BACKGROUND MATERIALS ON BUSINESS TAX ISSUES

PREPARED FOR THE HOUSE COMMITTEE ON

WAYS AND MEANS TAX POLICY DISCUSSION SERIES

Scheduled for Discussion

By the

HOUSE COMMITTEE ON WAYS AND MEANS

April and May, 2002

Prepared by

the Staff of the

JOINT COMMITTEE ON TAXATION

April 4, 2002

JCX-23-02
i

CONTENTS

Page

INTRODUCTION .......................................................................................................................... 1

I. OVERVIEW OF THE UNITED STATES FEDERAL TAX SYSTEM AND THE 

TAXATION OF CROSS-BORDER TRANSACTIONS ...................................................... 1

A. Summary of Components of the U.S. Federal Tax System................................................ 1

1. Individual Income Tax.................................................................................................... 1

2. Corporate Income Tax .................................................................................................... 5

3. Estate and Gift Taxes...................................................................................................... 8

4. Employment Taxes ......................................................................................................... 9

5. Major Excise Taxes......................................................................................................... 9

6. Summary Data................................................................................................................. 9

B. Summary of Income Tax Provisions Relating to Cross-Border Transactions .................. 13

II. OVERVIEW OF THE TAX SYSTEMS OF CERTAIN FOREIGN COUNTRIES ............... 19

A. The U.S. Tax System Compared to Those of Other Countries......................................... 19

B. Summaries of Selected Countries’ Tax Systems .............................................................. 27

C. Selected Countries’ Tax Treatment of Cross-Border Transactions .................................. 41

III. ISSUES IN CORPORATE TAX INTEGRATION ................................................................ 44

A. Introduction to Corporate Tax Integration........................................................................ 44

B. Rationale for a Classical Income Tax System.................................................................. 45

C. Problems with a Classical Income Tax System................................................................ 46

D. Methods of Implementing an Integrated Income Tax System.......................................... 46

E. Additional Issues to Consider in Adopting an Integrated Income Tax System................ 48

F. Economic Effects of Integration....................................................................................... 51

G. Alternatives to Integration ................................................................................................ 52

IV. ISSUES IN THE TAXATION OF CROSS-BORDER TRANSACTIONS........................... 53

A. Introduction: Worldwide vs. Territorial Tax Systems ...................................................... 53

B. Rationale for a Worldwide Tax System............................................................................ 53

C. Rationale for a Territorial Tax System............................................................................. 55

D. Methods of Implementing a Territorial Tax System......................................................... 56

E. Other Issues Raised by a Territorial System..................................................................... 57

F. Relationship of Territorial-vs.-Worldwide Debate to Trade Dispute Over FSC/ETI....... 58

G. Corporate Inversion Transactions ..................................................................................... 60

H. Possible Incremental Reforms .......................................................................................... 61

V. ISSUES IN CONSUMPTION TAXATION............................................................................ 65

A. Introduction to Broad-Based Consumption Tax Systems................................................. 65

B. Arguments For a Broad-Based Consumption Tax............................................................ 66

C. Arguments Against a Broad-Based Consumption Tax..................................................... 66

D. Methods of Implementing a Broad-Based Consumption Tax on Businesses................... 68

E. Additional Considerations in Implementing a Broad-Based Consumption Tax............... 69
ii

F. Tax Restructuring and International Investment Decisions.............................................. 72

G. Transition Issues ............................................................................................................... 73

VI. BACKGROUND AND DATA RELATING TO INTERNATIONAL TRADE AND 

INVESTMENT.................................................................................................................... 75

A. Trade Deficits and Cross-Border Capital Flows............................................................... 75

B. Trends in the United States' Balance of Payments............................................................ 81

C. Trends in the United States' Financial Account ................................................................ 99

APPENDIX................................................................................................................................. 129

GLOSSARY ............................................................................................................................... 139
1

INTRODUCTION

This document, 1 prepared by the staff of the Joint Committee on Taxation, contains 

background materials relating to various business tax issues. This document contains: (1) an 

overview of the U.S. Federal tax system (including the taxation of cross-border transactions); (2) 

an overview of the tax systems of selected foreign countries; (3) a discussion of issues with 

respect to corporate tax integration, the taxation of cross-border transactions, and consumption 

taxation; and (4) background and data relating to international trade and investment. These 

materials were prepared at the request of the House Committee on Ways and Means in 

connection with a series of discussions on tax policy issues scheduled by the Committee during 

April and May, 2002.

 

1

 This document may be cited as follows: Joint Committee on Taxation, Background 

Materials on Business Tax Issues Prepared for the House Committee on Ways and Means Tax 

Policy Discussion Series (JCX-23-02), April 4, 2002.
1

I. OVERVIEW OF THE UNITED STATES FEDERAL TAX SYSTEM AND

THE TAXATION OF CROSS-BORDER TRANSACTIONS

A. Summary of Components of the U.S. Federal Tax System

1. Individual Income Tax

In general

A United States citizen or resident generally is subject to the U.S. individual income tax 

on his or her worldwide taxable income. Taxable income equals the taxpayer's gross income less 

certain exclusions, exemptions, and deductions. Graduated tax rates are then applied to taxable 

income to determine his or her individual income tax liability. A taxpayer ma y reduce his or her 

income tax liability by any applicable tax credits.

Adjusted gross income

Under the Internal Revenue Code of 1986 (the “Code”), gross income means “income 

from whatever source derived” except for certain items specifically exempt or excluded by 

statute. Sources of income include compensation for services, interest, dividends, capital gains, 

rents, royalties, alimony and separate maintenance payments, annuities, income from life 

insurance and endowment contracts (other than certain death benefits), pensions, gross profits 

from a trade or business, income in respect of a decedent, and income from S corporations, 

partnerships, trusts or estates. Statutory exclusions from gross income include death benefits 

payable under a life insurance contract, interest on certain State and local bonds, employerprovided health insurance, employer-provided pension contributions, and certain other employerprovided fringe benefits.

An individual's adjusted gross income is determined by subtracting certain “above-theline” deductions from gross income. These deductions include trade or business expenses, 

capital losses, contributions to a tax-qualified retirement plan by a self-employed individual, 

contributions to individual retirement arrangements (“IRAs”), certain moving expenses, and 

alimony payments.

Taxable income

To determine taxable income, an individual reduces adjusted gross income by any 

personal exemption deductions and either the applicable standard deduction or his or her 

itemized deductions. Personal exemptions generally are allowed for the taxpayer, his or her 

spouse, and any dependents. For 2002, the amount deductible for each personal exemption is 

$3,000. This amount is indexed annually for inflation. The deduction for personal exemptions is 

reduced or eliminated for taxpayers with incomes over certain thresholds, which are indexed 

annually for inflation. The applicable thresholds for 2002 are $137,300 for single individuals, 

$206,000 for married individuals filing a joint return, $171,650 for heads of households, and 

$103,000 for married individuals filing separate returns.

The basic standard deduction varies depending upon a taxpayer's filing status. For 2002, 

the amount of the standard deduction is $4,700 for single individuals; $6,900 for heads of 
2

households; $7,850 for married individuals filing jointly; and $3,925 for married individuals 

filing separately. Additional standard deductions are allowed with respect to any individual who 

is elderly or blind. The amounts of the basic standard deduction and the additional standard 

deductions are indexed annually for inflation.

In lieu of taking the applicable standard deductions, an individual may elect to itemize 

deductions. The deductions that may be itemized include State and local income, real property 

and certain personal property taxes, home mortgage interest, charitable contributions, certain 

investment interest, medical expenses (in excess of 7.5 percent of adjusted gross income), 

casualty and theft losses (in excess of 10 percent of adjusted gross income and in excess of $100 

per loss), and certain miscellaneous expenses (in excess of 2 percent of adjusted gross income). 

The total amount of itemized deductions allowed is reduced for taxpayers with incomes over a 

certain threshold amount, which is indexed annually for inflation. The threshold amount for 

2002 is $137,300 ($68,650 for married individuals filing separate returns).

Tax liability

To determine tax liability, a taxpayer generally must apply the tax rate schedules (or the

tax tables) to his or her taxable income. The rate schedules are broken into several ranges of 

income, known as income brackets, and the marginal tax rate increases as a taxpayer's income 

increases. Separate rate schedules apply based on an individual's filing status. For 2002, the 

individual income tax rate schedules are as follows:

Table 1.–Federal Individual Income Tax Rates for 2002

If taxable income is Then income tax equals

Single individuals

$0-$6,000 ......................................................10 percent of taxable income.

$6,000-$27,950 ...............................................$600 plus 15% of the amount over $6,000.

$27,950-$67,700...............................................$3,892.50, plus 27% of the amount over $27,950.

$67,700-$141,250.............................................$14,625, plus 30% of the amount over $67,700.

$141,250-$307,050...........................................$36,690, plus 35% of the amount over $141,250.

Over $307,050..................................................$94,720 plus 38.6% of the amount over $307,050.

Heads of households

$0-10,000 ......................................................10 percent of taxable income.

$10,000-$37,450 .............................................$1,000 plus 15% of the amount over $10,000.

$37,450-$96,700...............................................$5,117.50, plus 27% of the amount over $37,450.

$96,700-$156,600.............................................$21,215, plus 30% of the amount over $96,700.

$156,600-$307,050...........................................$39,085, plus 35% of the amount over $156,600.

Over $307,050..................................................$91,742.50 plus 38.6% of the amount over $307,050.
3

Married individuals filing joint returns and surviving spouses 

$0-$12,000 ......................................................10 percent of taxable income.

$12,000-$46,700..............................................$1,200 plus 15% of the amount over $12,000.

$46,700-$112,850............................................$6,405, plus 27% of the amount over $46,700.

$112,850-$171,950... .......................................$24,265.50, plus 30% of the amount over $112,850.

$171,950-$307,050...........................................$41,995.50, plus 35% of the amount over $171,950.

Over $307,050..................................................$89,280.50, plus 38.6% of the amount over $307,050.

Married individuals filing separate returns

$0-$6,000 ......................................................10 percent of taxable income.

$6,000-$23,350 ................................................$600 plus 15% of the amount over $6,000.

$23,350-$56,425...............................................$3,202.50, plus 27% of the amount over $23,350.

$56,425-$85,975...............................................$12,132.75, plus 30% of the amount over $56,425.

$85,975-$153,250.............................................$20,997.75, plus 35% of the amount over $85,975.

Over $153,250..................................................$44,640.25 plus 38.6% of the amount over $153,250.

An individual may reduce his or her tax liability by any available tax credits. Tax credits 

are allowed for certain business expenditures, certain foreign income taxes paid or accrued, 

certain child care expenditures, certain expenditures relating to higher education, taxpayers who 

have qualifying children, and for certain elderly or disabled individuals. In addition, a 

refundable earned income credit is available to low-income workers who satisfy certain 

requirements. The amount of the earned income credit varies depending upon whether the 

taxpayer has one, more than one, or no qualifying children, and is determined by multiplying the 

credit rate by the taxpayer's earned income up to an earned income threshhold. For 2002, the 

maximum earned income credit is $4,140 for taxpayers with more than one qualifying child, 

$2,506 for taxpayers with one qualifying child, and $376 for taxpayers with no qualifying 

children.

Capital gains and losses

In general, gain or loss reflected in the value of an asset is not recognized for income tax 

purposes until a taxpayer disposes of the asset. On the sale or exchange by an individual of most 

capital assets held more than one year, any net capital gain that results from the sale is taxed at a 

rate of 20 percent (10 percent for taxpayers in the 15 percent rate bracket). Special treatment 

applicable to depreciable real estate is summarized below. Any net short-term capital gain is 

taxed at the taxpayer’s ordinary income rate. Net capital gain is the excess of the net long-term 

capital gain for the taxable year over the net short-term capital loss for the year. Net short-term 

capital gain is the excess of the net short-term capital gain over the net long-term capital loss. 

Gain or loss is treated as long-term if the asset is held for more than one year, and short-term if 

held for a period of one year or less.

Capital losses generally are deductible in full against capital gains. In addition, 

individuals may deduct capital losses against up to $3,000 of ordinary income in each year. Any 

remaining unused capital losses may be carried forward indefinitely to another taxable year.
4

A capital asset generally means any property except (1) inventory, stock in trade, or 

property held primarily for sale to customers in the ordinary course of the taxpayer's trade or 

business, (2) depreciable or real property used in the taxpayer's trade or business, (3) specified 

literary or artistic property, (4) business accounts or notes receivable, and (5) certain publications 

of the Federal Government, (6) certain commodity derivative financial instruments, (7) hedging 

transactions, and (8) business supplies.

In addition, the net gain from the disposition of certain property used in the taxpayer's 

trade or business is treated as long-term capital gain. Gain from the disposition of depreciable 

personal property is treated as ordinary income and not as capital gain to the extent of all 

previous depreciation allowances.

Gain from the disposition of depreciable real property generally is not treated as capital 

gain to the extent of the depreciation allowances in excess of the allowances that would have 

been available under the straight-line method. The amount of gain that is not in excess of the 

depreciation allowances that would have been available under the straight-line method is capital 

gain, but it is taxed at a rate of 25 percent. To summarize, gain from the disposition of 

depreciable real property held more than one year may be taxed at 25 percent to the extent of 

depreciation allowances not in excess of straight-line depreciation, at the taxpayer’s ordinary 

income rates to the extent of depreciation allowances above the amount determined under the 

straight-line method, and as long-term capital gain at a rate of 20 percent (10 percent for 

taxpayers in the 15 percent bracket) to the extent of any gain in excess of depreciation.

Alternative minimum tax

An individual is subject to an alternative minimum tax which is payable, in addition to all 

other tax liabilities, to the extent that it exceeds the taxpayer's regular income tax owed. The tax 

is imposed at rates of 26 and 28 percent on alternative minimum taxable income in excess of an 

exemption amount (for years 2001-2004, $49,000 for joint returns, $35,750 for single 

individuals, and $24,500 for married individuals filing separately). After 2001, the 

nonrefundable credits that are allowed to offset an individual's regular tax liability are not 

allowed to offset his or her minimum tax liability. If an individual pays the alternative minimum 

tax, a portion of the amount of the tax paid may be allowed as a credit against the regular tax of 

the individual in future years.

Alternative minimum taxable income is the taxpayer's taxable income increased by the 

taxpayer's tax preferences and adjusted by determining the tax treatment of certain items in a 

manner that negates the deferral of income resulting from the regular tax treatment of those 

items. Among the preferences and adjustments applicable to the individual alternative minimum 

tax are accelerated depreciation on certain property used in a trade or business, circulation 

expenditures, research and experimental expenditures, certain expenses and allowances related to 

oil and gas and mining exploration and development, certain tax-exempt interest income, and a 

percentage of the amount of gain excluded with respect to the sale or disposition of certain small 

business stock. In addition, personal exemptions, the standard deduction, and certain itemized 

deductions are not allowed to reduce alternative minimum taxable income.
5

2. Corporate Income Tax

Taxable income

Corporations organized under the laws of any of the 50 States (and the District of 

Columbia) generally are subject to the U.S. corporate income tax on their worldwide taxable 

income.

The taxable income of a corporation generally is comprised of gross income, less 

allowable exclusions, exemptions, and deductions. Gross income generally is income derived 

from any source, including gross profit from the sale of goods and services to customers, rents, 

royalties, interest (other than interest from certain indebtedness issued by State and local 

governments), dividends, gains from the sale of business and investment assets, and other 

income.

Allowable deductions include ordinary and necessary business expenditures, such as 

salaries, wages, contributions to profit-sharing and pension plans and other employee benefit 

programs, repairs, bad debts, taxes (other than Federal income taxes), contributions to charitable 

organizations (subject to an income limitation), advertising, interest expense, certain losses, 

selling expenses, and other expenses. Expenditures that benefit future accounting periods (such 

as the purchase of plant and equipment) generally are capitalized and recovered over time 

through depreciation, amortization or depletion allowances. A net operating loss incurred in one 

taxable year may be carried back two years and carried forward 20 years and allowed as a 

deduction in another taxable year. Deductions are also allowed for certain amounts despite the 

lack of an underlying expenditure. For example, a deduction is allowed for all or a portion of the 

amount of dividends received by a corporation from another corporation.

The Code also specifies certain expenditures that may not be deducted, such as dividends 

paid to shareholders, expenses associated with earning tax-exempt income such as exempt State 

and local obligations, certain entertainment expenditures, certain executive compensation in 

excess of $1,000,000 per year, a portion of the interest on certain high-yield debt obligations that 

resemble equity, and fines, penalties, bribes, kickbacks and illegal payments.

Tax liability

A corporation's regular income tax liability is determined by applying the following tax 

rate schedule to its taxable income.
6

Table 2.–Federal Corporate Income Tax Rates

If taxable income is: Then the income tax rate is:

$0-$50,000 .....................................................15 percent of taxable income

$50,001-$75,000 ............................................25 percent of taxable income

$75,001-$10,000,000 .....................................34 percent of taxable income

Over $10,000,000...........................................35 percent of taxable income

The first two graduated rates described above are phased out for corporations with 

taxable income between $100,000 and $335,000. As a result, a corporation with taxable income 

between $335,000 and $10,000,000 effectively is subject to a flat tax rate of 34 percent. Also, 

the application of the 34-percent rate is gradually phased out for corporations with taxable 

income between $15,000,000 and $18,333,333; a corporation with taxable income of 

$18,333,333 or more effectively is subject to a flat rate of 35 percent.

The maximum rate of tax on the net capital gains of a corporation is 35 percent. A 

corporation may not deduct the amount of capital losses in excess of capital gains for any taxable 

year. Disallowed capital losses may be carried back three years and carried forward five years.

Like individuals, corporations may reduce their tax liability by any applicable tax credits. 

Tax credits applicable to businesses include credits for producing fuels from nonconventional 

sources, investment tax credits (applicable to investment in certain reforestation, renewable 

energy property, and the rehabilitation of certain real property), the alcohol fuels credit 

(applicable to production of certain alcohol fuels), the research credit (applicable to the 

incremental investment in certain research and experimental activities), the low-income housing 

credit (applicable to the investment in certain low-income housing projects), the enhanced oil 

recovery credit (applicable to the recovery of certain difficult-to-extract oil reserves), the 

empowerment zone employment credit (applicable to wages paid to certain residents of 

empowerment zones), the renewable energy production credit, the employer-provided child care 

credit and the disabled access credit (applicable to expenditures by certain small businesses to 

make the business accessible to disabled individuals). The credits generally are determined 

based on a percentage of the cost associated with the underlying activity and generally are 

subject to certain limitations.

Affiliated group

Domestic corporations that are affiliated through 80 percent or more corporate ownership 

may elect to file a consolidated return in lieu of filing separate returns. Corporations filing a 

consolidated return generally are treated as a single corporation; thus, the losses (and credits) of a 

corporation can offset the income (and thus reduce the otherwise applicable tax) of other 

affiliated corporations. Also, corporations that file a consolidated return may engage in many 

types of transactions with their affiliates without immediate recognition of gain or loss.
7

Alternative minimum tax

A corporation is subject to an alternative minimum tax payable, in addition to all other 

tax liabilities, to the extent that it exceeds the corporation's regular income tax liability. The tax 

is imposed at a flat rate of 20 percent on alternative minimum taxable income in excess of a 

$40,000 exemption amount. Credits that are allowed to offset a corporation's regular tax liability 

generally are not allowed to offset minimum tax liability. If a corporation pays the alternative 

minimum tax, the amount of the tax paid is allowed as a credit against the regular tax in future 

years. A corporation with average annual gross receipts of less than $7.5 million for the prior 

three years is exempt from the corporate alternative minimum tax.

Alternative minimum taxable income is the corporation's taxable income increased by the 

corporation's tax preferences and adjusted by determining the tax treatment of certain items in a 

manner that negates the deferral of income resulting from the regular tax treatment of those 

items. Among the preferences and adjustments applicable to the corporate alternative minimum 

tax are accelerated depreciation on certain property, certain expenses and allowances related to 

oil and gas and mining exploration and development, certain amortization expenses related to 

pollution control facilities, and certain tax-exempt interest income. In addition, corporate 

alternative minimum taxable income is increased by 75 percent of the amount by which the 

corporation's “adjusted current earnings” exceeds its alternative minimum taxable income 

(determined without regard to this adjustment). Adjusted current earnings generally are 

determined with reference to the rules that apply in determining a corporation's earnings and 

profits.

Treatment of corporate distributions

The taxation of a corporation generally is separate and distinct from the taxation of its 

shareholders. A distribution by a corporation to its shareholders generally is taxable as a 

dividend to the shareholder to the extent of the corporation's current or accumulated earnings and 

profits. Thus, the amount of a corporate dividend generally is taxed twice: once when the 

income is earned by the corporation and again when the dividend is distributed to the 

shareholder. Conversely, amounts paid as interest to the debtholders of a corporation generally 

are subject to only one level of tax (at the recipient level) since the corporation generally is 

allowed a deduction for the amount of interest expense paid or accrued.

Amounts received by a shareholder in complete liquidation of a corporation generally are 

treated as full payment in exchange for the shareholder's stock. A liquidating corporation 

recognizes gain or loss on the distributed property as if such property were sold to the distributee 

for its fair market value. However, if a corporation liquidates a subsidiary corporation of which 

it has 80 percent or more control, no gain or loss generally is recognized by either the parent 

corporation or the subsidiary corporation.

Accumulated earnings and personal holding company taxes

Taxes at a rate equal to the top marginal rate applicable to individuals may be imposed 

upon the accumulated earnings or personal holding company income of a corporation. The 

accumulated earnings tax may be imposed if a corporation retains earnings in excess of 
8

reasonable business needs. Similarly, a personal holding company tax may be imposed upon the 

excessive passive income of a closely held corporation. The accumulated earnings tax and the 

personal holding company tax are designed to ensure that both a corporate tax and a shareholder 

tax are effectively imposed on corporate earnings.

S Corporations

A qualified small business corporation may elect, under subchapter S of the Code, not to 

be subject to the corporate income tax. If an S corporation election is made, the income of the 

corporation will flow through to the shareholders and be taxable directly to the shareholders.

