National Bureau 

of Economic Research, February 2011) www.nber.org/papers/

w16839. 
30 OPTIONS FOR TAXING U.S. MULTINATIONAL CORPORATIONS JANUARY 2013

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Figure A-1.

Combined Corporate Income Tax Rate of OECD Countries, 2011

(Percent)

Source: Congressional Budget Office based on data from the Organisation for Economic Co-operation and Development (OECD).

Note: The combined corporate income tax rate is the rate charged at the national and subnational (state or province, for example) levels.

Ireland

Czech Republic

Hungary

Poland

Slovak Republic

Chile

Greece

Iceland

Slovenia

Turkey

Estonia

Switzerland

Israel

South Korea

Austria

Denmark

Netherlands

Finland

United Kingdom

Sweden

Portugal

Italy

Canada

New Zealand

Norway

Luxembourg

Australia

Mexico

Spain

Germany

Belgium

France

United States

Japan

0 5 10 15 20 25 30 35 40
APPENDIX OPTIONS FOR TAXING U.S. MULTINATIONAL CORPORATIONS 31

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Effective Marginal Tax Rates

Another way to compare corporate tax rates among 

countries is to look at the effective marginal corporate tax 

rate—the rate of tax paid on an additional dollar of 

income. Like average tax rates, effective marginal tax rates 

take into account tax preferences as well as the statutory 

tax rate. 

Corporations generally consider their marginal tax rates 

when they assess whether to make additional investments 

in ongoing projects. In contrast, average tax rates are 

more relevant when considering substantial investments, 

such as those required for building manufacturing plants 

abroad. As a result, average tax rates could carry more 

weight than marginal rates do in the calculations that 

determine whether a company will make a large new 

investment in a particular country. 

Effective marginal tax rates depend on several factors, but 

two in particular—the treatment of depreciation and the 

treatment of financing—largely determine the differences 

between statutory rates and effective marginal tax rates. 

Consequently, an important component of the after-tax 

cost of using a capital asset is the rate at which it can be 

fully depreciated for tax purposes, which is specified in 

law for U.S. firms. (That rate may differ substantially 

from the rate at which the actual value of the asset 

decreases over time.) 

Under U.S. tax law—unlike that in the other OECD 

countries—the rules for depreciation tend to favor 

investments in machinery over investments in industrial 

structures. Combining those depreciation rules with the 

relatively high U.S. statutory tax rates, the corporate 

income tax in the United States distorts, to a greater 

degree than occurs in most other OECD countries, the 

incentives for marginal investment that are associated 

with the choice between machinery and structures. 

Marginal tax rates in the United States are similar to 

those in other OECD countries for equity-financed 

investments in machinery, they are substantially above 

the average for equity-financed investments in industrial 

structures, and they are substantially below the average 

for debt-financed investments in machinery.4

 (Businesses 

finance investments either through equity—by selling 

ownership shares or stock—or through debt.)

4. See Congressional Budget Office, Corporate Income Tax Rates: 

International Comparisons (November 2005). 
32 OPTIONS FOR TAXING U.S. MULTINATIONAL CORPORATIONS JANUARY 2013

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List of Tables and Figures

Tables

1. Progressive Structure of U.S. Corporate Income Tax Rates, 2012 4

2. Illustrative Effect of Limiting the Foreign Tax Credit on the Tax Liability of a 

U.S. Multinational Corporation 6

3. Illustrative Effect of Deferral on the Tax Liability of a U.S. Multinational Corporation 7

4. Illustrative Effect of Cross Crediting Under the Foreign Tax Credit on the 

Tax Liability of a U.S. Multinational Corporation 8

5. Use of the Foreign Tax Credit, by U.S. Industry, 2008 11

6. Foreign Taxes Paid by and Foreign Taxable Income Repatriated to 

U.S. Parent Companies for Selected Countries, 2008 12

7. Policy Options for the Tax Treatment of U.S. Multinational Corporations 18

8. Example of Pooling to Determine Credits 25

Figures

1. Effect of Check-the-Box Rules Under Current Law and If Eliminated 27

A-1. Combined Corporate Income Tax Rate of OECD Countries, 2011 30
JANUARY 2013 OPTIONS FOR TAXING U.S. MULTINATIONAL CORPORATIONS 33

CBO

About This Document

This report of the Congressional Budget Office (CBO) was prepared at the request of the former 

Chairman of the Senate Committee on the Budget. In keeping with CBO’s mandate to provide 

objective, impartial analysis, this study makes no recommendations.

Jennifer Gravelle of CBO’s Tax Analysis Division wrote the study under the direction of 

Frank Sammartino and Janet Holtzblatt. William Randolph of CBO provided comments. 

Kimberly Clausing of Reed College and Stephen Shay of Harvard Law School also commented on the 

manuscript. (The assistance of external reviewers implies no responsibility for the final product, which 

rests solely with CBO.)

Kate Kelly edited the report, and Jeanine Rees and Maureen Costantino prepared it for publication. 

The report is available on CBO’s Web site (www.cbo.gov).

Douglas W. Elmendorf 

Director

January 2013