3. Estate and Gift Taxes

The United States imposes a gift tax on any transfer of property by gift made by a U.S. 

citizen or resident, whether made directly or indirectly and whether made in trust or otherwise. 

Nonresident noncitizens are subject to the gift tax with respect to transfers of tangible real or 

personal property where the property is located in the United States at the time of the gift. The 

gift tax is imposed on the donor and is based on the fair market value of the property transferred. 

Deductions are allowed for certain gifts to spouses and to charities. Annual gifts up to a perdonor, per-donee exclusion amount ($11,000 for 2002) generally are not subject to tax.

An estate tax is imposed on the “taxable estate” of any person who was a citizen or 

resident of the United States at the time of death, and on certain property belonging to a 

nonresident of the United States that is located in the United States at the time of death. The 

estate tax is imposed on the estate of the decedent and generally is based on the fair market value 

of the property passing at death. The taxable estate generally equals the worldwide “gross 

estate” less certain allowable deductions, including a marital deduction for certain bequests to a 

surviving spouse and a deduction for certain bequests to charities.

Since 1976, the gift tax and the estate tax have been unified, so that a single graduated 

rate schedule applies to an individual's cumulative taxable gifts and bequests. Under this rate 

schedule, the unified estate and gift tax rates begin at 18 percent on the first $10,000 in 

cumulative taxable transfers and reach 50 percent on cumulative taxable transfers over $2.5 

million. This ma ximum rate phases down to 45 percent by 2007. A “unified credit” effectively 

exempts a total of $1,000,000 in cumulative taxable transfers from the estate and gift tax. The 

amount of this effective exemption will gradually increase (for estate tax purposes) to $3.5 

million by 2009. Effective for 2010 only, the estate tax is repealed. After 2010, the estate and 

gift taxes are scheduled to revert to pre-2001 law (55 percent maximum rate and $1 million 

unified credit).

A separate transfer tax is imposed on generation-skipping transfers, in addition to any 

estate or gift tax that is imposed on such transfers. This tax generally applies to transfers to a 

beneficiary more than one generation below that of the transferor (whether made directly or 

through a trust or similar arrangement). The generation-skipping transfer tax is imposed at the 

maximum estate tax rate on generation-skipping transfers in excess of an exemption amount that 

is roughly correlated with the unified credit effective exemption amount. Li ke the estate tax, the 

generation-skipping transfer tax is repealed for 2010 only.
9

4. Employment Taxes

Social security benefits are financed primarily by payroll taxes on covered wages. As 

part of the Federal Insurance Contributions Act (FICA), an employer must pay a social security 

tax based on the amount of wages paid to an employee during the year. The tax is comprised of 

two parts: (1) the old age, survivors, and disability insurance (OASDI) tax equal to 6.2 percent of 

covered wages (up to $84,900 of wages in 2002); and (2) the Medicare hospital insurance (HI) 

tax in an amount equal to 1.45 percent of wages (HI payroll tax is not subject to a wage cap). In 

addition to the tax on employers, each employee must pay a social security tax equal to the 

amount of tax owed by the employer. This amount generally must be withheld by the employer 

and remitted to the Federal Government. Self-employed individuals are subject to a tax that 

parallels the employer and employee portions of the social security tax.

In addition to the social security tax, employers are subject to a Federal unemployment 

insurance payroll tax equal to 6.2 percent of the total wages of each employee (up to $7,000). 

Employers are allowed a credit for a percentage of State unemployment taxes. Federal 

unemployment insurance payroll taxes are used to fund programs maintained by the States for 

the benefit of unemployed workers.

5. Major Excise Taxes

The Federal tax system imposes excise taxes on selected goods and services, but does not 

contain a broad-based consumption tax such as a value-added tax or national sales tax. Excise 

taxes are taxes imposed on a per unit or ad valorem (i.e., percentage of price) basis on the 

production, importation, or sale of a specific good or service. Among the goods and services 

subject to U.S. excise taxes are motor fuels, alcoholic beverages, tobacco products, firearms, air 

and ship transportation, certain environmentally hazardous activities and products, coal, 

telephone communications, certain wagers, vehicles lacking in fuel efficiency, and luxury 

automobiles.

Revenues from certain Federal excise taxes are dedicated to Trust Funds (e.g., the 

Highway Trust Fund) for designated expenditure programs, and revenues from other excise taxes 

(e.g., alcoholic beverages) go to the General Fund for general purpose expenditures.

6. Summary Data

The individual income tax is the Federal Government’s largest single revenue source, 

accounting for 49.9 percent of total Federal receipts in fiscal year 2001. Payroll and selfemployment taxes comprised 34.9 percent of total Federal receipts in fiscal year 2001, followed 

in importance by the corporate income tax which comprised 7.6 percent of total receipts, the 

various excise taxes which comprised 3.3 percent of receipts, and the estate and gift taxes which 

comprised 1.4 percent of receipts. Over the past 60 years, the composition of Federal tax 

revenues has changed, with the individual income taxes increasing in relative importance and the 

corporate income tax and excise taxes declining in relative importance. Figure 1 plots the 

changing composition of Federal tax revenues by measuring each component’s contribution as a 

percentage of total revenues from 1940 through 2001. Table 3 presents the same trends with 

receipts from each tax measured as a percentage of gross domestic product.
10

Figure 1

Source: Office of Management and Budget, JCT staff calculations, see Appendix Table 1.

Federal Tax Receipts as a Percentage of Total Federal Receipts, 1940-2001

0.00

10.00

20.00

30.00

40.00

50.00

60.00

1941194319451947194919511953195519571959196119631965196719691971197319751977197919811983198519871989199119931995199719992001

Year

Percentage of Total Receipts

Individual Income

Payroll

Excise

Corporate Income

Estate & Gift
11

Table 3 – Federal Receipts By Source, as a Percentage of GDP, 1940-2001

Fiscal

Year

Total

Receipts as 

% GDP

Individual

Income Tax as 

% GDP

Payroll

Taxes as

% GDP

Corporate

Income Tax as 

% GDP

Excise

Taxes as

% GDP

Estate &

Gift Taxes

% GDP

2001 19.62 9.80 6.84 1.49 0.65 0.28

2000 20.78 10.31 6.70 2.13 0.71 0.30

1999 20.03 9.64 6.71 2.02 0.77 0.30

1998 19.87 9.56 6.60 2.18 0.67 0.28

1997 19.29 9.01 6.59 2.23 0.70 0.24

1996 18.88 8.53 6.62 2.23 0.70 0.22

1995 18.46 8.06 6.61 2.14 0.78 0.20

1994 18.12 7.82 6.65 2.02 0.80 0.22

1993 17.60 7.77 6.53 1.79 0.73 0.19

1992 17.55 7.65 6.65 1.61 0.73 0.18

1991 17.77 7.89 6.68 1.65 0.71 0.19

1990 17.99 8.14 6.63 1.63 0.62 0.20

1989 18.34 8.25 6.65 1.91 0.64 0.16

1988 18.13 8.00 6.67 1.88 0.70 0.15

1987 18.39 8.45 6.53 1.81 0.70 0.16

1986 17.48 7.93 6.45 1.43 0.75 0.16

1985 17.75 8.09 6.41 1.48 0.87 0.16

1984 17.36 7.77 6.23 1.48 0.97 0.16

1983 17.46 8.40 6.07 1.08 1.03 0.18

1982 19.13 9.22 6.24 1.52 1.12 0.25

1981 19.57 9.34 5.97 2.00 1.33 0.22

1980 18.93 8.93 5.78 2.36 0.89 0.23

1979 18.50 8.70 5.55 2.62 0.75 0.22

1978 18.01 8.16 5.45 2.70 0.83 0.24

1977 18.04 8.00 5.40 2.78 0.89 0.37

1976 17.16 7.58 5.23 2.38 0.98 0.30

1975 17.89 7.85 5.42 2.60 1.06 0.30

1974 18.25 8.25 5.21 2.68 1.17 0.35

1973 17.64 7.89 4.82 2.76 1.24 0.38

1972 17.55 8.02 4.45 2.72 1.31 0.46

1971 17.31 7.97 4.38 2.48 1.54 0.35

1970 19.03 8.92 4.38 3.24 1.55 0.36

1969 19.69 9.19 4.11 3.86 1.60 0.37

1968 17.62 7.91 3.91 3.30 1.62 0.35

1967 18.29 7.56 4.01 4.18 1.69 0.37

1966 17.35 7.35 3.39 3.99 1.73 0.41

1965 16.98 7.09 3.23 3.70 2.12 0.39

1964 17.56 7.59 3.42 3.66 2.14 0.37

1963 17.77 7.94 3.30 3.60 2.20 0.36

1962 17.53 8.02 3.00 3.61 2.20 0.35

1961 17.75 7.77 3.09 3.94 2.23 0.36

1960 17.82 7.85 2.83 4.14 2.25 0.31

1959 16.10 7.46 2.38 3.52 2.15 0.27

1958 17.27 7.53 2.44 4.35 2.31 0.30

1957 17.75 7.90 2.22 4.70 2.34 0.30

1956 17.44 7.53 2.18 4.88 2.32 0.27

1955 16.56 7.27 1.99 4.52 2.31 0.23

1954 18.44 7.82 1.91 5.58 2.63 0.25

1953 18.64 7.99 1.83 5.69 2.65 0.24

1952 18.97 8.01 1.85 6.09 2.54 0.23
12

Fiscal

Year

Total

Receipts as 

% GDP

Individual

Income Tax as 

% GDP

Payroll

Taxes as

% GDP

Corporate

Income Tax as 

% GDP

Excise

Taxes as

% GDP

Estate &

Gift Taxes

% GDP

1951 16.08 6.73 1.77 4.39 2.69 0.22

1950 14.43 5.76 1.59 3.82 2.76 0.26

1949 14.52 5.73 1.39 4.12 2.76 0.29

1948 16.21 7.53 1.46 3.77 2.87 0.35

1947 16.42 7.64 1.46 3.67 3.07 0.33

1946 17.65 7.23 1.40 5.34 3.14 0.30

1945 20.41 8.30 1.56 7.22 2.83 0.29

1944 20.93 9.43 1.66 7.10 2.28 0.24

1943 13.33 3.61 1.69 5.31 2.27 0.24

1942 10.15 2.26 1.70 3.27 2.36 0.29

1941 7.64 1.15 1.70 1.86 2.24 0.35

1940 6.77 0.92 1.85 1.24 2.04 0.37

Source: Joint Committee on Taxation; Office of Management and Budget, Historical Tables, Budget of the

United States Government, Fiscal Year 2003.
13

B. Summary of Income Tax Provisions Relating to Cross-Border Transactions

Summary

U.S. citizens, residents, and corporations (collectively, "U.S. persons") are subject to U.S. 

income tax on all income, whether derived in the United States or abroad. Foreign persons are 

subject to U.S. tax only on income that has a sufficient connection to the United States.

Within this basic framework, a variety of rules affect the U.S. taxation of cross-border 

transactions. Detailed rules govern the determination of the source of income and the allocation 

and apportionment of expenses between foreign-source and U.S.-source income. Such rules are 

relevant not only for purposes of determining the U.S. taxation of foreign persons (because 

foreign persons are subject to U.S. tax only on income that is from U.S. sources or otherwise has 

sufficient U.S. nexus), but also for purposes of determining the U.S. taxation of U.S. persons 

(because the U.S. tax on a U.S. person's foreign-source income may be reduced or eliminated by 

foreign tax credits). Authority is provided for the reallocation of items of income and deductions 

between related persons in order to ensure the clear reflection of the income of each person and 

to prevent the avoidance of tax. Although U.S. tax generally is not imposed on a foreign 

corporation that operates abroad, several anti-deferral regimes apply to impose current U.S. tax 

on certain income from foreign operations of certain U.S.-owned foreign corporations.

A cross-border transaction potentially gives rise to tax consequences in two (or more) 

countries. The tax treatment in each country generally is determined under the tax laws of the 

respective country. However, an income tax treaty between the two countries may operate to 

coordinate the two tax regimes and mitigate the double taxation of the transaction. 

U.S. taxation of U.S. persons with foreign income

In general

The United States taxes U.S. persons on all income, whether derived in the United States 

or elsewhere. However, the United States generally cedes the primary right to tax income 

derived from sources outside the United States to the foreign country where such income is 

derived. Thus, a credit against the U.S. income tax imposed on foreign-source taxable income is 

provided for foreign taxes paid on that income. 

The tax rules of foreign countries that apply to foreign income of U.S. persons vary 

widely. For example, some foreign countries impose income tax at higher effective rates than 

the United States. In such cases, the foreign tax credit allowed by the United States is likely to 

eliminate any U.S. tax on income from a U.S. person's operations in the foreign country. On the 

other hand, operations in countries that have low statutory tax rates or generous deduction 

allowances or that offer tax incentives (e.g., tax holidays) to foreign investors are apt to be taxed 

at effective tax rates lower than the U.S. rates. In such cases, after application of the foreign tax 

credit, a residual U.S. tax generally is imposed on income from a U.S. person's operations in the 

foreign country.
14

Under income tax treaties, the tax that otherwise would be imposed under applicable 

foreign law on certain foreign-source income earned by U.S. persons may be reduced or 

eliminated. Moreover, U.S. tax on foreign-source income may be reduced or eliminated by 

treaty provisions that treat certain foreign taxes as creditable for purposes of computing U.S. tax 

liability.

Foreign operations conducted directly

The tax rules applicable to U.S. persons that control business operations in foreign 

countries depend on whether the business operations are conducted directly (through a foreign 

branch, for example) or indirectly (through a separate foreign corporation). A U.S. person that 

conducts foreign operations directly includes the income and losses from such operations on 

such person's U.S. tax return for the year the income is earned or the loss is incurred. Detailed 

rules are provided for the translation into U.S. currency of amounts relating to such foreign 

operations. Thus, the income from the U.S. person's foreign operations is subject to current U.S. 

tax, although a foreign tax credit may reduce or eliminate the U.S. tax on such income.

Foreign operations conducted through a foreign corporation

In general

Income earned by a foreign corporation from its foreign operations generally is subject to 

U.S. tax only when such income is distributed to any U.S. persons that hold stock in the 

corporation. Accordingly, a U.S. person that conducts foreign operations through a foreign 

corporation generally is subject to U.S. tax on the income from those operations only when the 

income is repatriated to the United States through a dividend distribution to the U.S. person. The 

income is reported on the U.S. person's tax return for the year the distribution is received, and the 

United States imposes tax on such income at that time. A foreign tax credit may reduce the U.S. 

tax imposed on such income.

A variety of complex anti-deferral regimes impose current U.S. tax on certain U.S. 

shareholders of foreign corporations with respect to certain categories of income earned by the 

foreign corporation. The main anti-deferral regimes set forth in the Code (in order of enactment) 

are the foreign personal holding company rules (secs. 551-558), the controlled foreign 

corporation rules of subpart F (secs. 951-964), and the passive foreign investment company rules 

(secs. 1291-1298). 

Foreign personal holding companies

The Revenue Act of 1937 established an anti-deferral regime for foreign personal holding 

companies (“FPHCs”). A FPHC generally is defined as any foreign corporation if five or fewer 

U.S. individual citizens or residents own (directly, indirectly, or constructively) more than 50 

percent of the corporation’s stock (measured by vote or value), and at least 60 percent of the 

corporation’s gross income consists of certain types of passive income (such as dividends, 

interest, certain royalties and certain rents). If a foreign corporation is a FPHC, all the U.S. 

shareholders of the corporation are subject to U.S. tax currently on their pro rata share of the 

corporation’s undistributed foreign personal holding company income.
15

Controlled foreign corporations

The Revenue Act of 1962 established an anti-deferral regime for controlled foreign 

corporations under subpart F of the Code. A controlled foreign corporation generally is defined 

as any foreign corporation if U.S. persons own (directly, indirectly, or constructively) more than 

50 percent of the corporation’s stock (measured by vote or value), taking into account only those 

U.S. persons that own at least 10 percent of the stock (measured by vote only). Under the 

subpart F rules, the United States generally taxes the U.S. 10-percent shareholders of a controlled 

foreign corporation on their pro rata shares of certain income of the controlled foreign 

corporation (referred to as “subpart F income”), without regard to whether the income is 

distributed to the shareholders. Subpart F income typically is passive income or income that is 

readily movable from one taxing jurisdiction to another. Subpart F income consists of foreign 

base company income (defined in sec. 954), insurance income (defined in sec. 953), and certain 

income relating to international boycotts and other violations of public policy (defined in sec. 

952(a)(3)-(5)). Foreign base company income, in turn, includes foreign personal holding 

company income, foreign base company sales income, foreign base company services income, 

foreign base company shipping income and foreign base company oil-related income. For 

example, foreign personal holding company income includes, among other items, dividends, 

interest, rents and royalties (subject to certain exceptions). In effect, the United States treats the 

U.S. 10-percent shareholders of a controlled foreign corporation as having received a current 

distribution out of the corporation's subpart F income. In addition, the U.S. 10-percent 

shareholders of a controlled foreign corporation are required to include currently in income for 

U.S. tax purposes their pro rata shares of the corporation's earnings invested in U.S. property. 

The U.S. tax on such amounts may be reduced through foreign tax credits.

Passive foreign investment companies

The Tax Reform Act of 1986 established an anti-deferral regime for passive foreign 

investment companies. A passive foreign investment company generally is defined as any 

foreign corporation if 75 percent or more of its gross income for the taxable year consists of 

passive income, or 50 percent or more of its assets consists of assets that produce, or are held for 

the production of, passive income. Alternative sets of income inclusion rules apply to U.S. 

persons that are shareholders in a passive foreign investment company, regardless of their 

percentage ownership in the company. One set of rules applies to passive foreign investment 

companies that are “qualified electing funds,” under which electing U.S. shareholders currently 

include in gross income their respective shares of the company’s earnings, with a separate 

election to defer payment of tax, subject to an interest charge, on income not currently received. 

A second set of rules applies to passive foreign investment companies that are not qualified 

electing funds, under which U.S. shareholders pay tax on certain income or gain realized through 

the company, plus an interest charge that is attributable to the value of deferral. A third set of 

rules applies to passive foreign investment company stock that is marketable, under which 

electing U.S. shareholders currently take into account as income (or loss) the difference between 

the fair market value of the stock as of the close of the taxable year and their adjusted basis in 

such stock (subject to certain limitations), often referred to as “marking to market.”

Detailed rules for coordination among the anti-deferral regimes are provided to prevent 

U.S. persons from being subject to U.S. tax on the same item of income under multiple regimes. 
16

For example, the passive foreign investment company rules generally do not apply to U.S. 

shareholders that are subject to the subpart F rules.

Foreign tax credit

Because the United States taxes U.S. persons on their worldwide income, Congress 

enacted the foreign tax credit in 1918 to prevent U.S. taxpayers from being taxed twice on their 

foreign-source income: once by the foreign country where the income is earned and again by the 

United States. The foreign tax credit generally allows U.S. taxpayers to reduce the U.S. income 

tax on their foreign-source income by the foreign income taxes they pay on that income. The 

foreign tax credit, however, does not operate to offset U.S. income tax on U.S.-source income.

A credit against U.S. tax on foreign-source income is allowed for foreign taxes directly 

paid or accrued by a U.S. person (the “direct” foreign tax credit). In addition, a credit is allowed 

to a U.S. corporation for foreign taxes paid by certain foreign subsidiary corporations and 

deemed paid by the U.S. corporation upon a dividend received by, or certain other income 

inclusions of, the U.S. corporation with respect to earnings of the foreign subsidiary (the 

“deemed-paid” or “indirect” foreign tax credit).

The foreign tax credit provisions are elective on a year-by-year basis. In lieu of electing 

the foreign tax credit, U.S. persons generally are permitted to deduct foreign taxes. For purposes 

of the alternative minimum tax, foreign tax credits generally cannot be used to offset more than 

90 percent of the U.S. person's pre-foreign tax credit tentative minimum tax.

A foreign tax credit limitation, which is calculated separately for various categories of 

income, is imposed to prevent the use of foreign tax credits to offset U.S. tax on U.S.-source 

income. Under this limitation, the credit for foreign taxes on income in a particular category 

may not exceed the same proportion of the taxpayer’s U.S. tax liability which the taxpayer’s 

foreign-source taxable income in that category bears to the taxpayer’s worldwide taxable income 

for the taxable year. Detailed rules are provided for the allocation of expenses against 

foreign-source income. Special rules apply to require the recharacterization of foreign-source 

income for a year subsequent to a foreign loss year as U.S.-source income.

Transfer pricing

In the case of a multinational enterprise that includes at least one U.S. corporation and at 

least one foreign corporation, the United States taxes all of the income of the U.S. corporation, 

but only so much of the income of the foreign corporation as is determined to have sufficient 

nexus to the United States. The determination of the amount that properly is the income of the 

U.S. member of a multinational enterprise and the amount that properly is the income of a 

foreign member of the same multinational enterprise thus is critical to determining the amount of 

income the United States may tax (as well as the amount of income other countries may tax).

Due to the variance in tax rates and tax systems among countries, a multinational 

enterprise may have an incentive to shift income, deductions, or tax credits among commonly 

controlled entities in order to arrive at a reduced overall tax burden. Such a shifting of items 

between commonly controlled entities could be accomplished by establishing artificial transfer 

prices for transactions between group members.
17

Under section 482, the Secretary of the Treasury is authorized to redetermine the income 

of an entity subject to U.S. taxation when it appears that an improper shifting of income between 

that entity and a commonly controlled entity has occurred. This authority is not limited to 

reallocations of income between different countries; it permits reallocations in any common 

control situation, including reallocations between two U.S. entities. However, it has significant 

application to multinational enterprises.

Section 482 grants the Secretary of the Treasury broad authority to allocate income, 

deductions, credits or allowances between any commonly controlled organizations, trades, or 

businesses in order to prevent evasion of taxes or to clearly reflect income. The statute generally 

does not prescribe any specific reallocation rules that must be followed, other than establishing 

the general standards of preventing tax evasion and clearly reflecting income. Treasury 

regulations adopt the concept of an arm's-length standard as the method for determining whether 

reallocations are appropriate. Thus, the regulations attempt to identify the respective amounts of 

taxable income of the related parties that would have resulted if the parties had been uncontrolled 

parties dealing at arm's length. The regulations contain complex rules governing the 

determination of an arm's-length charge for various types of transactions. The regulations 

generally attempt to prescribe methods for identifying a relevant comparable unrelated party 

transaction and for providing adjustments for differences between such transactions and the 

related-party transactions in question. In some instances, the regulations also provide safe 

harbors.

Extraterritorial income exclusion

The United States has in the past provided export-related benefits under its tax law --

specifically the domestic international sales corporation (“DISC”) and foreign sales corporation 

(“FSC”) regimes. The FSC regime was enacted in 1984 in response to concerns that the DISC 

regime constituted an export subsidy in violation of the General Agreement on Tariffs and Trade 

(“GATT”). In response to European Union complaints, a World Trade Organization (“WTO”) 

Appellate Body held in 2000 that the FSC regime constituted a prohibited export subsidy under 

the relevant WTO agreements. Later that year, the United States repealed the FSC regime and 

enacted an exclusion for certain “extraterritorial income” (“ETI”), which was generally defined 

to include not only export income but also certain types of non-export income. In 2001, a WTO 

panel held that the ETI regime also constituted a prohibited export subsidy, and in 2002 the 

Appellate Body affirmed this holding. 
18

U.S. taxation of foreign persons with U.S. income

The United States taxes nonresident noncitizen individuals and foreign corporations 

(collectively, “foreign persons”) only on income that has a sufficient nexus to the United States. 

Foreign persons are subject to U.S. tax on income that is “effectively connected” with the 

conduct of a trade or business in the United States. This “effectively connected” income 

generally is taxed in the same manner and at the same rates as the income of a U.S. person. An 

applicable tax treaty may limit the imposition of U.S. tax on business operations of a foreign 

person to cases where the business is conducted through a permanent establishment in the United 

States.

In addition, foreign persons generally are subject to U.S. tax at a flat 30-percent rate on 

certain gross income (interest, dividends, rents, royalties, and other similar types of income) 

derived from U.S. sources. Certain types of interest (for example, interest from certain bank 

deposits and from certain portfolio obligations) are not subject to the tax. The tax generally is 

collected by means of withholding by the person making the payment to the foreign person. The 

tax may be reduced or eliminated pursuant to an applicable tax treaty. 

Income tax treaties

In addition to the U.S. and foreign statutory rules for the taxation of foreign income of 

U.S. persons and U.S. income of foreign persons, bilateral income tax treaties limit the amount 

of income tax that may be imposed by one treaty partner on residents of the other treaty partner. 

For example, treaties often reduce or eliminate withholding taxes imposed by a treaty country on 

certain types of income (e.g., dividends, interest and royalties) paid to residents of the other 

treaty country. Treaties also contain provisions governing the creditability of taxes. Treaties 

further provide procedures under which inconsistent positions taken by the treaty countries with 

respect to a single item of income or deduction may be mutually resolved by the two countries.
19

II. OVERVIEW OF THE TAX SYSTEMS OF CERTAIN FOREIGN COUNTRIES

A. The U.S. Tax System Compared to Those of Other Countries

The public sector in the United States comprises a smaller proportion of the economy 

than does the public sector in most other developed countries. As a consequence, tax revenue as 

a proportion of gross domestic product (“GDP”) is smaller in the United States than in many 

other countries. Figure 2 shows total tax revenue, at all levels of government, as a percentage of 

GDP for the OECD member countries in 1999. 

Figure 2

Source: OECD, Revenue Statistics 1965-2000.

Note: Data include all taxes imposed at both national and subnational levels.

Total Tax Revenue as a Percentage of GDP in OECD Member Countries, 1999

0.0 10.0 20.0 30.0 40.0 50.0 60.0

Sweden

Denmark

Finland

Belgium

France

Austria

Norway

Italy

Luxembourg

Netherlands

Hungary

Czech Republic

Poland

Canada

United Kingdom

Germany

New Zealand

Switzerland

Portugal

Spain

Greece

Iceland

Ireland

Australia

United States

Turkey

Japan

Korea

Mexico

Countries

Percentage
20

While all OECD countries impose an individual income tax, a corporate income tax, 

payroll taxes, and general sales taxes (or value-added taxes) and selective excise taxes, the

relative reliance on these different tax bases varies across countries. Among OECD countries, 

the United States relies more heavily on the individual income tax and less heavily on general 

sales taxes or other general consumption taxes. Figure 3, Figure 4, Figure 5, and Figure 6 report 

individual income tax revenue, corporate income tax revenue, payroll tax revenue, and general 

consumption tax revenue (general sales taxes or value-added taxes), respectively, as a percentage 

of GDP in OECD member countries in 1999. All of these figures include taxes imposed at both 

national and subnational levels.

Figure 3

Source: OCED, Revenue Statistics 1965-1999.

Note: Data include all taxes imposed at both national and subnational levels.

Individual Income Tax Revenue as a Percentage of GDP in OECD Member Countries, 1999

0.0 5.0 10.0 15.0 20.0 25.0 30.0

Denmark

Sweden

New Zealand

Finland

Canada

Belgium

Australia

Iceland

United States

Norway

Italy

United Kingdom

Austria

Switzerland

Ireland

Germany

France

Poland

Luxembourg

Turkey

Spain

Hungary

Netherlands

Portugal

Greece

Czech Republic

Japan

Slovak Republic

Korea

Countries

Percentage
21

Figure 4

Source: OCED, Revenue Statistics 1965-1999.

Note: Data include all taxes imposed at both national and subnational levels.

Corporate Income Tax Revenue as a Percentage of GDP in OECD Member Countries, 1999

0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0

Luxembourg

Australia

Netherlands

Finland

Portugal

New Zealand

Ireland

United Kingdom

Czech Republic

Belgium

Japan

Italy

Greece

Norway

Sweden

Denmark

France

Slovak Republic

Spain

Canada

Poland

Switzerland

Turkey

United States

Hungary

Korea

Austria

Germany

Iceland

Countries

Percentage
22

Figure 5

Source: Data include all taxes imposed at both national and subnational levels.

Note: OCED, Revenue Statistics 1965-1999.

Payroll Tax Revenue as a Percentage of GDP in OECD Member Countries, 1999

0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0 20.0

Austria

Czech Republic

France

Sweden

Netherlands

Germany

Belgium

Slovak Republic

Hungary

Italy

Switzerland

Spain

Finland

Greece

Luxembourg

Norway

Poland

Japan

Portugal

United States

United Kingdom

Canada

Turkey

Ireland

Korea

Mexico

Iceland

Denmark

Australia

New Zealand

Countries

Percentage
23

Figure 6

Source: OCED, Revenue Statistics 1965-1999.

Note: Data include all taxes imposed at both national and subnational levels.

General Consumption Tax Revenue as a Percentage of GDP in OECD Member Countries, 1999

0.0 2.0 4.0 6.0 8.0 10.0 12.0

Iceland

Hungary

Denmark

Turkey

New Zealand

Norway

Finland

Austria

Portugal

France

Greece

Poland

Czech Republic

Belgium

Slovak Republic

Sweden

Ireland

Netherlands

Germany

United Kingdom

Luxembourg

Spain

Italy

Canada

Korea

Switzerland

Mexico

Australia

Japan

United States

Countries

Percentage
24

While total tax revenue as a proportion of GDP is presently considerably lower in the 

United States than in most other OECD member countries, this has not always been the case. In 

the 1960s, for example, tax revenue as a proportion of GDP was roughly equivalent in the United 

States and in the OECD member countries. Since that time, however, tax revenue relative to 

GDP has grown significantly in Europe, while it has grown only slightly in the United States. 

Figure 7 shows total taxes (at all levels of government) as a percentage of GDP in OECD Europe 

and the United States in 1965 and 1999.2

Figure 7

Source: OCED, Revenue Statistics 1965-2000.

Note: Data include all taxes imposed at both national and subnational levels.

 

2

 The data for this and the following figure reflect GDP-weighted averages of the 

percentage of tax revenue relative to GDP for the certain members of the OECD. The use of a 

GDP-weighted average causes the tax systems of large economies such as Germany and Japan to 

be weighted more heavily in the average than the tax systems of smaller economies such as 

Iceland and Luxembourg. In addition, since the number of European members of the OECD has 

grown over the past 40 years, the figures for both 1965 and 1999 are not based on the current 

membership of the non-U.S. OECD countries, but on those countries for which comparable data 

for both 1965 and 1999 are available. The countries in these comparisons are: Australia, Austria, 

Belgium, Canada, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Japan, 

Luxembourg, Netherlands, New Zealand, Norway, Spain, Sweden, Switzerland, Turkey, and the 

United Kingdom.

Total Taxes as a Percentage of GDP in Select OECD Countries

and the United States in 1965 and 1999

36.3

28.9

26.8

25.0

0.0 5.0 10.0 15.0 20.0 25.0 30.0 35.0 40.0

Total OECD, 1999

Total United States, 1999

Total OECD, 1965

Total United States, 1965
25

The revenues from different types of taxes relative to GDP also have changed over time 

in the United States and other OECD member countries. For example, the United States has 

come to rely more heavily on the individual income tax and on payroll taxes as revenue sources 

than it did in the 1960s. OECD member countries likewise have increased their reliance on 

individual income taxes and payroll taxes, but general consumption taxes also have become a 

much more important source of revenue in other OECD countries, unlike in the United States. 

Another point of difference is that corporate income tax revenues relative to GDP have declined 

slightly over time in the United States, while they have increased slightly in other OECD 

countries. Indeed, revenues from all four types of tax shown have increased relative to GDP in 

other OECD countries, as average tax revenues have grown substantially relative to GDP in 

other countries. Figure 8 shows revenues from different types of taxes (at all levels of 

government) as a percentage of GDP in non-U.S. OECD countries and the United States in 1965 

and 1999.

Figure 8

Source: OECD, Revenue Statistics 1965-2000.

Note: Data include all taxes imposed at both national and subnational levels.

Tax Revenues as a Percentage of GDP in Select OECD Countries

and the United States in 1965 and 1999 by Type of Tax

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

Individual Income Corporate Income Payroll Taxes General Consumption

United States 1965

OECD 1965

United States 1999

OECD 1999
26

In addition to differing reliance on the various tax bases, the structure of each tax may 

vary across countries. The material in the following section briefly describes the tax systems of 

Australia, Belgium, Canada, China, France, Germany, Ireland, Italy, Japan, Mexico, the 

Netherlands, Spain, and the United Kingdom. Table 4 shows the extent to which each of these 

countries relies on the individual income tax, the corporate income tax, payroll taxes, property 

taxes, and goods and services taxes3 for their government revenue (including all levels of 

government). This table expresses the revenue from each tax as a percentage of total tax 

revenues in the particular country, rather than as a percentage of GDP as in the figures above.

Table 4 – Percentage of Total Revenue Derived

from Different Taxes in Select Countries, 1998

Percentage of Total Revenue Comprised From

Individual

Income

Taxes

Corporate

Income

Taxes

Payroll

Taxes

Property

Taxes

Goods &

Services

Taxes

Australia 43.3 15.2 6.6 9.5 25.5

Belgium 30.7 8.5 31.5 3.2 24.9

Canada 37.8 10.0 15.8 10.4 24.7

China n.a. n.a. n.a. n.a. n.a.

France 17.4 5.9 38.5 7.3 26.6

Germany 25.0 4.4 40.4 2.4 27.4

Ireland 30.9 10.7 13.8 5.2 38.7

Italy 25.0 7.0 29.5 4.8 27.4

Japan 18.8 13.3 38.4 10.5 18.8

Netherlands 15.2 10.6 39.9 4.9 27.7

Spain 20.8 7.3 35.2 6.0 29.4

United Kingdom 27.5 11.0 17.6 10.7 32.6

United States 40.5 9.0 23.7 10.6 16.2

Source: Organisation for Economic Co-Operation and Development, Revenue Statistics, 1965-1999.

Note: Data include all taxes imposed at both national and subnational levels. Column "Goods and Services Taxes" 

includes general sales taxes, value added taxes, and specific excise taxes.

 

3

 In Table 4 the category “goods and services taxes” includes specific excise taxes as 

well as general sales taxes and value added taxes.
27

B. Summaries of Selected Countries’ Tax Systems 4

Australia 

Individual Income Taxation 

Australian residents are subject to tax in Australia on their worldwide income. A foreign 

tax credit is provided. Foreign individuals are generally subject to Australian income tax only on 

their Australian source income.

Individual income tax rates are progressive and range from 17 percent to 47 percent.

Corporate Income Taxation 

Australian resident corporations are subject to tax on their worldwide income. A foreign 

tax credit is provided. Dividends received by an Australian corporation from a foreign affiliate 

(10 percent or more ownership) in listed countries (generally comparable-tax countries) are 

exempt from tax in Australia. Foreign corporations are subject to Australian tax only on their 

Australian-source income. A corporation is resident in Australia if: (1) it is incorporated under 

Australian law; or (2) it carries on business in Australia, and either its place of central 

management and control is Australia, or its voting power is controlled by Australian residents. 

Under controlled foreign corporation rules, if five or fewer Australian residents own at least 50 

percent of a foreign company, then the Australian shareholders are currently taxed on certain 

tainted income of the company (mainly passive income and income from related-party 

transactions). Australia also has a foreign investment fund rule that is designed to complement 

and backstop the controlled foreign corporation regime.

Corporate income is subject to tax at a flat 34 percent rate (scheduled to be reduced to 30 

percent this year).

Substantial integration of the individual and corporate income taxes is achieved through 

an imputation credit mechanism. A dividend paid by an Australian company to a nonresident 

shareholder is generally subject to a 30 percent withholding tax (that may be reduced by treaty). 

If the dividend is a “franked” dividend (one on which corporate taxes have already been paid), 

then no withholding tax applies and no imputation credit is permitted to the nonresident 

shareholder (dividend exclusion mechanism).

Australia does not currently permit the filing of consolidated returns although informal 

consolidation is possible. Australia is expected to make consolidated filing available effective 

July 1, 2002.

 

4

 The following materials relate to foreign law and are based on the Joint Committee 

staff’s review of various publicly available secondary sources in mid-2001. The descriptions are 

intended to serve as general overviews; they may not be fully accurate in all respects, as many 

details have been omitted and simplifying generalizations made for ease of exposition. 
28

Value-Added Tax 

Since July 1, 2000, Australia has imposed a VAT (known as a “goods and services tax,” 

or “GST”) at a standard rate of 10 percent.
29

Belgium 

Individual Income Taxation 

Belgian residents are subject to tax in Belgium on their worldwide income. Foreignsource income of Belgian residents is generally taxed at half the normally applicable Belgian 

rate, thus permitting significant double taxation of cross-border income, absent treaty relief. 

Under Belgian treaties, double taxation of Belgian residents is usually relieved via an exemptionwith-progression method, under which foreign-source income is exempt from Belgian tax, but 

other income is taxed at the average rate that would apply to all income if foreign-source income 

were included. Foreign individuals are generally subject to Belgian income tax only on Belgiansource income. 

Individual income tax rates are steeply progressive and range from 0 percent to 55 

percent. A 3 percent “crisis contribution” surtax on the income tax liability also applies.

Corporate Income Taxation 

Belgian resident companies are subject to tax on their worldwide income. Double 

taxation is relieved via exemption under most Belgian tax treaties; absent a treaty, Belgian 

corporate income tax is generally reduced by 75 percent on income earned and taxed abroad. 

Dividends received by a Belgian company from a foreign affiliate (generally 5 percent or more 

ownership, or shareholding value of at least a certain minimum amount) are generally 95 percent 

exempt from Belgian tax. This participation exemption does not apply to dividends from 

companies subject to substantially more favorable tax regimes than Belgium. Non-Belgian 

companies are subject to Belgian tax only on Belgian-source income. Residence is generally 

determined by place of management. Belgium has no controlled foreign corporation rules. 

Corporate income is generally subject to a flat 39 percent basic rate, although reduced 

rates apply to lower income levels under certain circumstances. A 3 percent “crisis contribution” 

surtax on the income tax liability also applies, effectively raising the general rate to 40.17 

percent. 

The individual and corporate income taxes are not integrated, but dividends received by 

individuals are subject to reduced rates.

Belgium does not permit the filing of consolidated returns.

A special favorable tax regime is available for coordination centers, service centers, and 

distribution centers.

Value-Added Tax 

Belgium imposes a VAT at a standard rate of 21 percent.
30

Canada

Individual Income Taxation 

Canadian residents are subject to tax in Canada on their worldwide income. A foreign 

tax credit is provided, subject to a country-by-country limitation. Foreign individuals are 

generally subject to Canadian income tax only on their Canadian-source income.

Individual income tax rates are progressive and range from 16 percent to 29 percent. 

Provincial and territorial taxes also apply.

Corporate Income Taxation 

Canadian resident corporations are subject to tax on their worldwide income. A foreign 

tax credit is provided, subject to a country-by-country limitation. Dividends received by a 

Canadian corporation from a foreign affiliate (10 percent or more ownership) may be exempt 

from tax in Canada if received out of the “exempt surplus” of the foreign affiliate. Exempt 

surplus is generally defined as active business income earned in countries with which Canada has 

a tax treaty. Foreign corporations are subject to Canadian tax only on their Canadian-source 

income. A corporation is resident in Canada if it is incorporated under Canadian law or Canada 

is its place of central management and control. Under controlled foreign corporation rules, if 

five or fewer (in some instances four or fewer) Canadian residents control a foreign company 

(known as a “controlled foreign affiliate”), then 10 percent Canadian shareholders are taxable 

currently on their shares of the controlled foreign affiliate’s tainted (mainly passive) income. 

Canada also has a foreign investment fund rule that is designed to complement and backstop the 

controlled foreign corporation regime.

Corporate income is subject to a 38 percent tax rate that is generally reduced to 28 

percent for taxable income earned in a province or territory, with a four percent surtax, resulting 

in an effective tax rate of 29.12 percent. (The 28 percent rate will be reduced to 21 percent over 

four years beginning in year 2001.) Provincial and territorial taxes also apply. 

Substantial integration of the individual and corporate income taxes is achieved through 

an imputation credit mechanism. A dividend paid by a Canadian company to a nonresident 

shareholder is generally subject to a 25 percent withholding tax (that may be reduced by treaty).

Canada does not permit the filing of consolidated returns, although informal 

consolidation is possible.

Value-Added Tax 

Canada imposes a VAT (known as a “goods and services tax,” or “GST”) at a standard 

rate of 7 percent.
31

China 

Individual Income Taxation 

Chinese residents are generally subject to tax in China on their worldwide income. 

Individuals who do not have permanent homes in China and have resided in China for between 

one and five years are subject to tax in China on Chinese source income and on foreign source 

income that is paid or remitted to China. A foreign tax credit is provided. Foreign individuals 

are generally subject to Chinese income tax only on their Chinese source income. 

Individual income tax rates are progressive and range from 5 percent to 45 percent. Most 

investment income is taxed at a flat rate of 20 percent.

Corporate Income Taxation 

Corporations are classified into three categories: domestic state-owned enterprises, 

foreign investment enterprises, and foreign enterprises. A domestic state-owned enterprise is 

taxed on its worldwide income. A foreign investment enterprise, which includes joint ventures 

and entities wholly owned by foreign persons, is also taxed on its worldwide income. A foreign 

enterprise, which includes a foreign corporation, is taxed only on its Chinese source income. 

Corporate income is subject to a flat 30 percent tax rate (plus an additional 3 percent local 

rate). A reduced rate of 15 percent applies to foreign investment enterprises (and some foreign 

enterprises) with establishments in “special economic zones,” “economic and technological 

development zones,” or “export processing zones” in China.

A dividend paid from Chinese sources to a nonresident shareholder is generally subject to 

a 20 percent withholding tax (that may be reduced by treaty).

China generally does not permit the filing of consolidated returns but several exceptions 

apply.

Value-Added Tax 

China imposes a VAT at a standard rate of 17 percent and reduced rates of 6 percent and 

13 percent.
32

France

Individual Income Taxation 

French nationals and residents are subject to tax in France on their worldwide income. 

Foreign taxes are deductible, and are not creditable except by treaty. Foreign individuals are 

generally subject to French income tax only on French-source income. 

Individual income tax rates are steeply progressive and range from 0 percent to 54 

percent. Two surtaxes also apply: (1) a flat 8 percent “social tax” on 95 percent of salary, 

passive income, and capital gains; and (2) a 2 percent surcharge on all passive income and 

capital gains. 

Corporate Income Taxation 

France taxes corporations on a territorial basis. Thus, income earned by companies 

(wherever resident) in the conduct of a trade or business abroad is generally not subject to French 

corporate income tax. However, under controlled foreign corporation rules, a French resident 

company may be subject to tax on income earned abroad through a foreign enterprise if such 

income is subject to an effective tax rate that is less than two thirds of the French rate on similar 

income, and the French company is unable to prove both that the controlled foreign corporation 

engages in industrial or commercial activities and that the controlled foreign corporation’s 

business is carried out mostly in its local market. Corporate residence is determined by place of 

incorporation. 

Corporate income is subject to a flat 33.33 percent basic rate, but two surtaxes raise the 

effective rate to 36.44 percent. 

Partial integration of the individual and corporate income taxes is achieved through an 

imputation credit mechanism.

France permits the filing of consolidated returns.

Value-Added Tax 

France imposes a VAT at a standard rate of 19.6 percent.
33

Germany 

Individual Income Taxation 

German domiciliaries are subject to tax in Germany on their worldwide income 

(citizenship is usually not relevant to German tax law, except under treaties). A foreign tax 

credit is provided. Foreign individuals are generally subject to German income tax only on 

German-source income. 

Individual income tax rates are progressive and range from 20 percent to 48.5 percent. 

An additional 5.5 percent “solidarity surcharge” on the income tax liability is imposed to finance 

the costs of German unification.

Corporate Income Taxation 

German resident corporations are taxed on their worldwide income. A foreign tax credit 

is provided. Dividends received by a German corporation from a foreign affiliate (10 percent or 

more ownership) are generally 95 percent exempt from German tax. Under controlled foreign 

corporation rules, a German shareholder of a low-tax controlled foreign corporation is taxed 

currently when the controlled foreign corporation earns “tainted” (mainly passive) income. A 

controlled foreign corporation is “low-tax” if it pays tax at a rate of less than 30 percent. A 

corporation is resident in Germany if it is incorporated under the laws of Germany or its place of 

management is Germany. Foreign corporations are generally taxed only on German-source 

income. 

Corporate income is subject to a flat 25 percent tax rate. An additional 5.5 percent 

“solidarity surcharge” on the income tax liability is imposed to finance the costs of German 

unification. Sub-national income taxes also apply, often at relatively high rates.

Germany formerly provided substantial integration of the individual and corporate 

income taxes through an imputation credit system, but this system was recently repealed. 

However, beginning in 2002, partial integration will be achieved via a 50 percent dividendsreceived deduction for individual shareholders. A similar 50 percent exclusion will apply to 

gains on the sale of stock.

Germany permits the filing of consolidated returns.

Value-Added Tax 

Germany imposes a VAT at a standard rate of 16 percent and a reduced rate of 7 percent.
34

Ireland 

Individual Income Taxation 

Irish residents are subject to tax in Ireland on their worldwide income. A foreign tax 

credit is provided under treaties. Absent treaty relief, foreign taxes are only deductible, not 

creditable. Foreign individuals are generally subject to Irish income tax only on Irish-source 

income. 

Individual income tax rates are progressive and range from 22 percent to 44 percent. 

Corporate Income Taxation 

Irish resident corporations are taxed on their worldwide income. A foreign tax credit is 

provided under treaties. Absent treaty relief, foreign taxes are generally deductible, and not 

creditable, although companies that derive income from certain computer-related and other 

activities are eligible for a 90 percent unilateral foreign tax credit. Ireland has no controlled 

foreign corporation rules. A corporation is resident in Ireland if it is incorporated under the laws 

of Ireland (unless certain conditions are met) or its place of central management and control is 

Ireland. Foreign corporations are generally taxed only on Irish-source income. 

Corporate “trading income” is generally subject to a flat 20 percent rate, but a reduced 

rate of 10 percent applies to income from the sale of goods manufactured in Ireland and from 

certain services performed in Ireland. Under pressure from the European Union, Ireland recently 

agreed to raise the reduced rate to 12.5 percent beginning in 2002. The reduced 10 percent rate 

will generally remain available to existing operations through 2010, although the more recently 

established projects will lose the benefit of the 10 percent rate beginning in 2003. 

Until 1999, Ireland had a partial imputation credit system; since mid-1999, Ireland has 

had an unintegrated corporate income tax system.

Although Ireland does not currently permit the filing of consolidated returns, effective 

consolidation is available to a limited extent through various “group relief” provisions.

Value-Added Tax 

Ireland imposes a VAT at a standard rate of 21 percent and reduced rates of 0 percent, 4.2 

percent, and 12.5 percent.
35

Italy

Individual Income Taxation 

Italian residents are subject to tax in Italy on their worldwide income. A foreign tax 

credit is provided. Foreign individuals are generally subject to Italian income tax only on Italiansource income. 

Individual income tax rates are progressive and range from 18.1 percent to 45.1 percent. 

Regional and municipal income taxes may add roughly one or two percentage points to the 

national rates.

Corporate Income Taxation 

Italian resident corporations are taxed on their worldwide income. A foreign tax credit is 

provided. Dividends received by an Italian corporation from an EU affiliate (25 percent or more 

ownership) are generally 95 percent exempt from Italian tax. Dividends received by an Italian 

corporation from a non-EU affiliate (20 percent or more ownership, 10 percent if subsidiary is a 

listed company) are generally 60 percent exempt from Italian tax. Historically, Italy has not had 

controlled foreign corporation rules, but the Italian parliament enacted a controlled foreign 

corporation regime in November 2000. Under this new regime, the Italian tax authority will 

develop a “blacklist” of countries employing preferential tax regimes, and income earned by 

controlled foreign corporations incorporated in blacklisted countries will generally be taxable to 

controlling Italian shareholders, subject to certain activity-based and other exceptions. Foreign 

corporations are generally taxed only on Italian-source income. 

Corporate income is generally taxed at a rate of 36 percent, but lower rates apply to 

certain income, pursuant to the “dual income tax” system. Under the dual income tax system, a 

certain level of return on newly invested capital or reinvested corporate earnings is subject to tax 

at a preferred rate (generally 19 percent), although this dual income tax preference cannot cause 

the average rate to fall below 27 percent. Companies in their first 3 years of being publicly 

traded are generally eligible for a more favorable dual income tax regime (7 percent reduced rate, 

20 percent average rate limit). Regional corporate income taxes are imposed at relatively high 

rates and are computed using an expanded tax base, by denying various common income tax 

deductions.

The individual and corporate income taxes are integrated, through a full imputation credit 

mechanism.

Italy does not permit the filing of consolidated returns, but effective consolidation is 

available to a limited extent through an intra-group tax credit exchange mechanism.

Value-Added Tax 

Italy imposes a VAT at a standard rate of 20 percent and reduced rates of 4 percent and 

10 percent. 
36

Japan 

Individual Income Taxation 

Japanese permanent residents are subject to tax in Japan on their worldwide income. 

Japanese nonpermanent residents (i.e., individuals who do not intend to permanently reside in 

Japan and have resided in Japan for between one and five years) are subject to tax in Japan on 

Japanese source income and on foreign source income that is paid or remitted to Japan. A 

foreign tax credit is provided. Foreign individuals are generally subject to Japanese income tax 

only on their Japanese source income. 

Individual income tax rates are progressive and range from 10 percent to 37 percent. An 

“individual inhabitant tax” (composed of a municipal and a prefectural tax) also applies. Most 

dividend and interest income is subject to a 20 percent withholding tax, which is the final tax 

liability on such income. Capital gains are taxed, and certain types may receive preferential 

treatment.

Corporate Income Taxation 

Japanese resident corporations are subject to tax on their worldwide income. A foreign 

tax credit is provided. Foreign corporations are subject to Japanese tax only on their Japanesesource income. A corporation is resident in Japan if it is incorporated under Japanese law or has 

its head office in Japan. Japan has imposed a controlled foreign corporation regime since 1978. 

It applies to a Japanese domestic corporation that owns five percent or more of a tax-haven 

subsidiary where Japanese domestic corporations or Japanese residents own 50 percent or more 

of the subsidiary. A foreign subsidiary is a tax-haven subsidiary if its head office is located in a 

country with no income tax or if the effective tax rate is 25 percent or less. Japan does not have 

a foreign investment fund rule. 

Corporate income is generally subject to a 30 percent tax rate. Smaller corporations (i.e., 

corporations with capitalization of roughly $800,000 or less and taxable income of roughly 

$65,000 or less) are subject to tax at a 22 percent rate. Japan also has an inhabitant tax and an 

enterprise tax, both of which are levied on corporations at the local level.

Corporate and individual income taxes are partially integrated, using both dividend 

exclusion and imputation credit mechanisms. A dividend paid by a Japanese company to a 

nonresident shareholder is generally subject to a 20 percent withholding tax (that may be reduced 

by treaty).

Japan currently does not permit the filing of consolidated returns.

Value-Added Tax 

Japan imposes a VAT at a standard rate of 5 percent (4 percent national and 1 percent 

local).
37

Mexico 

Individual Income Taxation 

Mexican residents are subject to tax in Mexico on their worldwide income. A foreign tax 

credit is provided. Foreign individuals are generally subject to Mexican income tax only on their 

Mexican source income.

Individual income tax rates are progressive and range from 3 percent to 40 percent. 

Capital gains are generally taxed, with an exception for gains from the sale of shares on the 

Mexican Stock Exchange. Certain other types of capital gains may receive preferential 

treatment.

Corporate Income Taxation 

Mexican resident corporations are subject to tax on their worldwide income. A foreign 

tax credit is provided. Foreign corporations are generally subject to Mexican tax only on their 

Mexican-source income. A corporation is resident in Mexico if it is incorporated under Mexican 

law or Mexico is its principal place of management. Mexico has a controlled foreign corporation 

regime that applies to any Mexican resident with an interest in a foreign entity created or 

established in a listed tax haven.

Distributed corporate income is subject to a 35 percent tax rate; undistributed income is 

subject to a 30 percent rate.

Partial integration of the individual and corporate income taxes is achieved through a 

dividend exclusion mechanism. A dividend paid by a Mexican company to a nonresident 

shareholder is generally subject to a 5 percent withholding tax (that may be reduced by treaty) 

that may be grossed up to create an effective tax rate of approximately 7.7 percent.

Mexico permits the filing of consolidated returns.

Value-Added Tax 

Mexico imposes a VAT at a standard rate of 15 percent.
38

Netherlands 

Individual Income Taxation 

Dutch residents are subject to tax in Netherlands on their worldwide income. A foreign 

tax credit is provided. Foreign individuals are generally subject to Dutch income tax only on 

Dutch-source income. 

Income is divided into three “boxes”: Box 1 includes income from work and home 

ownership, which is subject to progressive tax rates ranging from 32.25 percent to 52 percent for 

individuals under age 65, and from 14.35 percent to 52 percent for individuals aged 65 and over; 

Box 2 includes income from a “substantial shareholding,” which is subject to a flat 25 percent 

rate; and Box 3 includes income from savings and investments, which is subject to a flat 30 

percent rate. Netherlands formerly also imposed an annual wealth tax (a “net worth tax”) at a 0.7 

percent rate beyond a certain threshold amount of wealth, but this tax was abolished at the 

beginning of 2001.

Corporate Income Taxation 

Dutch resident corporations are taxed on their worldwide income. A foreign tax credit is 

provided. Dividends received by a Dutch corporation from a foreign affiliate (5 percent or more 

ownership) are generally exempt from Dutch tax. The participation exemption also extends to 

gains on the sale of shares of the affiliate. Netherlands does not have a controlled foreign 

corporation regime. It does have anti-avoidance rules that address certain accumulations of 

passive assets and income offshore, but these rules have a more limited reach than the typical 

controlled foreign corporation regime. A corporation is resident in Netherlands if it is 

incorporated under Dutch law or it is effectively managed and controlled from Netherlands. 

Foreign corporations are generally taxed only on certain categories of Dutch-source income. 

Corporate income is generally subject to tax at a 35 percent rate, although a 30 percent 

rate applies to a relatively small initial threshold amount of income.

Netherlands has an unintegrated corporate income tax system.

Netherlands permits the filing of consolidated returns.

Netherlands is generally viewed as an attractive place in which to establish a holding 

company, because: (1) it imposes no withholding tax on interest and royalties; (2) it has an 

extensive tax treaty network; and (3) it provides a favorable participation exemption.

Value-Added Tax 

Netherlands imposes a VAT at a standard rate of 19 percent and reduced rates

of 0 percent and 6 percent.
39

Spain

Individual Income Taxation 

Spanish residents are subject to income tax in Spain on their worldwide income. A 

foreign tax credit is provided. Foreign individuals are generally subject to Spanish income tax 

only on Spanish-source income. 

National and sub-national (“autonomous community”) income tax rates are combined to 

determine an individual’s total tax liability. The maximum combined marginal rate is 48 

percent. In addition, Spain levies an annual net worth tax at graduated rates from 0.2 percent to 

2.5 percent, subject to modification by the various autonomous communities, within certain 

limits.

Corporate Income Taxation 

Spanish resident corporations are taxed on their worldwide income. Both exemption and 

credit mechanisms are employed to relieve double taxation in different circumstances. 

Dividends received by a Spanish corporation from a foreign affiliate (5 percent or more 

ownership) may be exempt from Spanish tax if various conditions are met. Under controlled 

foreign corporation rules (first implemented in 1995), Spanish resident companies are taxable 

currently on passive income of their low-tax foreign subsidiaries. A corporation is resident in 

Spain if it is incorporated under the laws of Spain or its legal headquarters or effective place of 

management is in Spain. Foreign corporations are generally taxed only on Spanish-source 

income. 

Corporate income is generally taxed at a rate of 35 percent. 

The individual and corporate income taxes are partially integrated through a partial 

imputation credit mechanism.

Spain permits the filing of consolidated returns.

Value-Added Tax 

Spain imposes a VAT at a standard rate of 16 percent and reduced rates of 7 percent and 

4 percent.
40

United Kingdom

Individual Income Taxation 

British residents and domiciliaries are subject to tax in the United Kingdom on their 

worldwide income. A foreign tax credit is provided. Foreign individuals are generally subject to 

British income tax only on British-source income. 

Individual income tax rates are progressive and range from 10 percent to 40 percent.

Corporate Income Taxation 

British resident corporations are taxed on their worldwide income. A foreign tax credit is 

provided. Under controlled foreign corporation rules, British resident companies are taxable 

currently on the income of low-tax controlled foreign corporations in which they hold at least 25 

percent share ownership, unless the controlled foreign corporation carries on certain exempt 

activities. The controlled foreign corporation rules include an intent-based exception: if the 

primary purpose of the controlled foreign corporation’s activities is not to reduce U.K. tax, and 

the underlying reason for the corporation’s existence is not to divert profits from the United 

Kingdom, then the controlled foreign corporation rules do not apply. A corporation is resident in 

the United Kingdom if it is incorporated under U.K. law or its place of central management and 

control is the United Kingdom. Foreign corporations are generally taxed only on British-source 

income. 

Corporate income is generally taxed at a rate of 30 percent, but lower rates are available 

to certain small corporations. 

The United Kingdom formerly provided significant integration of the individual and 

corporate income taxes through a partial imputation credit system (the “advance corporation 

tax,” or “ACT”), but this system was eliminated in 1999. Under present law, dividends generally 

still carry tax credits, but these credits are smaller than those provided under the advance 

corporation tax, such that they fully offset the individual-level tax on dividends only for 

individuals in a lower rate bracket. Dividends generally now are taxed in the hands of higherincome individuals.

The United Kingdom does not permit the filing of consolidated returns, but effective 

consolidation is available through “group relief” provisions.

Value-Added Tax 

The United Kingdom imposes a VAT at a standard rate of 17.5 percent and reduced rates 

of 5 percent and 0 percent.
41

C. Selected Countries’ Tax Treatment of Cross-Border Transactions

Table 5, below, is based on the summaries of selected countries’ tax systems set forth in 

the previous section. Table 5 summarizes those features of the tax systems that are particularly 

relevant to the taxation of cross-border transactions. In particular, the table indicates whether 

resident corporations are subject to worldwide or territorial taxation (or whether they are subject 

to a system that approximates territorial taxation in many respects, by virtue of a “participation 

exemption” system).5 Table 5 also summarizes how the different countries mitigate the double 

taxation of foreign-source income, whether the countries use “controlled foreign corporation” 

anti-deferral regimes, and whether the countries tax corporate income under an “integrated” 

model (in which corporate income generally is taxed only once) or a “classical” model (in which 

corporate income generally is taxed at both the corporate and shareholder levels). Finally, Table 

5 describes certain other characteristics of the country’s tax regime relevant to the taxation of 

international transactions. More detailed descriptions of the features summarized in this table are 

provided in the summaries set forth in the previous section.

Table 5 – Comparison of Selected Countries’ Rules Governing the Taxation of

Cross-Border Transactions

Country Taxation of 

resident 

corporations

Relief of 

cross-border 

double 

taxation

Controlled 

foreign 

corporation rules?

Integrated 

or classical 

(double-tax) 

corporate 

tax system

Special 

characteristics

Australia Worldwide 

(but 100% 

participation 

exemption 

for 10% 

owners)

Foreign tax 

credit

Yes, with foreign 

investment fund 

rules

Partially 

integrated; 

imputation 

credit

Integration relief 

extends to 

nonresidents in 

some cases

Belgium Worldwide 

(but 95% 

participation 

exemption 

for 5% 

owners)

Exemption 

under treaties; 

otherwise 

75% 

reduction of 

tax liability 

on foreignsource 

income

No Classical, 

but 

dividends 

taxed at 

reduced 

rates

Favorable 

regimes for 

coordination, 

service, and 

distribution 

centers

 

5

 See Section III, "Issues in the Taxation of Cross-Border Transactions" of these 

materials for a discussion of participation exemption systems and other systems based on 

territorial tax principles.
42

Country Taxation of 

resident 

corporations

Relief of 

cross-border 

double 

taxation

Controlled 

foreign 

corporation 

rules?

Integrated or 

classical 

(double-tax) 

corporate 

tax system

Special 

characteristics

Canada Worldwide 

(but 100% 

participation 

exemption 

for 10% 

owners)

Foreign tax 

credit

Yes, with foreign 

investment fund 

rules

Substantially 

integrated; 

imputation 

credit

China Worldwide Foreign tax 

credit

No Classical Favorable 

regimes for 

certain 

enterprises and 

zones

France Territorial 

(but 

worldwide 

for 

individuals)

Foreign tax 

credit if 

controlled 

foreign 

corporation 

rules generate 

tax on 

foreignsource 

income

Yes Partially 

integrated; 

imputation 

credit

Germany Worldwide 

(but 95% 

participation 

exemption 

for 10% 

owners)

Foreign tax 

credit

Yes Partially 

integrated; 

50% 

dividendsreceived 

deduction

Imputation 

credit system 

recently 

abandoned

Ireland Worldwide Foreign tax 

credit under 

treaties; 

otherwise 

deduction for 

foreign taxes 

or unilateral 

foreign tax 

credit for 

special types 

of income

No Classical Favorable rates 

for business 

income derived 

in Ireland; 

partial 

imputation 

credit system 

abandoned in 

1999
43

Country Taxation of 

resident 

corporations

Relief of 

cross-border 

double 

taxation

Controlled 

foreign 

corporation 

rules?

Integrated 

or classical 

(doubletax) 

corporate 

tax system

Special 

characteristics

Italy Worldwide 

(but 95% or 

60% 

participation 

exemption)

Foreign tax 

credit

Yes Integrated; 

imputation 

credit

Controlled 

foreign 

corporation 

rules first 

implemented in 

late 2000

Japan Worldwide Foreign tax 

credit

Yes Partially 

integrated; 

dividend 

exclusion 

and 

imputation 

credit

Mexico Worldwide Foreign tax 

credit

Yes Partially 

integrated; 

dividend 

exclusion

Netherlands Worldwide 

(but 100% 

participation 

exemption 

for 5% 

owners)

Foreign tax 

credit

No, but limited 

anti-deferral rules 

for passive 

income

Classical Favorable 

jurisdiction for 

holding 

companies 

receiving 

passive income

Spain Worldwide 

(but 

effective 

participation 

exemption)

Exemption or 

foreign tax 

credit, 

depending on 

circumstances

Yes Partially 

integrated; 

imputation 

credit

Controlled 

foreign 

corporation 

rules first 

implemented in 

1995

United 

Kingdom

Worldwide Foreign tax 

credit

Yes Partially 

integrated; 

imputation 

credit

Integration 

reduced since 

1999 repeal of 

advance 

corporation tax 

system 
44

III. ISSUES IN CORPORATE TAX INTEGRATION

A. Introduction to Corporate Tax Integration

Classical income tax systems 

The United States has a classical income tax system. In a classical income tax system, 

corporate earnings are taxed twice: first to the corporation when it earns the income, and second 

to the shareholders when they receive the income as a dividend (or when they recognize gain on 

a sale of their shares). Although double taxation of corporate income is the norm in a classical 

income tax system, in some cases corporate earnings may be taxed only once or not at all. For 

example, corporate earnings are taxed only at the corporate level when a corporation distributes 

a dividend to a tax-exempt shareholder; corporate earnings are taxed only at the investor level 

when a corporation distributes its earnings in the form of deductible interest payments; and 

corporate earnings may be entirely free of U.S. tax when a corporation distributes its earnings in 

the form of deductible interest payments to a tax-exempt shareholder or foreign person. 

Integrated income tax systems 

A fully integrated income tax system would eliminate the double tax on corporate 

earnings and would impose a uniform tax on capital income, whether earned through a 

corporation or not, thus creating a single level of tax on corporate earnings. Many OECD 

countries have some form of an integrated income tax system, usually resulting in partial 

integration and thus not completely eliminating the double tax on corporate earnings. 

Integration models within the existing U.S. system

The United States has a number of regimes that achieve some form of integration under 

certain circumstances, and which some may argue can serve as models for broader integration 

mechanisms.

Subchapter K 

Partnerships and limited liability companies are taxed as pass-through entities, resulting 

in a single level of tax at the partner or member level, with the principal limitation that the entity 

not be publicly traded (in which case it would generally be treated as a “publicly traded 

partnership” and taxed as a C corporation). In 1997, taxpayers were provided significant 

flexibility in electing to treat various business entities as partnerships under the so-called "checkthe-box" regulations.

Subchapter S

S corporations are generally taxed as pass-through entities, resulting in a single level of 

tax at the shareholder level, with the principal limitations being a limit on the number of 

shareholders, the allowance of only a single class of stock, and a rule that no foreign persons 

may hold shares.
45

Subchapter J 

Estates and trusts are taxed like pass-through entities in certain cases, leading to a single 

level of tax.

Subchapter M

Regulated investment companies (RICs), real estate investment trusts (REITs), real estate 

mortgage investment conduits (REMICs), and financial asset securitization investment trusts 

(FASITs) are taxed as pass-through entities, subject to a number of requirements specific to each 

type of entity.

Subchapter T 

Cooperatives are effectively taxed as pass-through entities in certain cases by allowing a

dividends-paid deduction.

B. Rationale for a Classical Income Tax System 

Benefits of incorporation and separate legal status

Corporations are considered appropriate entities to tax on a separate basis because of 

their separate legal status and the limited liability provided to their shareholders. This rationale 

has arguably weakened in light of recent changes to the entity classification regulations, which 

allow certain limited liability companies to achieve pass-through tax treatment. However, since 

publicly traded companies generally cannot achieve pass-through taxation under these rules, 

some argue that taxing such companies on a separate basis reflects the benefit of access to the 

public equity markets. 

Capture windfall gains

Large business enterprises may benefit from economic “rents” (returns due to unique 

attributes and not competition) that are essentially windfall gains. Taxation of these returns will 

not create economic distortions.

Increase the progressivity of the federal income tax system 

The corporate income tax, in conjunction with the individual income tax, is generally 

thought to promote progressivity in the tax system. However, the degree to which it does has 

long been debated, since relatively little is known about the extent to which corporations can 

effectively pass the burden of the corporate tax on to consumers, employees, and others, instead 

of allowing that burden to rest with shareholders. Moreover, stock ownership has become much 

more widespread in the United States over the last several years (through tax-favored retirement 

plans and otherwise), rendering questionable any assumption that a tax borne by shareholders as 

a group is a progressivity-enhancing tax on wealthy individuals.
46

Prevent an increase in other taxes 

Revenue loss from eliminating the corporate income tax could require other taxes to be 

increased, and also may create winners and losers.

C. Problems with a Classical Income Tax System

Disincentive for investment in new corporate capital 

A classical corporate income tax discourages investors from investing in corporations 

because of the additional corporate tax burden (higher effective tax rate on corporate equity than 

on non-corporate equity).

Incentive for corporate financing by debt or retained earnings

Corporations are encouraged to finance their activities through debt or their own retained 

earnings to avoid the additional corporate tax burden, because interest on debt is deductible, 

while dividends paid on equity are not deductible.

Incentive to distribute or retain corporate earnings 

A classical corporate income tax provides an incentive to distribute or retain earnings 

depending on the relative tax rates for corporations and shareholders and the capital gains tax 

rate.

Incentive to distribute corporate earnings in tax-preferred forms 

Corporations are encouraged to distribute earnings in forms eligible for capital gains 

treatment, for example, redemptions of stock that give rise to capital gains, rather than dividends 

that are taxed as ordinary income (i.e., at non-preferential rates and without basis recovery).

D. Methods of Implementing an Integrated Income Tax System

Shareholder credit for corporate taxes paid 

Under a shareholder credit system, when a shareholder receives a taxable dividend, the 

shareholder is entitled to a credit for the corporate taxes paid with respect to the dividend. The 

American Law Institute (“ALI”) recommended this approach in a 1993 study, 6 which set forth 

four proposals to implement the system: (1) a withholding tax on dividends, with a credit for the 

corporate income tax paid with respect to the dividend; (2) shareholders would receive a 

refundable tax credit for the dividend withholding tax; (3) certain corporate tax preferences could 

be passed through to shareholders; and (4) a withholding tax on corporate interest payments; this 

tax would be fully creditable by and refundable to the recipients of the interest payments. The 

 

6

 American Law Institute, Federal Income Tax Project: Integration of the Individual and 

Corporate Income Taxes (Reporter’s Study of Corporate Tax Integration by Alvin C. Warren, 

Jr.) (1993).
47

Treasury Department (“Treasury”) did not recommend this approach in a 1992 study, 7

principally because of its complexity; instead Treasury recommended a dividend exclusion 

method. Most countries that have integrated systems use some form of the shareholder credit 

method, although in many cases there is a limitation on the amount of the credit, so that only 

partial integration is achieved.

Corporate deduction for dividends paid 

Under a dividends-paid deduction model, a corporation deducts dividends paid to its 

shareholders, which would generally equalize the treatment of dividends (equity) and interest 

(debt). However, as a matter of timing, some differential treatment of debt and equity would 

likely persist, since interest is deductible as it accrues, while dividends are deductible only when 

paid. Dividends are taxed only at the shareholder rate, which may create a bias toward 

distributions, particularly if the corporate rate is higher than the individual rate. 

Treasury in 1984 recommended a 50 percent dividends-paid deduction, and the 

President’s tax proposals in 1985 included a ten percent dividends-paid deduction. However, the 

1992 Treasury study abandoned this approach, due to a concern that allowing deductible 

dividends to be paid to tax-exempt and foreign shareholders might completely eliminate the 

corporate level tax, and a belief that the approach would prove more expensive than a dividend 

exclusion or imputation credit method of achieving integration.

Shareholder exclusion of dividends received 

Under a dividend exclusion model, a shareholder excludes from gross income dividends 

received from a corporation. The 1992 Treasury study recommended the dividend exclusion 

model because of the system’s overall simplicity, and because it could be implemented with 

relatively little structural change.

From 1954 to 1986, individuals were permitted to exclude a limited amount of dividends 

from gross income (in the early years this was a credit). The Tax Reform Act of 1986 repealed a 

provision that permitted individuals to exclude up to $100 ($200 for married individuals filing 

jointly) of dividends from domestic corporations. 

Other methods of achieving integration 

The shareholder credit, dividends-paid deduction, and dividend exclusion models are 

generally regarded as the most viable alternatives for integration. However, a few other possible 

approaches also warrant mention.

 

7

 Report of the Department of the Treasury, Integration of the Individual and Corporate 

Tax Systems: Taxing Business Income Once (January 1992).
48

Pass-through taxation

One alternative would be to treat the corporation as a pass-through or conduit (in a 

manner similar to the taxation of partnerships or S corporations). This proposal is sometimes 

referred to as “full integration.” The system would treat retained earnings and distributed 

earnings equally, thus relieving the incentive to distribute earnings, as may occur under a 

distribution-based integration system. The 1992 Treasury study discussed a “shareholder 

allocation” prototype, which is one variation on a pass-through model, but did not recommend it 

for two reasons: (i) the method raises policy concerns, such as extending tax preferences to 

shareholders and exempting from U.S. tax foreign-source income; and (ii) the method also raises 

administrative and compliance problems, such as amending corporate governing documents to 

provide for income allocations, maintaining capital accounts, and allocation difficulties for 

shareholders selling stock during the year.

Comprehensive Business Income Tax (“CBIT”) 

Under the CBIT, there would be no corporate-level deduction for dividends or interest 

paid, but both shareholders and debtholders would exclude dividends and interest received, 

thereby achieving equality in the tax treatment of debt and equity. The 1992 Treasury study 

proposed the CBIT as a comprehensive, long-term option for equalizing the tax treatment of debt 

and equity. Treasury recognized that implementing the system would require significant 

statutory revision and suggested that full implementation would likely be phased in over a period 

of about ten years. The system would be applicable to all but the smallest businesses, whether 

conducted in corporate form or not. Treasury predicted that the system would be self-financing 

and would permit lowering the corporate tax rate from 34% to 31% (which was the maximum 

individual tax rate in 1992) on a revenue-neutral basis.

Repeal of corporate income tax 

Another option would be to repeal the corporate income tax and impose a modified 

shareholder-level tax. In the case of publicly traded stock, shareholders would be taxed currently 

on the change in value of their stock under a “mark-to-market” system. Thus, the realization 

doctrine would be repealed with respect to publicly traded stock. In the case of non-publicly 

traded stock, shareholders would be taxed currently on the corporation’s income by treating the 

corporation as a pass-through entity.

E. Additional Issues to Consider in Adopting an Integrated Income Tax System

Untaxed corporate income 

Corporate income distributed to shareholders may not have been subject to corporate 

income tax (for example, a corporation receiving tax-exempt interest on municipal bonds). This 

poses a challenge for the distribution-based integration models.

Under the shareholder credit method, a shareholder should not receive credit for taxes 

that have not been paid at the corporate level. The 1993 ALI study would impose an auxiliary 

withholding tax on dividends to ensure that shareholders do not receive credits for taxes that 

have not been paid at the corporate level. The ALI study would also treat payments of the 
49

corporate tax as prepayments of the auxiliary withholding tax. Certain dividends could be free of 

corporate tax as a result of tax preferences that pass through to shareholders.

Under the dividend exclusion method, a shareholder should not exclude a dividend if the 

dividend is paid out of income that has not been taxed at the corporate level. The 1992 Treasury 

study recommended that shareholders treat dividends as taxable or non-taxable based on a 

statement from the corporation as to the amount of the dividend that had incurred corporate tax. 

Treasury initially rejected the idea of passing through corporate tax preferences to shareholders, 

primarily because of the large revenue loss. However, a later Treasury release in December 

1992 proposed allowing a limited amount of corporate tax preferences to pass through to 

shareholders.

Equal tax treatment of equity and debt 

The different approaches to integration would reduce or eliminate the differential in 

income tax treatment of equity and debt to varying degrees. The 1993 ALI study proposed 

achieving equivalent treatment between equity and debt by imposing a withholding tax on 

interest payments, which would function in the same manner as the credit for dividends. The 

dividend exclusion method recommended by the 1992 Treasury study would not achieve 

equivalent treatment between equity and debt, because corporate earnings distributed as a 

dividend would be taxed at the corporate-level rate, while corporate earnings distributed as 

deductible interest would be taxed at the investor-level rate. The CBIT system recommended as 

a long-term option by the 1992 Treasury study would achieve equivalent treatment between 

equity and debt, because neither dividends nor interest would be deductible by the corporation, 

nor would either be included in income by the investor. Equalizing the treatment of debt and 

equity would remove a significant source of complexity and economic inefficiency, and would 

also reduce the opportunity for tax shelter activity and other difficulties encountered in the 

taxation of financial transactions.

Double taxation of retained earnings of a corporation 

Corporate retention of earnings may lead to double taxation of the same income upon the 

sale of stock, because the earnings may have been subject to corporate tax, and the corporation’s 

retention of the earnings will increase the value of the stock without an increase to the 

shareholder’s basis in the stock. Thus, when the shareholder sells the stock, the gain may be 

partially or entirely attributable to earnings that have been subject to tax at the corporate level. 

This form of double taxation can be eliminated by a constructive dividend and reinvestment 

mechanism, which would increase the shareholder’s basis in the stock. Alternatively, gains from 

the sale of stock might be excluded from income altogether. The adoption of one of these 

mechanisms would address the concern that moving to an integrated system might cause 

investors to prefer dividend-paying stocks to traditionally non-dividend-paying stocks (e.g., 

high-technology growth stocks). 

Tax-exempt shareholders and creditors 

Generally, interest received by a tax-exempt debtholder will bear no tax at all, because 

the interest is deductible by the corporation, while dividends received by an exempt shareholder 
50

will bear a corporate level tax, because the dividend is not deductible. Ideally, an integration 

system would reduce or elimi nate the differential treatment of these two forms of investment by 

tax-exempt persons. However, neither the 1993 ALI study nor the 1992 Treasury study 

recommended that corporate income attributable to tax-exempt investors automatically be free of 

all tax. The ALI recommended that a new tax be imposed on corporate investment income of 

tax-exempt organizations against which the shareholder and creditor withholding credits could 

be used (with any excess refundable). Treasury did not propose a new tax on corporate 

investment income of tax-exempt organizations (but did note that a tax of six to eight percent 

would approximate the tax burden on investment income received by tax-exempt shareholders). 

Thus, under the dividend exclusion method recommended by Treasury, differential treatment of 

debt and equity would continue for tax-exempt investors. Under the CBIT method, equal 

treatment of debt and equity would be achieved for tax-exempt investors, since neither interest 

nor dividends would be deductible at the corporate level.

International income 

Generally, direct taxes on corporate income are collected by the source country, while 

taxes on interest and dividend income are collected (mainly) by the investor’s residence country. 

For this reason, integration of the corporate and individual taxes creates an immediate problem in 

coordinating source-country and residence-country taxation. The 1992 Treasury study would 

impose tax at the corporate level, while the 1993 ALI study would impose tax at the shareholder 

level. In either case, existing U.S. law and treaties would have to be reexamined (and 

renegotiated). Integration of the domestic corporate and individual income taxes can be viewed 

as incompatible with the norm of double taxation of international corporate income and, as a 

result, certain international issues arise in an integrated system.

To what extent should the United States tax U.S. corporate income paid to foreign 

investors and foreign parent companies? 

The ALI recommended that a separate new tax be imposed on U.S. investment income of 

foreign investors and foreign parent companies (replacing the current nonrefundable withholding 

tax), against which the new dividend and interest withholding tax set forth in the core ALI 

proposal would be creditable (with any excess refundable). The tax rate could be reduced by 

treaty. The effects of this mechanism would be to ensure that the United States levies a sourcecountry tax on corporate income paid to foreign investors, to extend integration credits to foreign 

investors, and to facilitate the mitigation of international double taxation via a residence-country 

foreign tax credit or a treaty provision. The 1992 Treasury study did not propose a new tax on 

U.S. investment income of foreign investors and foreign parent companies, and would not extend 

the benefits of integration to foreign shareholders except as negotiated by treaty.
51

How should foreign taxes paid by U.S. companies on foreign income affect the U.S. 

taxation of U.S. shareholders on the distribution of those earnings? 

The ALI recommended treating corporate foreign income benefiting from the foreign tax 

credit as tax-exempt when distributed as a dividend to achieve a result approximate to passing 

through the foreign tax credits to the shareholders, but without the complexity. This would be 

provided as part of a tax treaty. Treasury initially recommended no changes in this regard, and 

would not permit the pass-through of foreign tax credits to shareholders. In a subsequent release 

in December 1992, Treasury concluded that it would be desirable to permit pass through of some 

foreign tax credits.

Nondividend distributions 

A further question is whether the benefits of integration should extend to nondividend 

distributions (e.g., redemptions and liquidations), in order to achieve neutrality with dividends. 

The ALI proposed that nondividend distributions carry shareholder credits to achieve parity with 

dividends. The 1992 Treasury study would not change existing law as to nondividend 

distributions, believing that integration would reduce the incentive to make nondividend 

distributions in the first place.

Transition Rules 

There are two general approaches to transitioning to an integrated income tax system. 

Integration could be made immediately effective, or it could be phased in over time, which is 

what both the ALI and Treasury recommended. In transitioning to an integrated income tax 

system, a decision would need to be made as to whether integration would be limited to new 

equity (as opposed to pre-enactment equity, which the capital markets would have already 

discounted to account for double taxation).

F. Economic Effects of Integration

Economic efficiency 

The 1992 Treasury study determined that integration, by reducing the distortions created 

by a classical system, would increase the flow of assets into corporations, reduce the use of debt 

financing by corporations, and create a more uniform (and lower) cost of capital for corporations.

Tax revenue 

Most methods of integration involve a projected revenue loss, the amount of which 

depends on the method of integration and behavioral responses to integration.

Distributional effects 

The distributional effects of integration can be analyzed once behavioral responses and 

revenue gains/losses are estimated.
52

G. Alternatives to Integration

Cash-flow corporate taxation 

One alternative to taxing an individual on personal income is to tax that individual on 

consumption (or cash flow), which may generally be defined as income minus savings. This 

idea could likewise be applied to corporations by replacing the corporate income tax with a 

corporate cash-flow tax. There are three main possible methods of implementing a cash flow 

corporate tax. One method would be to expense capital expenditures, exclude interest receipts, 

and disallow interest deductions. A second method would be to include all business receipts in 

the tax base and deduct all business expenditures (gains and losses from financial assets would 

be included in the tax base). Finally, a third method would be to tax net distributions to 

shareholders (business receipts minus business expenditures would equal net distributions to 

shareholders).

Corporate deduction for return on equity 

Another proposal would allow interest payments to be deductible to the extent of a 

specified interest rate, and allow dividends likewise to be deductible to the extent they are 

attributable to new equity, up to the same specified rate used for interest deductibility. This 

proposal was advanced by the ALI in its 1982 and 1989 studies. The proposal would eliminate 

double taxation of corporate earnings on income earned on corporate assets up to the specified 

rate of return, but double taxation of corporate earnings would continue on the return to debt and 

new equity in excess of the specified rate of return, and on the entire return to old equity. A 

variant of this idea would permit a corporation to deduct annually the product of a specified rate 

of interest and the amount of its equity capital (and would not rely on an actual payment of 

dividends). Equity finance in a corporation would be treated similarly to debt finance (except for 

the cash flow associated with interest payments).
53

IV. ISSUES IN THE TAXATION OF CROSS-BORDER TRANSACTIONS

A. Introduction: Worldwide vs. Territorial Tax Systems

Worldwide tax system 

In a pure worldwide tax system, resident individuals and entities are taxable on their 

worldwide income, regardless of where the income is derived. Double taxation of foreign 

income is mitigated through the allowance of a foreign tax credit. However, the credit is 

generally limited to ensure that the residence country preserves its right to tax income derived 

within the residence country. Since corporations are separate entities, foreign-source income 

earned by a resident through a foreign corporation generally is not subject to tax until repatriated. 

In the United States, several complex anti-deferral regimes apply as exceptions to this general 

rule and U.S. shareholders are taxed currently on certain mobile or passive income derived 

through certain foreign corporations.

Territorial tax system 

In a pure territorial tax system, the country taxes only income derived within its borders, 

irrespective of the residence of the taxpayer. Thus, unlike in a worldwide tax system, foreignsource income earned by a resident is exempt from tax. In a pure territorial system, there is no 

need for a foreign tax credit, because exemption generally eliminates the possibility of double 

taxation of foreign income. There also is no need for complicated anti-deferral rules, because 

foreign-source income is exempt from tax in the first place.

Mixed systems 

No country uses a pure worldwide or territorial system. Systems may be accurately 

characterized as predominantly worldwide or territorial, but all systems share at least some 

features of both worldwide and territorial approaches. (See accompanying materials for 

summary descriptions of the tax systems of some major U.S. trading partners.)

B. Rationale for a Worldwide Tax System

Economic efficiency 

A pure worldwide tax system arguably promotes economic efficiency, in that it does not 

distort the decision of whether to locate investment at home or abroad. A resident has no tax 

incentive either to move activities abroad or to keep them within the residence country, since in 

either case the income generally will be subject to tax at the residence-country rate. Thus, 

investment-location decisions are governed by business considerations, instead of by tax law. 

This efficiency norm is referred to as capital export neutrality. Common deviations from the 

“pure” form of the worldwide tax system, such as the foreign tax credit limitation, reduce this 

neutrality.
54

Equity

A worldwide tax system arguably promotes equity in a number of ways. 

Horizontal equity 

First, a worldwide tax system arguably furthers the policy that taxpayers earning similar 

levels of income should be subject to tax at similar overall effective rates. Thus, a resident 

taxpayer earning income abroad should be subject to tax at the same effective rate as a taxpayer 

earning the same amount of income domestically. Providing a foreign tax credit mitigates the 

possibility that the taxpayer earning income abroad will be subject to a higher overall effective 

rate than the taxpayer earning income domestically; subjecting foreign-source income to 

residence-country tax mitigates the possibility that the taxpayer earning income abroad will be 

subject to a lower overall effective rate. Thus, a worldwide system provides a framework for 

treating similarly situated individuals similarly -- a concept known as horizontal equity.

Vertical equity

Second, a worldwide tax system arguably furthers the policy of a progressive income tax 

that taxes resident taxpayers earning higher levels of income at progressively higher marginal 

rates, on the theory that their greater ability to pay renders it fair to require them to shoulder a 

greater proportionate share of the tax burden. If ability to pay is regarded as important, then 

income earned abroad should be included in the tax base and subjected to progressive rates. 

Otherwise, the overall progressivity of the tax system may be eroded, as wealthier taxpayers may 

shift activities and income abroad. Thus, a worldwide system helps to promote the policy that 

higher income-earners should bear a larger proportionate share of the tax burden -- a concept 

known as vertical equity.

Citizenship and residency as values 

Taxing citizens and residents on their worldwide income arguably also reflects the notion 

that citizenship and residency bestow important benefits (e.g., legal and technical business 

infrastructure, military protection, passport and embassy services) that citizens and residents 

should be made to pay for, regardless of where they might earn their income. The United States 

is the only industrialized country in the world that taxes its citizens on their worldwide income, 

even if they reside outside the country.

Preservation of the U.S. tax base 

A worldwide tax system arguably preserves the residence-country tax base more 

effectively than a pure territorial system. If foreign-source income is entirely exempt from 

taxation, then resident taxpayers will shift investment and income into tax havens, eroding the 

residence-country tax base. For this reason, even those countries that employ predominantly 

territorial systems (e.g., France) typically provide for current taxation of certain types of foreignsource income that may easily be earned in tax havens -- a significant departure from “pure” 

territorial taxation.
55

C. Rationale for a Territorial Tax System

Economic efficiency 

A territorial system arguably promotes economic efficiency better than a worldwide tax 

system, because a territorial system treats all investment within a particular source country the 

same, regardless of the residence of the investor. This efficiency norm is referred to as capital 

import neutrality. Thus, if a residence country adopts a pure territorial system, residents of that 

country, when investing abroad in a particular source jurisdiction, will not be disadvantaged 

relative to other investors by virtue of their country of residence. For example, if a source 

country provides low effective tax rates on manufacturing income, a taxpayer resident in a 

country with a territorial tax system will fully enjoy the benefits of the lower source-country rate, 

while a taxpayer resident in a country with a worldwide tax system generally will not. In a world 

with diverse tax systems and rates, it is impossible to fully achieve both capital import neutrality 

and capital export neutrality at the same time. Difficult balancing decisions are unavoidable, and 

there is no consensus as to which of the two goals should take precedence. The weight of 

academic opinion generally favors capital export neutrality, while the business community 

generally leans toward capital import neutrality. (It has also been argued that these concepts are 

inadequate, and too indeterminate to be of any use in formulating policy in the first place, but 

this is a minority view in the relevant literature.) 

Simplicity in compliance and administration 

Some argue that territorial tax systems are less complex from an administrative and 

compliance standpoint than worldwide tax systems. It is certainly true that many complicated 

features of a worldwide system are not necessary in a pure territorial system. For example, the 

foreign tax credit and anti-deferral regimes, two of the most complex features of a worldwide tax 

system, are not necessary in a pure territorial system. However, a pure territorial system may not 

be viable because the country’s tax base would be significantly eroded as residents shifted 

investments and activities abroad to low-tax jurisdictions. Thus, in order to make a territorial 

system work as a practical matter, various features of a worldwide system probably must be 

incorporated, which in turn adds back much of the complexity that a pure territorial system 

would avoid. For example, some type of anti-deferral regime (e.g., for passive income shifted to 

low-tax jurisdictions) would probably be necessary to protect the tax base, but once adopted, 

such a regime would add substantial complexity to the system, both in the complexity of the antideferral regime itself and in the collateral consequences of having such a regime, such as the 

need for a foreign tax credit or other mechanism to mitigate double taxation of the “tainted” 

income. In addition, since source of income would be the fundamental basis for taxation under a 

territorial system, the rules for sourcing income and expenses (e.g., interest expense), as well as 

the transfer pricing rules, would bear considerably more weight than they do under a worldwide 

system, and thus may become more complex to serve their expanded role. 

Source vs. residence as basis for taxation 

The concept of residence is the fundamental basis of taxation under a worldwide tax 

system, whereas a pure territorial system, by relying on source, renders the concept of residence 

generally irrelevant. Several commentators have argued that, as applied to corporations, the 
56

concept of residence is becoming meaningless as a practical matter, since large multinational 

corporations are becoming “nationless” in the sense that their shareholders, employees, business 

activities, and income are increasingly spread throughout the world, rather than concentrated 

predominantly in any one country. Thus, the de-emphasis of residence is arguably one 

advantage of a territorial system. Of course, in a territorial system that incorporates some 

attributes of a worldwide system, the concept of residence would become important again, 

although probably less so than under a predominantly worldwide system. 

D. Methods of Implementing a Territorial Tax System

Exempt all foreign-source income 

A pure territorial tax system would simply exempt all foreign-source income from 

residence-country tax.

Exempt only active foreign-source income 

A modified territorial tax system might exempt only active foreign-source income, but 

currently tax passive (or other highly mobile) foreign-source income.

Exempt only high-taxed foreign-source income 

Another approach could be to exempt only foreign-source income that is subject to a 

certain minimum effective foreign tax rate, and to tax foreign-source income that is subject to 

foreign tax below that rate.

Exempt only certain kinds of foreign-source income 

Another approach would be to exempt limited categories of foreign-source income, such 

as income from e-commerce transactions.

Exempt only income derived from certain countries 

Yet another approach might be to exempt only income earned in a country with which the 

United States has a tax treaty, or simply to extend more favorable treatment to such income if a 

broader exemption system were adopted (e.g., by not subjecting the exemption to a high-tax test 

in the case of income derived in a treaty country, if the high-tax variation described above were 

adopted). Alternatively, a broad exemption system could be adopted, but income derived in tax 

havens could be excepted from the system (a “blacklist” approach).

Exemption with progression 

A further possibility is to employ an exemption system in which the exempt foreignsource income, while not taxed, is nevertheless considered in determining the taxpayer’s position 

on a progressive marginal rate schedule, thus affecting the rate that applies to the taxpayer’s 

local-source income. The rationale for this approach would be to preserve as much progressivity 

as is possible under a territorial tax system.
57

“Participation exemption” systems 

Many countries (including several in Europe) tax resident multinational enterprises on a 

predominantly territorial basis by exempting dividends received from certain foreign subsidiaries 

from residence-country tax. The exemption typically applies only where the parent company’s 

ownership (“participation”) in the subsidiary exceeds a certain threshold (commonly 5-10%), 

reflecting an intent not to extend territorial principles to portfolio-type investments. The 

exemption may be total or partial (e.g., only 95%, or 60%, of qualifying dividends might be 

exempted), and other restrictions generally apply, in order to limit the exemption to certain 

categories of income (e.g., active income) and to address concerns about shifting income to tax 

havens. The exemption also may or may not be extended to gains on the sale of a participation 

interest. A participation exemption system generally provides a significant degree of 

territoriality with respect to parent companies that receive mainly dividend income from their 

foreign subsidiaries; much less territoriality is achieved with respect to parent companies that 

receive large volumes of other types of income (e.g., royalties) from their foreign subsidiaries, 

and indeed these latter companies may even be better off under present law than under a 

participation exemption system. 

As a mechanical matter, a participation exemption system also may be implemented 

through a dividends-received deduction. For example, existing dividends-received deduction 

rules in the United States could be modified to extend to certain dividends received by U.S. 

corporations from foreign subsidiaries.

Transition issues 

A shift from a predominantly worldwide tax system to a predominantly territorial tax 

system would raise a number of transition issues. For example, it is not clear how the preexemption-system deferred income of controlled foreign corporations would be treated. Options 

would include exempting such income entirely ("fresh start" approach), taxing it upon 

repatriation (as under present law), or taxing it immediately as a “toll charge” into the new 

exemption-based system. Pre-exemption-system losses would raise similar issues.

E. Other Issues Raised by a Territorial System

U.S. employment and “runaway plants” 

Some would argue that a shift to a territorial system, by exempting income earned 

overseas, would encourage U.S. companies to move plants (and thus jobs) abroad. Others would 

respond that, under the present worldwide system that allows deferral of income earned abroad 

through a foreign corporate entity, these incentives already exist, particularly in the case of 

favorable source-country tax regimes for various types of manufacturing income. Nevertheless, 

some may argue that the adoption of a territorial system would not alleviate, and could very well 

exacerbate, this problem. On the other hand, the adoption of a territorial system also would 

arguably make the United States a more attractive place in which to incorporate, which may help 

to create or preserve various “headquarters” jobs, such as research, financial, and corporate and 

administrative services. This could arguably help to halt or reverse the recent trend toward 
58

“corporate expatriation” from the United States, via cross-border mergers and corporate 

inversion transactions.

Tax competition 

Some argue that if the United States and other major home countries of multinational 

enterprises were to adopt territorial tax systems, tax competition would intensify. Without the 

constraint of some residence-based taxation of foreign-source income, a major barrier to tax 

competition would be removed, and a “race to the bottom” would arguably ensue. Some would 

argue that a concerted effort, through the OECD or otherwise, would be necessary to ensure an 

adequate level of tax revenues to finance necessary government operations throughout the world. 

Others would find the prospect of increased tax competition appealing, and would reject any 

effort to curtail this.

Tax treaties 

The United States has an extensive network of bilateral tax treaties. These treaties are 

premised on the fact that the United States has a worldwide tax system. A switch to a territorial 

system would require existing tax treaties to be renegotiated, creating uncertainty in taxation of 

business investments for a lengthy period of time.

F. Relationship of Territorial-vs.-Worldwide Debate to Trade Dispute Over FSC/ETI 

Background and History of the Trade Dispute Over the FSC and ETI Regimes 

Like many other countries, the United States has long provided export-related benefits 

under its tax law. For most of the last two decades, these benefits were provided under the FSC 

regime. In 2000, the European Union succeeded in having the FSC regime declared a prohibited 

export subsidy by the WTO. In response to this WTO ruling, the United States repealed the FSC 

rules and enacted the ETI regime. The European Union immediately challenged the ETI regime 

in the WTO, and in January of 2002 a WTO Appellate Body held that the ETI regime also 

constituted a prohibited export subsidy under the relevant trade agreements. 

Prior to the enactment of the FSC regime, the United States provided a different system 

of export-related tax benefits, which applied to certain export-intensive corporations known as 

“domestic international sales corporations” (“DISCs”). Under this regime, DISCs were 

incorporated as domestic corporations, but DISC income was exempt from corporate income tax, 

and the shareholder-level tax on that income was partially deferred. Shortly after the DISC 

regime’s enactment in 1971, certain signatories to the General Agreement on Tariffs and Trade 

(“GATT”) challenged the regime as a prohibited export subsidy. In 1976, a GATT panel 

sustained these challenges, as well as U.S. challenges to certain export tax incentives provided 

by France, Belgium, and the Netherlands. These rulings proved controversial and remained 

unadopted by the relevant signatory countries for a number of years. 

In 1981, without conceding that the DISC regime violated the GATT, the United States 

agreed to adopt the general findings of the GATT panel, subject to a 1981 GATT Council 

Decision (the “1981 Understanding”), which was understood to qualify those findings. The 1981 

Understanding had three main components: (1) GATT signatories are not required to tax export 
59

income that is attributable to economic processes occurring outside their territorial limits; (2) 

“arm’s length” transfer pricing principles should be observed in transactions between exporting 

enterprises and related foreign buyers; and (3) the GATT does not prohibit the adoption of 

measures to avoid the double taxation of foreign-source income. 

A debate subsequently ensued as to whether the DISC regime violated the GATT, as 

interpreted in light of the 1981 Understanding. The European Communities (“EC”) argued that 

the DISC regime constituted an illegal export subsidy because it provided tax benefits for export 

income earned within the United States. The United States defended the regime on the grounds 

that, as applied to exports, it merely approximated the effect of a territorial tax system of the kind 

commonly used by European countries, which in turn was considered acceptable under the 1981 

Understanding. A majority of GATT Council members sided with the EC and urged the United 

States to bring the DISC regime into compliance with the GATT. In addition, the EC took steps 

toward seeking approval for the imposition of trade sanctions against the United States, and other 

signatories indicated that they would seek compensation from the United States. In late 1982, 

the United States made a commitment to the GATT Council to develop legislation that would 

address these concerns, and in early 1983, the President set forth a proposal to replace the DISC 

regime with a new system that was thought to be GATT-compliant (without conceding that the 

DISC regime was not GATT-compliant).

In 1984, the Congress enacted legislation along the general lines proposed by the 

President, creating the FSC regime. Unlike the DISC regime, the FSC regime provided tax 

benefits for export-related income earned by foreign corporations that were required to have a 

foreign presence and to perform export-related activities outside the United States. Transfer 

pricing principles were also set forth for the measurement of FSC income. In light of these 

features, which caused the FSC regime to emulate more closely certain aspects of an exemptionmethod territorial tax system, the FSC regime was thought to fall directly within the terms of the 

1981 Understanding. 

The FSC regime had been in existence for approximately 14 years when the EU brought 

a case against it in the WTO in mid-1998. In 1999, a WTO panel agreed with the EU that the 

FSC regime constituted a prohibited export subsidy under the relevant WTO agreements, and in 

early 2000 a WTO Appellate Body upheld that finding. The rulings held that the FSC rules 

constituted a subsidy because under those rules the government refrained from collecting 

revenue that was “otherwise due”; the rulings held that this subsidy was prohibited because it 

was export-contingent. The EU also expressed additional objections to the FSC regime that were 

not addressed by the WTO -- specifically, that the FSC transfer pricing rules were not “arm’s 

length,” and that the FSC regime encouraged the use of tax havens. 

In an effort to comply with these rulings (and to address the additional concerns raised by 

the EU), in 2000 the United States repealed the FSC regime and enacted the ETI regime. Two 

days after the President signed the FSC Repeal and Extraterritorial Income Exclusion Act of 

2000 into law, the EU brought its case against the ETI regime in the WTO. In August of 2001, a 
60

WTO panel held that the ETI regime constituted a prohibited export subsidy under the relevant 

WTO agreements,8 and a WTO Appellate Body later affirmed the panel’s holding. 9 

Relevance of WTO rulings to U.S. choice of overall tax framework 

Some argue that, given the current state of international trade law as reflected by the 

WTO decisions on the FSC and ETI regimes, the United States should shift to a territorial-based 

system (or, for that matter, to a VAT or other consumption-based system), in order to allow U.S. 

companies to compete on an equal footing with other companies without running afoul of 

international trade law. However, others argue that the benefits provided by the FSC and ETI 

regimes, and potentially provided under a territorial system, represent only one consideration 

among many in evaluating a fundamental shift in the U.S. tax system. In dollar terms, the 

activities that have benefited from the FSC and ETI regimes represent a relatively small portion 

of overall U.S. cross-border economic activity. Thus, some argue that it would not be prudent to 

make a fundamental change to the U.S. tax system on the basis of this narrower set of concerns, 

and that various incremental proposals may provide an appropriate response (see H. below). 

G. Corporate Inversion Transactions

Recent press reports and public filings with the Securities and Exchange Commission 

indicate that certain U.S. corporations are reincorporating (or planning to do so) as foreign 

corporations in low-tax jurisdictions such as Bermuda or the Cayman Islands. These transactions 

are generally referred to as corporate inversions. Inversions can take many forms, including 

stock inversions, asset inversions, or a combination of the two.

In one stock inversion that has been described publicly, a U.S. corporation forms a 

Bermuda corporation, which in turn forms a domestic merger subsidiary. The domestic merger 

subsidiary merges into the U.S. corporation, with the U.S. corporation surviving (as a subsidiary 

of the Bermuda corporation). As a result of the merger, the U.S. corporation’s shareholders 

receive shares of the Bermuda corporation and are treated as having exchanged their U.S. 

corporation shares for the Bermuda corporation shares. 

An inversion may be accompanied or followed by further restructuring of the corporate 

group. For example, the U.S. corporation may transfer foreign subsidiaries directly to the new 

top-tier foreign corporation. By transferring or growing foreign operations directly under the 

top-tier foreign parent corporation, the group can remove income from its foreign operations 

from the U.S. taxing jurisdiction. Thus, for example, the subpart F rules applicable to controlled 

foreign corporations no longer would apply to foreign subsidiaries of the new foreign parent. As 

 

8

 United States -- Tax Treatment for “Foreign Sales Corporations” -- Recourse to Article 

21.5 of the DSU by the European Communities, WT/DS108/RW, Report of the Panel, August 

20, 2001.

9

 United States -- Tax Treatment for “Foreign Sales Corporations” -- Recourse to Article 

21.5 of the DSU by the European Communities, WT/DS108/RW, Report of the Panel, as 

modified by the Appellate Body, January 14, 2002, adopted January 29, 2002 (the “Appellate 

Body Decision”).
61

a result, the corporate group can obtain the equivalent of a pure territorial tax system (i.e., an 

exemption for both passive and active foreign-source income). 

The corporate group also may engage in various related party transactions to reduce U.S. 

tax on U.S.-source income. This may include "earnings stripping" through payment by a U.S. 

corporation of deductible amounts such as interest, royalties, or reinsurance premiums to related 

foreign entities (including the foreign parent corporation).10

Inversion transactions may give rise to U.S. tax consequences, both at the shareholder 

and corporate level, depending on the type of inversion. For example, in stock inversions, the 

U.S. shareholders may recognize gain (but not loss) under section 367(a), based on the difference 

between the fair market value of the foreign corporation shares received and the adjusted basis of 

the U.S. corporation stock exchanged. Further restructuring of the group may also give rise to 

tax consequences at the corporate level. 

The Treasury Department recently announced that it is conducting a study of the issues 

arising in connection with corporate inversions and the implications of these transactions for the 

U.S. tax rules. In addition, certain recently introduced bills would curtail the benefits of certain 

inversion transactions.11

H. Possible Incremental Reforms

Fundamental reform unnecessary?

Some argue that fundamental reform of the U.S. international tax system is unnecessary, 

and that the competitiveness, complexity, and other concerns raised by U.S.-based multinational 

enterprises could be adequately addressed within the framework of the present system through a 

number of incremental reforms. Indeed, some regard such incremental changes as constituting 

an appropriate and adequate response to recent developments regarding the FSC and ETI 

regimes. Various incremental changes have been proposed in recent years, mostly affecting two 

key areas of the U.S. international tax system: the foreign tax credit and the anti-deferral 

regimes. The major proposals are described below.

Incremental reform proposals relating to the foreign tax credit

Background

Since the United States taxes its citizens and residents on their worldwide income, and 

the countries in which such income is earned generally also tax the same income on the basis of 

source, cross-border income earned by U.S. persons may be subject to double taxation. In order 

 

10 In the case of debt, section 163(j) addresses the use of earnings stripping for interest 

paid by a U.S. corporation (with a debt-equity ratio of in excess of 1.5 to 1) to a foreign related 

party, by capping the amount of deductible interest in a year to no more than 50 percent of an 

adjusted taxable income amount.

11 See H.R. 3857, H.R. 3884, and S. 2050.
62

to mitigate this possibility, the United States provides a credit against U.S. tax liability for 

foreign income taxes paid, subject to a number of limitations. Most incremental reform 

proposals in this area relate to these limitations. 

Allocation of interest expense using “worldwide fungibility” approach

The foreign tax credit generally is limited to the U.S. tax liability on a taxpayer’s foreignsource income, in order to ensure that the credit serves its purpose of mitigating double taxation 

of cross-border income without offsetting the U.S. tax on U.S.-source income. In light of this 

limitation, a taxpayer must allocate gross income and expenses between U.S. and foreign sources 

in order to determine the amount of foreign tax credits allowable. Under present law, interest 

expense that a U.S.-based multinational enterprise incurs in the United States is allocated to U.S. 

and foreign sources based on the gross assets located in the United States and abroad. Thus, a 

U.S.-based multinational with a significant portion of its assets overseas must allocate a 

significant portion of its interest expense to foreign-source income, which reduces the foreign tax 

credit allowable (even though the interest expense incurred in the United States is not deductible 

in computing the actual tax liability under the relevant foreign law). Many companies complain 

that this approach unduly limits their ability to claim foreign tax credits and leaves them exposed 

to double taxation of their foreign-source income. The proposal would allocate interest expense 

using an elective “worldwide fungibility” approach, under which interest expense incurred in the 

United States would be allocated against foreign-source income only if the debt-to-asset ratio 

was higher for U.S. than for foreign investments.

Reduction of the number of foreign tax credit limitation categories (or “baskets”)

Present law applies the foreign tax credit limitation separately to different types of 

foreign-source income, in order to reduce the extent to which excess foreign taxes paid in a hightax foreign jurisdiction can be “cross-credited” against the residual U.S. tax on low-taxed 

foreign-source income. For example, if a taxpayer pays foreign tax at an effective rate of 45 

percent on certain active income earned in a high-tax jurisdiction, and pays little or no foreign 

tax on certain passive income earned in a low-tax jurisdiction, the untaxed (or low-taxed) passive 

income could expand the taxpayer’s ability to claim a credit for the otherwise uncreditable 

excess foreign taxes paid to the high-tax jurisdiction. This sort of cross-crediting is constrained 

by rules that require the computation of the foreign tax credit limitation on a category-bycategory basis. Thus, in the example above, the rules would place the passive income and the 

active income into separate limitation categories (or “baskets”), and the low-taxed passive 

income would not be allowed to increase the foreign tax credit limitation applicable to the credits 

arising from the high-taxed active income. Present law provides nine separate baskets as a 

general matter, and effectively many more in situations in which various special rules apply. 

Many companies complain that the large number of different baskets creates unnecessary

complexity and distorts business decisionmaking. The proposal would reduce the number of 

baskets to three or even two. This proposal would likely reduce complexity and compliance 

costs, but at a risk of allowing more cross-crediting than may be considered appropriate.
63

Incremental reform proposals relating to the subpart F anti-deferral rules 

Background

Generally, income earned indirectly by a U.S. person through a foreign corporation is 

subject to U.S. tax only when the income is distributed to the U.S. person. This deferral of U.S. 

tax is limited by a number of anti-deferral regimes (e.g., “subpart F”) that impose current U.S. 

tax on certain types of income earned by certain corporations. Drawing the line between “good” 

income (active business income) and “tainted” income (passive or highly mobile income) has 

proven contentious and has also engendered considerable complexity. 

Exclusion of all active income from the scope of subpart F

Present law places the income from many sales, services, shipping, and certain other 

activities conducted abroad on the “tainted” side of the line (because such activities are thought 

to be highly mobile and thus prone to tax-motivated manipulation), thus subjecting the income 

from such activities to current U.S. tax. Many U.S.-based multinationals complain that these 

rules penalize the use of common, non-tax-motivated business structures (e.g., centralizing sales 

and services functions for a number of different foreign markets within a single foreign entity), 

thus placing U.S.-headquartered businesses at a competitive disadvantage in the normal conduct 

of their active business activities around the world. They argue that the scope of subpart F 

should be limited to passive income (e.g., dividends and interest) earned abroad, and that other 

rules (e.g., the arm’s length transfer pricing rules of section 482) are sufficient to address any 

abuses involving the manipulation of active income streams. The proposal would eliminate 

certain subpart F active-income categories (the foreign base company sales, services, shipping, 

and oil-related income categories). This proposal arguably could exacerbate problems that may 

arise in taxing income from electronic-commerce transactions.

Permanent “active financing” exception

Passive income (e.g., interest) generally falls on the “tainted” side of the subpart F line, 

since such income can easily be shifted into low-tax jurisdictions. In the case of banking, 

financing, insurance, and similar businesses, however, this taint is arguably inappropriate, since 

these businesses earn this type of income in the active conduct of their core business activities. 

Subjecting this income to subpart F would arguably cause U.S.-based financial services 

companies to be treated more harshly than both U.S.-based manufacturing companies and 

foreign-based financial services companies. Accordingly, since 1997 a temporary exception 

from subpart F for “active financing income” has been provided. The exception under present 

law is set to expire after 2006. U.S.-based financial services companies argue that the temporary 

nature of the exception makes it difficult for them to engage in long-range business planning. 

The proposal would make the exception permanent. 

Expansion of the “de minimis” exception

To avoid subjecting taxpayers to the complex rules of subpart F when a controlled 

foreign corporation earns incidental amounts of “tainted” income, subpart F provides a “de 

minimis” exception. Under this exception, a controlled foreign corporation’s income is not

treated as tainted as long as the tainted income constitutes less than the lesser of $1 million or 5% 
64

of the corporation’s gross income. For example, a controlled foreign corporation that conducts 

an active business but also earns a trivial amount of interest on its working capital generally does 

not need to contend with subpart F, as long as the amount of the interest falls short of the de 

minimis threshold. U.S.-based multinational enterprises argue that this threshold is set too low 

to provide them any meaningful relief. For example, a controlled foreign corporation that earns 

only $1 million of interest income on its working capital is ineligible for the exception, even 

though $1 million may indeed represent an incidental amount in the context of a large foreign 

subsidiary of a U.S.-based multinational. The proposal would raise the dollar limit (or even 

eliminate it), and the percentage limit.
65

V. ISSUES IN CONSUMPTION TAXATION

A. Introduction to Broad-Based Consumption Tax Systems

In general

The term “consumption tax” is a generic description for systems that tax some form of 

“dissaving” (i.e., purchases and withdrawals from savings or investments) rather than taxing 

income. By contrast, a corporate income tax is imposed and collected on the taxable income 

(generally, gross income minus deductions) of a corporation.

There are numerous forms that a broad-based consumption tax can take, including a retail 

sales tax, business transfer tax (or subtraction method value-added tax), or credit-invoice method 

value-added tax. A characteristic that is common to all broad-based consumption taxes is the 

current deduction of all investment, including capital expenditures that would otherwise only be 

depreciable or amortizable under an income tax. It is widely believed that the economic burden 

of a consumption tax is borne by the ultimate consumer of taxed goods.

Retail sales tax

A retail sales tax is a tax imposed and collected on the retail sales (i.e., sales to end-use 

consumers) of taxable goods or services. A retail sales tax is the most conspicuous and 

transparent form of consumption tax.

Business transfer tax (or subtraction method VAT)

Generally, a value-added tax (“VAT”) is a tax that is imposed and collected on the “value 

added” at every stage in the production and distribution process of a good or service. The VAT 

base is generally defined as the amount of value added, which is the difference between the value 

of sales (outputs) and purchases (inputs) of an enterprise. A broad-based VAT generally 

achieves the same economic results as a retail sales tax, although a VAT is collected at many 

stages of production rather than only at the time of final sale to an end-use consumer.

A business transfer tax (or subtraction-method VAT) is a form of a VAT in which a 

statutory tax rate is applied to newly added value, as measured by the difference between an 

enterprise’s taxable sales and its purchases of taxable goods and services from other enterprises.

Credit-invoice method VAT

The most common type of VAT is the credit-invoice method VAT, under which the 

statutory tax rate is applied to gross sales (rather than only to newly added value), and credits for 

previously paid taxes on gross purchases are allowed. 
66

B. Arguments For a Broad-Based Consumption Tax

Effect on private savings

By reducing the disincentives to save that can result from an income tax, a broad-based 

consumption tax would benefit U.S. international trade through increased saving and reduced 

cost of capital to domestic businesses. Lower cost of capital can improve the productivity and 

price competitiveness of U.S. goods and services in foreign markets, reduce the demand for 

imported goods (relative to U.S. goods), and help redress the persistent imbalance of imports and 

exports.

Effect on international competitiveness 

Proponents of a broad-based consumption tax maintain that, if U.S. sales by both foreignand U.S.-owned firms were subject to the same broad-based consumption tax instead of a 

corporate income tax, the competitiveness of U.S. firms would be enhanced relative to imports 

from foreign firms or foreign-owned U.S. firms because all U.S. sales would bear the same U.S. 

tax liability without regard to the location of the firm. In addition, some argue that a border 

adjustable VAT that would exempt exports from such a tax would better enable U.S. 

manufactured goods to compete in foreign markets.

Simplification

Switching from a system of worldwide income taxation with foreign tax credits to a 

broad-based consumption tax could simplify tax compliance and international tax planning 

because the consumption tax base typically is territorial rather than worldwide.

Suitability for electronic commerce

A broad-based consumption tax generally may be more suitable than an income tax for 

the taxation of electronic commerce, although difficult issues are presented by the consumption 

taxation of cross-border services provided through electronic commerce. A consumption tax 

could reduce the potential for double-taxation or non-taxation of cross-border electronic 

commerce transactions that involve other countries with a consumption tax.

C. Arguments Against a Broad-Based Consumption Tax 

Incidence of tax

Many argue that the purportedly positive effects of a broad-based consumption tax on the 

competitiveness of U.S. firms generally reflect only the statutory incidence (i.e., the legal 

burden) of a corporate income tax relative to a consumption tax. Thus, any competitive 

advantage that is derived from replacing a corporate income tax with a broad-based consumption 
67

tax would be diminished if (as is generally conceded) the economic incidence (i.e., the financial 

burden) of a broad-based consumption tax differs from its statutory incidence.12

Balance of trade

Although it is commonly believed that a broad-based consumption tax may improve the 

U.S. international trading position, economists have determined that broad-based consumption 

taxes do not directly affect the overall volume of exports or imports.

In addition, even if the imposition of a broad-based consumption tax creates a short-term 

competitive advantage in cross-border trade, most economists believe that offsetting adjustments 

in exchange rates are likely to restore the pre-existing equilibrium to international markets in the 

long run and eliminate any immediate price advantage that a consumption tax might provide in 

the short run.

Administrative concerns

Because a consumption tax presents unique compliance issues, the necessary 

enforcement regime under a consumption tax is much different from the enforcement regime 

under an income tax. The taxation of imported property and services under a broad-based 

consumption tax raises additional administrative concerns.

Taxation of services 

Cross-border services present difficulties under a broad-based consumption tax because 

services may be performed in whole or in part in one jurisdiction but may be used or provide 

benefits in another jurisdiction.

Taxation of financial services 

Financial services can raise special implementation and administration issues under a 

broad-based consumption tax. The taxation of financial services under a VAT has proven to be 

particularly problematic because of the difficulty in determining the value-added component of 

financial services, and because the financial inputs purchased by financial services (i.e., deposits) 

are often obtained from clients who are outside of the VAT system. Taxing financial services 

under a retail sales tax raises similar concerns.

 

12 As discussed in Joint Committee on Taxation, Description and Analysis of Proposals 

to Replace the Federal Income Tax (JCS-18-95), June 5, 1995, the burden of consumption taxes 

is widely assumed to be passed along to consumers. However, this assumption is not beyond 

reasonable dispute. There is much less agreement about the burden of the corporate income tax. 

A large body of public finance literature has focused on the “Harberger model,” which concludes 

that the corporate income tax is borne by all capital. However, the Harberger model assumes 

that savings is not responsive to changes in tax rates and that capital is not mobile across 

international borders. To the extent that these assumptions are not correct, the burden of the tax 

may be partially or totally borne by consumers or by labor.
68

D. Methods of Implementing a Broad-Based Consumption Tax on Businesses

National retail sales tax

A retail sales tax is a tax imposed on the retail sales price of taxable goods and services. 

A retail sales tax is collected only by entities that sell directly to end-use consumers of the taxed 

goods or services, while purchases by other businesses are exempt.

The primary distinction between a retail sales tax and a business transfer tax or creditinvoice method VAT involves the statutory incidence of tax (i.e., who actually collects and 

remits the tax). A retail sales tax has approximately the same economic burden as a creditinvoice method VAT and, as an economic matter, the tax base for a retail sales tax generally is 

identical to that used for a business transfer tax or subtraction method VAT.

A retail sales tax may vary from other broad-based consumption taxes in terms of 

administrability, compliance burden, and ease of implementation. A retail sales tax may be 

attractive because the transition and overall compliance costs of the tax could be small compared 

to those of other broad-based consumption taxes, although ongoing enforcement of a retail sales 

tax (especially at high tax rates) may be relatively greater because of the lack of cross-validation. 

Unlike a business transfer tax or credit-invoice method VAT, a retail sales tax compresses the tax 

collection responsibilities into a single stage in the production and distribution chain, potentially 

resulting in greater noncompliance when businesses at just one stage (i.e., retail businesses) in 

the entire production and distribution process fail to remit the taxes owed. Taxable retail sales 

that are erroneously treated as nontaxable sales to business has been a particular source of 

noncompliance for State and local governments with retail sales taxes, especially with regard to 

small business owners who make purchases for both business and personal use. It is widely 

believed that a high retail sales tax rate would exacerbate these compliance problems.

Most States and many local governments impose general retail sales taxes within their 

jurisdictions. Even though retail sales tax bases vary among States, the experience of State and 

local governments with a retail sales tax may facilitate the implementation of a national retail 

sales tax, although most advocates of a national retail sales tax envision a tax base that is 

significantly broader than the sales tax imposed by any State.

Business transfer tax (or subtraction method VAT)

A business transfer tax provides for a rate of tax that is applied to the difference between 

an enterprise’s taxable sales and its purchases of taxable goods and services from other 

enterprises. The statutory tax rate is applied to a net amount of value added (taxable sales less 

purchases of taxable goods and services) rather than to gross sales with credits for taxes 

previously paid on gross purchases (as under the credit-invoice method VAT, discussed below). 

In other words, the business transfer tax is based upon deductions, while the credit-invoice VAT 

method is a credit-based system.

A business transfer tax generally imposes lower compliance costs on a business than a 

credit-invoice method VAT because it requires records that usually are already maintained by the 

business. However, the business transfer tax also potentially entails lower levels of compliance.
69

Compared to a credit-invoice method VAT, a business transfer tax is less similar in 

appearance to a retail sales tax (assuming that the tax is not separately stated at the retail level) 

and more similar to a corporate income tax, with the major difference between a business

transfer tax and a corporate income tax being the current deduction of what otherwise would 

constitute depreciable or amortizable capital expenditures under a corporate income tax.

Credit-invoice method VAT

The credit-invoice method VAT is utilized in nearly all industrialized countries with a 

VAT. A credit-invoice method VAT provides a tax credit to purchasers (except ultimate end-use 

consumers) for all VAT previously paid by the seller on all purchases of taxable goods and 

services used in the seller's business.

A fundamental VAT principle is that the cumulative amount of tax paid with respect to a 

good or service at all levels of production and distribution should equal the sales price of the 

good or service to the ultimate consumer multiplied by the statutory VAT rate. By providing a 

business credit for inputs, the credit-invoice method VAT generally fulfills this principle and 

prevents the imposition of multiple layers (or “cascading”) of tax with respect to the total final 

purchase price, so that the net tax paid at a particular stage of production or distribution is based 

only on the value added by that taxpayer at that stage of production or distribution.

Adopting a credit-invoice method VAT would impose new compliance costs on 

businesses, which would likely intensify with multiple tax rates and statutory exemptions. 

However, the record keeping requirements would improve compliance through cross-validation 

of taxes paid by sellers with credits claimed by buyers, similar to information return matching 

performed by the IRS under present law. A credit-invoice method VAT is regarded as more 

suitable than a business transfer tax for accommodating targeted tax relief, but this suitability 

also leaves the credit-invoice method VAT more susceptible to complexity and economic 

inefficiency.

E. Additional Considerations in Implementing a Broad-Based Consumption Tax 

Exclusions from the consumption tax base

Many broad-based consumption tax regimes provide special treatment for imported and 

exported goods and services and provide exclusions for various goods and services, certain 

classes of taxpayers (for economic, social, or political reasons), and goods and services that are 

difficult to measure either in terms of the amount of the value added or the element of 

consumption (such as financial services).

Exclusions from the consumption tax base may be implemented through “zero rating” or 

statutory exemption, with potentially significant different consequences. A zero-rated sale is 

considered to be taxable, but the statutory rate of tax is zero percent. Accordingly, sellers of 

zero-rated goods or services need not collect or remit any tax on their sales of such items, but 

nevertheless may claim credits for the tax they paid with respect to purchased goods and 

services. By contrast, an exempt sale is not considered to be taxable. Although the seller of 

exempt goods or services also is not required to collect or remit any tax on such sales, the seller 
70

may not claim any refunds of, or (in the case of a credit-invoice method VAT) credits for, the tax 

that may have been paid on related purchases.

In a credit-invoice method VAT, a statutory exemption breaks the chain between inputs 

and outputs along the various stages of production and distribution and may result in a 

“cascading” of the tax (i.e., the total tax collected from all stages of production is greater than the 

retail sales price multiplied by the VAT rate). By contrast, statutory exemptions may be 

implemented under a business transfer tax without the occurrence of cascading.

Destination-principle taxation and origin-principle taxation 

Broad-based consumption taxes can differ depending on whether they are imposed under 

a destination principle or an origin principle. 

Destination principle 

Under the destination principle, imports are taxed (either by taxing them directly or by 

making their purchase nondeductible to the importer), and exports are exempt from tax through 

border tax adjustments (i.e., rebates on previously paid taxes), on the premise that goods and 

services should be taxed where they are consumed. Thus, the tax base consists of expenditures 

on domestic consumption of goods and services. A national retail sales tax is an example of a 

destination-principle consumption tax. The credit-invoice method VATs imposed in Europe and 

elsewhere generally are also destination-principle taxes.

Origin principle 

Under the origin principle, domestic production of goods and services is taxed (including 

those for export), and imported goods and services are exempt from tax, on the premise that 

goods and services should be taxed where they are produced. Thus, the tax base consists of 

domestic consumption plus net exports.

Comparison of destination-principle consumption taxes with origin-principle 

consumption taxes

In the short term, destination-principle consumption taxes are thought to be economically 

superior to origin-principle consumption taxes because of greater neutrality with regard to 

international trade (i.e., less distortion of consumer’s choices between domestic and imported 

goods in both domestic and overseas markets).

Although the tax base of a destination-principle consumption tax clearly differs from that 

of an origin-principle consumption tax (particularly with regard to transition issues and the 

treatment of above-normal returns on investment), the two variations generally are thought to be 

economically equivalent in the long run (assuming equivalent tax rates) because other 

self-executing market adjustments, such as reductions in wage rates or in the value of the 

domestic currency, could wholly offset any potentially detrimental trade effects of origin-based 

taxation on exported goods.
71

Taxation of sales of goods and services and financing transactions

There are two primary alternative business consumption tax bases. One consumption tax 

base consists of sales of goods and services. The tax base of most business transfer taxes, creditinvoice method VATs, and retail sales taxes is limited to the cash flow from such transactions. 

This feature distinguishes typical consumption taxes from a pure income-based business tax. 

Alternatively, the consumption tax base may consist of both sales of goods and services and 

financing transactions (except for transactions with the equity holders of a business).

Although the treatment of interest is economically equivalent under either variation of the 

consumption tax base, the distinction between a consumption tax that is based only upon sales of 

goods and services and a consumption tax that is based upon both sales of goods and services 

and financing transactions may be important in the international context, because interest 

expense is not deductible under the tax base that only includes sales of goods and services but is 

deductible under the tax base that includes both sales of goods and services and financing 

transactions. This difference may affect borrowing transactions by multinational firms.

Because the entire cost of capital expenditures and inventory purchases is currently 

deductible at the time of purchase (rather than over the life of the asset or using an inventory 

method of accounting) under a consumption tax, capital income is untaxed at the margin without 

regard to whether the tax base includes only sales of goods and services or includes both sales of 

goods and services and financing transactions, and without regard to whether the income arises 

from capital invested domestically or abroad (although a foreign country may continue to impose 

tax on the marginal investments of U.S. persons in that country).

Taxation of financial services 

Financial services raise special implementation and administration issues under a 

consumption tax. These issues include: how to measure the value of financial services; 

allocating the value of financial services among various clients; distinguishing financial 

institutions from other businesses; the treatment of imports and exports; and transition issues. 

These issues dictate the extent to which financial services should be included in the tax base of a 

consumption tax.

It is often argued that certain types of financial services should not be subject to 

consumption tax because taxing such services would be equivalent to taxing savings. Another 

reason for excluding financial services from the base of a consumption tax is that the charge for 

financial services typically is blended with other elements of the transaction and, thus, the value 

of most financial services is not easily determined. The difficulties in ascertaining the value of 

financial services has led most countries that impose a consumption tax to totally or partially 

exempt financial services.

Others argue that economic efficiency and equity dictate the inclusion of financial 

services in the tax base of any broad-based consumption tax at the same statutory tax rate that 

generally applies to other goods and services. Additionally, exempting financial services from 

the tax base raises additional issues and may be disadvantageous to nonexempt businesses that 

purchase financial services. Under the consumption tax systems of many countries, exempting 
72

financial services means that financial institutions are not considered taxpayers. Consequently, 

financial transactions with nonexempt business customers generally result in cascading of tax.

F. Tax Restructuring and International Investment Decisions

Major destination-principle consumption tax features affecting international business 

Three main features of a destination-principle consumption tax are particularly important 

in connection with cross-border transactions: the exclusion of exports from the tax base; the 

taxation of imports; and the exemption of foreign subsidiaries and branches of U.S. businesses 

from U.S. tax.

Location of investment and economic efficiency

The highest and best use of investment funds may not always coincide with locating 

investment in the United States, and adopting a broad-based consumption tax to encourage 

investment in the United States at the expense of investment elsewhere may not necessarily 

promote global economic efficiency. However, increased investment in the United States should 

increase the future income of United States residents and citizens.

Because anti-deferral rules would be eliminated under a broad-based consumption tax, 

the timing of income repatriation by foreign subsidiaries of U.S. businesses would no longer be 

relevant because repatriation would not be a taxable event. For U.S. businesses operating abroad 

and foreign businesses operating in the United States, transfer pricing would no longer be an 

issue under a consumption tax with border tax adjustments.

Consequently, under a destination-principle consumption tax, the net tax burden of 

locating in a particular jurisdiction would primarily depend on the tax rate in that jurisdiction 

relative to other jurisdictions.

Location of investment in tangible assets

Location of investment in tangible assets by U.S. persons

Broad-based consumption tax systems in foreign countries may encourage investment in 

such countries by U.S. persons because the choice of investment location (all other factors being 

equal) depends upon the after-tax return offered to the investor by alternative locations, and 

capital income is untaxed at the margin under a business consumption tax. A destinationprinciple consumption tax is neutral regarding the location of investment. Therefore, U.S. 

persons may have an incentive to invest abroad in low-tax foreign jurisdictions because 

investments are subject to lower effective tax rates when located abroad.

A consumption tax would eliminate taxes on returns from investments at the margin. 

Therefore, adopting a consumption tax would likely make the United States a relatively more 

attractive location for investment by U.S. persons, which should reduce foreign investment and 

increase domestic investment by U.S. businesses. Adoption of a consumption tax (which would 

not provide a credit for foreign income taxes paid) may encourage U.S. businesses to locate 

investments in low-tax foreign jurisdictions or in the United States rather than in high-tax foreign 
73

jurisdictions. If reduced taxation of the returns on new investment under a broad-based 

consumption tax increases total investment by U.S. businesses, investment abroad would be 

expected to continue to increase, but less rapidly than domestic investment.

Location of investment in tangible assets by foreign persons

If the home country does not tax foreign-source income, increased foreign investment in 

the United States would be expected to result, because adoption of a broad-based consumption 

tax effectively would lower taxes on new investment by foreign persons in the United States. If 

the home country taxes foreign-source income, but provides a credit for foreign income taxes 

paid that completely offsets the home country's otherwise applicable income tax, adoption of a 

broad-based consumption tax would be expected to have no effect on foreign investment in the 

United States. If the home country taxes foreign-source income and provides a credit for foreign 

income taxes paid that permits only deferral of home-country tax on foreign-source income, 

adoption of a broad-based consumption tax may only modestly increase foreign investment in 

the United States.

Location of investment in intangible assets and research and development

By permitting the current deduction of expenditures on capital goods at the time of 

purchase, a broad-based consumption tax may shift business investment toward tangible assets 

and away from investment in intangible assets or research and development because a 

consumption tax provides no preferential tax treatment of expenditures to create intangibles and 

expenditures for research and development.

Similarly, by eliminating the relative U.S. tax preference for outbound royalty payments 

by certain U.S. persons, a broad-based consumption tax generally would be expected to induce 

increased location of intangible assets in the United States relative to locations abroad.

Because expenses incurred in the United States would be fully deductible (including 

research and development expenditures), a broad-based consumption tax may increase research 

and development activity in the United States.

G. Transition Issues

For several reasons, transition is the threshold issue in replacing an income tax with a 

broad-based consumption tax. Transitioning to a consumption tax likely would require 

substantial educational resources as both taxpayers and administrators become familiar with 

statutory rules and fundamental consumption tax principles. Adopting a consumption tax also 

likely would shift the relative tax burdens of businesses with different profiles or in different 

sectors of the economy, which raises certain political issues involving the perceived “winners” 

and “losers” under a broad-based consumption tax. In addition, any transition to a consumption 

tax would need to address the disposition of certain pre-existing tax attributes maintained by 

businesses under an income tax, such as scheduled depreciation and amortization deductions that 

have not yet been claimed, costs that have not yet been deducted under inventory accounting, 

and carryovers of net operating losses and tax credits. Similarly, adjustments would be needed 

in converting businesses from accrual-based accounting to cash-based accounting.
74

At least in the short run, addressing these transition issues could require the investment of 

significant fiscal resources and diminish the expected efficiency gains that would otherwise 

result from adopting a broad-based consumption tax.
75

VI. BACKGROUND AND DATA RELATING TO INTERNATIONAL

TRADE AND INVESTMENT

This part presents background data relating to the scope of the international trade sector 

in the United States economy. This part discusses the economic relationship between trade 

deficits, capital inflows, investment, and savings in the economy. It briefly reviews trends in 

both the current account (the trade surplus or deficit) and the financial account13 (U.S. 

investment abroad and foreign investment in the United States).

A. Trade Deficits and Cross-Border Capital Flows

National income accounting

In popular discussion of trade issues, much attention is given to the trade deficit or 

surplus, that is, the difference between the exports and imports of the economy. In the late 

1980s, there was also attention given to inflows of capital from abroad. Capital inflows can take 

the form of foreign purchases of domestic physical assets, of equity interests, or of debt 

instruments. These two phenomena, trade balances and capital inflows, are not independent, but 

are related to each other. Trade deficits, capital inflows, investment, savings, and income are all 

connected in the economy. The connection among these economic variables can be examined 

through the national income and product accounts, which measure the flow of goods and services 

and income in the economy.14

 

13 Prior to 1999, the U.S. Department of Commerce, Bureau of Economic Analysis 

reported and described international transactions by reference to the “current account” and the 

“capital account.” Beginning in June 1999 the Bureau of Economic Analysis adopted a threegroup classification to make U.S. data reporting more closely aligned with international 

guidelines. The three groups are labeled: current account; capital account; and financial 

account. Under this regrouping, the “financial account” encompasses all transactions that used 

to fall into the old “capital account,” that is, the financial account measures U.S. investment 

abroad and foreign investment in the United States. Under the new system, the “current 

account” is redefined by removing a small part of the old measure of unilateral transfers and 

including it in the newly defined “capital account.” The newly defined capital account consists 

of capital transfers and the acquisition and disposal of non-produced, non-financial assets. For 

example, the newly defined capital account includes such transactions as forgiveness of foreign 

debt, migrants’ transfers of goods and financial assets when entering or leaving the country, 

transfers of title to fixed assets, and the acquisition and disposal of non-produced assets such as 

natural resource rights, patents, copyrights, and leases. In practice, the Bureau of Economic 

Analysis believes that newly defined “capital account” transactions will be small in comparison 

to the current account and financial account.

14 The national income and product accounts measure the flow of goods and services 

(product) and income in the economy. The most commonly reported measure of national 

economic income is gross domestic product (GDP). Related to GDP is gross national product 

(GNP). GNP is GDP plus the net factor income received by residents of United States from 
76

The value of an economy's total output must be either consumed domestically (by private 

individuals and government), invested domestically, or exported abroad. If an economy 

consumes and invests more than it produces, it must be a net importer of goods and services. If 

the imports were all consumption goods, in order to pay for those imports, the country must 

either sell some of its assets or borrow from foreigners. If the imports were investment goods, 

foreign persons would own the investments. Thus, an economy that runs a trade deficit will also 

experience foreign capital inflows as foreign persons purchase domestic assets, make equity 

investments or lend funds (purchase debt instruments).

For example, when the United States imports more than it exports, the United States pays 

for the imports with dollars. If foreigners are not buying goods with the dollars, then they will 

 

abroad. Thus, wages earned by a U.S. resident from temporary work abroad constitutes part of 

GNP but not GDP. Similarly, the returns from investment abroad constitute part of GNP but not 

GDP. To help understand the connection between trade deficits and cross border capital flows, 

in the following it is useful to use GNP, which includes cross border returns to investment, rather 

than the more commonly reported GDP concept. The GNP of the economy is the total annual 

value of goods and services produced by the economy and may be measured in several ways. 

One way to measure GNP is by expenditures on final product. By this measure, 

(1) GNP = C + I + G + (X-M) + NI. 

Equation (1) is an accounting identity which states that gross national product equals the 

sum of private consumption expenditures (C), private investment expenditures on plant, 

equipment, inventory, and residential construction (I), government purchases of goods and 

services (G), net exports (exports less imports of goods and services and net interest payments to 

foreigners, or X-M), plus net investment income (the excess of investment income received from 

abroad over investment income sent abroad or NI). 

An alternative is to measure GNP by the manner in which income is spent. By this 

measure, 

(2) GNP = C + S + T. 

Equation (2) is another accounting identity which states that gross national product equals 

the sum of private consumption expenditures (C), saving by consumers and businesses (S), and 

net tax payments to the government (T) (net tax payments are total tax receipts less transfer, 

interest, and subsidy payments made by all levels of government). 

Because both measures of GNP are simple accounting identities, the right hand side of 

equation (1) must equal the right hand side of equation (2). From this observation can be derived 

an additional national income accounting identity: 

(3) I = S + (T - G) + (M - X) - NI 

Equation (3) states that private investment equals private saving (S), plus public saving 

(T-G) and net imports (M - X), less net investment income.
77

use the dollars to purchase U.S. assets. (An alternate way of viewing these relationships is that 

dollars flowing out of the U.S. economy in order to purchase goods or to service foreign debt 

must ultimately return to the economy as payment for exports or as capital inflows.)

The previous discussion focuses on the disposition of the economy's output. If the 

economy is a net importer, it must attract capital inflows to pay for those imports. If the 

economy is a net exporter, it must have capital outflows to dispose of the payments it receives 

for its exports. Another way of looking at the connection between capital flows and the goods 

and services in the economy is to concentrate on the sources of funds for investment. Because 

domestic investment must be financed either through saving or foreign borrowing, net capital 

inflows must also equal the difference between domestic investment and saving.

These relationships can be summarized as follows (the equation ignores relatively small 

unilateral transfers such as foreign aid and assumes, without loss of generality, that the 

government budget is balanced):

Net Foreign Borrowing = Investment - Saving

= (Imports - Exports) - Net Investment Income

For this purpose, imports and exports include both goods and services, and net 

investment income is equal to the excess of investment income received from abroad over 

investment income sent abroad.15 The excess of imports over exports is called the trade deficit in 

goods and services. Net investment income can be viewed as payments received on previouslyacquired foreign assets (foreign investments) less payments made to service foreign debt.

If the investment in an economy is larger than that country's saving, the country must 

either be running a trade deficit or the economy is increasing its foreign borrowing. Similarly, a 

country cannot run a trade surplus without also exporting capital, either by increasing its foreign 

investments, or by servicing previously-acquired foreign debt. Because the level of net 

investment income in any year is fixed by the level of previous foreign investment (except for 

changes in interest rates), changes in investme nt or saving that are associated with capital 

inflows will have a negative impact on a country's trade balance.

Economic implications of trade deficits

A trade deficit is not necessarily undesirable. What is important is the present and future 

consumption possibilities of the economy. That will depend in part on whether the trade deficit 

is financing consumption or investment. For example, if a country uncovers profitable 

investment opportunities, then it will be in that country's interest to obtain funds from abroad to 

 

15 This equation in the text can be seen from equation (3) in footnote 14 above if the 

government budget is assumed to be balanced, that is, if G = T. It follows that if the government 

runs a deficit, that is, if G>T, for a given level of investment, saving, and net investment income, 

net foreign borrowing must be greater. 
78

invest in these profitable projects.16 If the economy currently does not have enough domestic 

savings to invest in these projects, it could reduce its consumption (generating more domestic 

saving) or look to foreign sources of funds (thus allowing investment without reducing current 

consumption). For example, suppose new oil reserves that could be profitably recovered through 

increased investment are discovered in the United States. The investment may be financed by 

foreigners. In order to invest in U.S. assets, foreigners will have to buy dollars, thus increasing 

the value of the dollar. This dollar appreciation makes U.S. goods more expensive to foreigners, 

thereby reducing their demand for U.S. exports. At the same time, the dollar appreciation makes 

foreign goods cheaper for U.S. residents, increasing the demand for imports and resulting in a 

trade deficit. Eventually, the flow of capital will be reversed, as the U.S. demand for new 

investment falls, and foreigners receive interest and dividend payments on their previous 

investments.

The foreign borrowing in the above example was used to finance investment. This 

borrowing did not reduce the living standards of current or future U.S. residents, because the 

interest and dividends that were paid to foreigners came from the return from the new 

investment. If foreign borrowing finances consumption instead of investment, there are no new 

assets created to generate a return that can support the borrowing. When the debt eventually is 

repaid, the repayments will come at the expense of future consumption. For instance, consider a 

situation in which the domestic supply of funds for investment decreases because domestic 

saving rates fall. Foreign borrowing in this case is not associated with increased investment, but 

instead is devoted to investment that was previously financed with domestic savings. Because 

the foreign borrowing is not associated with increased investment, future output does not 

increase, and interest and dividends on the investment will be paid to foreign persons at the 

expense of future domestic consumption. In this case, there may be an increase in the standard 

of living for current U.S. residents at the expense of a decrease in the standard of living of future 

residents.

During the period that foreign borrowing finances U.S. consumption, the United States 

runs a trade deficit. Although the United States could service its growing foreign debt by 

increased borrowing, and hence larger trade deficits, in the long run trade deficits cannot keep 

growing. In fact, the United States must eventually run a trade surplus. If the United States 

imported more goods than it exported every year, there also would be an inflow of foreign 

capital every year. This capital inflow would be growing with the increasing costs of servicing 

the foreign debt. Eventually, foreigners would be unwilling to continue lending to the United 

States, and the value of the dollar would fall. The fall in the dollar would eliminate the trade 

deficit, and the United States would eventually run a trade surplus, so that the current account 

deficit (the sum of the trade deficit in goods and services and the net interest on foreign 

obligations) would be small enough for foreigners to be willing to lend again to the United 

States.

Even when foreign investment finances domestic consumption, trade deficits and capital 

inflows themselves should not necessarily be viewed as undesirable, because the foreign capital 

 

16 This scenario describes the experience of the United States in the mid to late 1800s, 

when foreign capital inflows financed much of the investment in railroads and other assets. 
79

inflows help to keep domestic investment, and hence labor productivity, from falling. For 

instance, the large inflow of foreign capital to the United States in the 1980s is widely viewed to 

be a result of low U.S. saving rates. If the mobility of foreign capital had been restricted 

(through capital or import controls, for example), then the low saving rate could have led to 

higher domestic interest rates and lower rates of investment. That decreased investment would 

have led to decreases in future living standards because the lower growth rate of the capital stock 

would have resulted in lower growth rates of U.S. labor productivity. The fact that foreign 

capital was not restricted and did finance U.S. investment helped mitigate the negative effects on 

economic growth of low domestic saving.

The above observations support the argument that the trade deficit does not in itself 

provide a useful measure of international competitiveness, since trade deficits and trade 

surpluses can be either good or bad for the United States. The example of oil discovery 

discussed above shows that even increases in a country's stock of exportable goods can have 

ambiguous effects on the trade deficit. If the discovery of oil also increases the demand for 

investment, then the trade deficit may actually increase in the short run. Increases in natural 

resources, advances in technology, increases in worker efficiency, and other wealth-enhancing 

innovations have ambiguous effects on the trade deficit in the short and medium run. Because 

these innovations increase the productivity of U.S. workers and lower production costs, they 

increase the attractiveness of U.S. goods, and may result in increased exports. To the extent 

these innovations increase the demand for investment, however, they can have the opposite 

effect on the trade deficit. Nonetheless, each of these innovations increases the output of the 

economy, and hence the incomes of U.S. residents.

The balance of payments accounts, presented in Table 6, are analogous to a sources and 

uses of funds statement of the United States with the rest of the world. As demonstrated above, 

the current account balance, which consists primarily of the trade balance, should be exactly 

offset by the capital account and financial account balances, which measure the net inflow or 

outflow of capital to or from the United States. The difference between the current account 

surplus or deficit and the capital and financial accounts deficit or surplus is recorded as a 

statistical discrepancy. Problems of measureme nt, which have been large in some years, cause 

the accounts to be somewhat mismatched in practice, but basic patterns are unlikely to be 

significantly distorted by these problems. The subsequent sections examine trends in the current 

account and financial account in more detail.
80

Table 6 – International Transactions of the United States, Selected Years,

1975-2000

($ Billions nominal)

1975 1985 1995 2000

Current Account Balance

Exports of Goods and Services

Merchandise

Services

Receipts from U.S. assets abroad

Imports of Goods and Services

Merchandise

Services

Payments on foreign-owned U.S. assets

18.1

157.9

107.1

25.5

25.4

132.7

98.2

22.0

12.6

-118.2

387.6

215.9

73.2

98.5

483.8

338.1

72.9

72.8

-109.9

1,005.9

575.2

219.2

211.5

1,081.8

749.4

141.4

191.0

-444.7

1,418.6

772.2

293.5

352.9

1,809.1

1,224.4

217.0

367.7

Unilateral Transfers 7.1 22.0 34.1 54.1

Financial Account Balance

Foreign Investment in the United States

Direct Investment

Private non-direct investment

Official

-22.5

17.2

2.6

7.5

7.0

101.3

146.1

19.7

127.5

-1.1

113.3

465.7

57.8

298.0

109.9

443.2

1,024.2

287.7

700.2

37.6

U.S. Investment Abroad

Direct Investment

Private non-direct investment

Increase in government assets

39.7

14.2

21.1

4.3

44.8

18.9

19.1

6.7

352.4

98.8

242.9

10.7

581.0

152.4

427.3

1.2

Capital Account Transactions, net n.a. 0.3 0.4 0.7

Statistical Discrepancy 4.4 16.5 3.8 0.7

Source: Douglas B. Weinberg, “U.S. International Transactions, First Quarter 2001,” Survey of Current Business, 

81, July 2001, pp. 37-81.

n.a. - not applicable
81

B. Trends in the United States' Balance of Payments

Overview of U.S. balance of payments (current account)

Foreign trade has become increasingly important to the United States economy. Figure 9

presents the value of exports from the United States and imports into the United States as a 

percentage of GDP for the period 1960-2001.17 As depicted in Figure 9, exports and imports 

each have risen from less than six percent of GDP in 1960 to more than 12 percent in 2001. 

Figure 9 also shows that the United States generally was a net exporter of goods and services 

prior to 1982. Since that time, the United States has been a net importer of goods and services.

Figure 9

Source: Department of Commerce, Bureau of Economic Analysis.

 

17 Data for Figure 9 are from the U.S. Commerce Department, Bureau of Economic 

Analysis and are reprinted in Appendix Table 2 and Appendix Table 3.

Exports and Imports as a Percentage of United States GDP, 1960-2001

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

20.00

196019621964196619681970197219741976197819801982198419861988199019921994199619982000

Year

Percentage of GDP

Imports

Exports
82

The net trade position of a country is commonly summarized by its current account. The 

U.S. current account as a whole, which compares exports of goods and services and income 

earned by U.S. persons on foreign investments to imports of goods and services and income 

earned by foreign persons on their investments in the United States (plus unilateral remittances), 

generally was positive from 1960 through 1981, but generally has been in deficit by over $90 

billion per year 13 times since 1984. Figure 10 reports the current account balance of the United 

States for the period 1960 through 2001 in nominal (non-inflation-adjusted) dollars.18 Figure 11

presents the same data as a percentage of GDP to eliminate the effect of inflation on reported 

nominal figures. Figure 10 and Figure 11, like Figure 9, show the United States' change in status 

from net exporter to net importer since the early 1980s. Figure 10 and Figure 11 reflect a 

substantial reduction in the current account deficit for 1992. In that year, the United States 

received substantial payments from abroad related to the Persian Gulf War. 

Figure 10

Source: Department of Commerce, Bureau of Economic Analysis.

 

18 Data for Figure 10 and Figure 11 are from the U.S. Commerce Department, Bureau of 

Economic Analysis and are reprinted in Appendix Table 2. 

United States Current Account Balance, 1960-2001

[millions nominal dollars]

-500,000

-400,000

-300,000

-200,000

-100,000

0

100,000

196019621964196619681970197219741976197819801982198419861988199019921994199619982000

Millions of Dollars
83

Figure 11

Source: Department of Commerce, Bureau of Economic Analysis.

United States Current Account Balance as a Percentage of GDP, 1960-2001

(percent)

-5.00

-4.00

-3.00

-2.00

-1.00

0.00

1.00

2.00

196019621964196619681970197219741976197819801982198419861988199019921994199619982000

Percentage
84

Components of the current account

Merchandise trade, trade in services, and income from investments

The aggregate data reported in Figure 9, Figure 10, and Figure 11 mask differences in the 

trade position of various sectors of the economy. As explained above, the current account 

compares exports of goods and services and payments of income earned by U.S. persons on 

foreign investments to imports of goods and services and payments of income earned by foreign 

persons on their investments in the United States. Figure 12 and Figure 13 separately chart the 

nominal dollar value of exported and imported goods referred to as “merchandise trade” (Figure 

12) and merchandise trade as a percentage of GDP (Figure 13). Figure 14 and Figure 15

separately chart exported and imported services in nominal dollars and as a percentage of GDP. 

Figure 16 and Figure 17 separately chart investment income earned by U.S. and foreign persons 

in nominal dollars and as a percentage of GDP.19 The sum of the export curves in, Figure 12, 

Figure 13, Figure 14, Figure 15, Figure 16, and Figure 17 less the sum of the import curves (plus 

unilateral remittances) equals the current account balance curves of Figure 10 and Figure 11.

Figure 12, Figure 13, Figure 14, Figure 15, Figure 16, and Figure 17 reveal different 

trends. As has been widely reported, the merchandise (goods only) trade deficit has been over 

$100 billion per year since 1984 and over $500 billion per year since 1996. On the other hand, 

the United States has been a net exporter of services since the mid-1970s (Figure 14 and Figure 

15). Only since 1998 have payments of income to foreign persons on their U.S. investments 

exceeded U.S. receipts of income on investments abroad (Figure 16 and Figure 17).

 

19 Data for Figure 12, Figure 13, Figure 14, Figure 15, Figure 16, and Figure 17 are from 

the U.S. Commerce Department, Bureau of Economic Analysis and are reprinted in Appendix 

Table 2.
85

Figure 12

Source: Department of Commerce, Department of Economic Analysis.

U.S. Merchandise Trade, 1960-2001

[millions nominal dollars]

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

196019621964196619681970197219741976197819801982198419861988199019921994199619982000

Year

Millions of Dollars

Exports

Imports
86

Figure 13

Source: Department of Commerce, Bureau of Economic Analysis.

U.S. Merchandise Trade as a Percentage of GDP, 1960-2001

(percent)

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

196019621964196619681970197219741976197819801982198419861988199019921994199619982000

Year

Percentage

Merchandise Exports

Merchandise Imports
87

Figure 14

Source: Department of Commerce, Bureau of Economic Analysis.

Trade in Services, 1960-2001

[millions nominal dollars]

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000

Year

Millions of Dollars

Service Exports

Service Imports
88

Figure 15

Source: Department of Commerce, Bureau of Economic Analysis.

Trade in Services as a Percentage of GDP, 1960-2001

(percent)

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

196019621964196619681970197219741976197819801982198419861988199019921994199619982000

Year

Percentage

Service Exports

Service Imports
89

Figure 16

Source: Department of Commerce, Bureau of Economic Analysis.

Receipts of Income from Abroad and U.S. Payments to Foreign Persons, 1960-2001

[millions nominal dollars]

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

196019621964196619681970197219741976197819801982198419861988199019921994199619982000

Year

Millions of Dollars

U.S. receipts from abroad

U.S. payments to foreigners
90

Figure 17

Source: Department of Commerce, Bureau of Economic Analysis.

Intra-firm trade

These aggregate data also do not reveal the extent to which growing trade flows result 

from trade between related parties. For example, a domestic company might ship components 

manufactured in the United States to its foreign subsidiary for final assembly and sale. Such 

shipments would be counted as exports from the United States. A domestic company might 

produce components abroad and ship them to the United States for final assembly and sale. Such 

shipments would be counted as imports to the United States. Likewise, a foreign parent 

company might ship components from abroad to its U.S. affiliate for final assembly and sale in 

the United States. Such shipments would be counted as imports into the United States. The 

foreign affiliate might ship components to another country for assembly and sale. Such 

shipments would be counted as exports from the United States.

Receipts of Income from Abroad and U.S. Payments to Foreign Persons

as a Percentage of GDP, 1960-2001

(percent)

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

196019621964196619681970197219741976197819801982198419861988199019921994199619982000

Year

Percentage

U.S. receipts from abroad

U.S. payments to foreigners
91

The preceding paragraph suggests that intra-firm trade involves the shipment of 

components across borders. Other intra-firm trade may involve the shipment of raw materials 

abroad for manufacture abroad or shipment of finished goods to a foreign sales affiliate. The 

data do not permit such distinctions to be drawn. Nevertheless, the extent of this intra-firm 

cross-border trade is large. In 1996, large foreign-owned domestic corporations reported sales of 

tangible goods to related foreign persons (exports) of $68.6 billion, a figure representing 11.2 

percent of total U.S. merchandise exports in 1996. Large foreign-owned domestic corporations 

reported purchases of tangible goods from related foreign persons (imports) of $181.9 billion, a 

figure representing 22.6 percent of total U.S. merchandise imports in 1996.20 Similarly, in 1996, 

U.S. multinational enterprises shipped $162.4 billion of goods to their foreign affiliates, a figure 

representing 26 percent of U.S. merchandise exports in 1996. Foreign affiliates of U.S. 

multinational enterprises shipped $136.1 billion of goods to their U.S. parent enterprise, a figure 

representing 16.9 percent of U.S. merchandise imports in 1996.21 Thus, in total, in 1996 intrafirm trade accounted for at least 37 percent of U.S. merchandise exports and 39 percent of U.S. 

merchandise imports.

Merchandise trade data by industry and geographic region

Intra-firm trade helps explain two other aspects of merchandise trade. First, sectors that 

are important sources of U.S. exports are often also substantial import sectors. For example, a 

U.S. manufacturer of computer equipment may produce some components in the United States 

and ship the components abroad for assembly before re-importing the product for sale in the 

United States. Such a business arrangement would produce exports from the computer and 

computer components sector and imports into the computer and computer component sector. 

Beyond intra-firm trade, competition in the market place also would result in the same sector 

being the source of exports and the recipient of imports. Figure 18 and Figure 19 detail the 

composition, by industry, of U.S. merchandise exports (Figure 18) and U.S. merchandise imports 

(Figure 19) for 2000. To highlight the example above, the data show that seven percent of U.S. 

exports were from the computer and peripherals industry and similarly seven percent of U.S. 

imports were in the computer and peripherals industry. 

 

20 Michael G. Seiders and Heather R. Duffy, “Transactions Between Large ForeignOwned Domestic Corporations and Related Foreign Persons, 1996,” SOI Bulletin, 19, Fall 1999, 

pp. 192-213. The data are from 545 foreign-owned domestic corporations, each with total 

receipts of $500 million or more in 1996 or a prior year. The figures reported in the text are the 

sum of reported “sales of stock in trade” and “sales of other tangible property.” In 1991, such 

inter-affiliate trade by large foreign-owned domestic corporations represented 11 percent of 

merchandise exports and 24 percent of merchandise exports. In 1994, such inter-affiliate trade 

by large foreign-owned domestic corporations represented 14 percent of merchandise exports 

and 27 percent of merchandise imports.

21 Raymond J. Mataloni, Jr. “U.S. Multinational Companies: Operations in 1996,” 

Survey of Current Business, 78, September 1998, p. 54. Unlike the data cited above for foreignowned U.S. corporations, these data are more inclusive of U.S. foreign affiliates, not being 

restricted by the size of the foreign affiliate.
92

Intra-firm trade also is a factor in understanding why countries or areas that are important 

export markets also often are significant points of origin of imports. Figure 20 and Figure 21

show the destinations of U.S. merchandise exports and the areas of origin of U.S. merchandise 

imports in 2000.22

Figure 18

Source: Bureau of Economic Analysis, Department of Commerce and JCT staff calculations.

 

22 Data for Figure 18 through Figure 21 are found in Douglas B. Weinberg, “U.S. 

International Transactions, First Quarter 2001,” Survey of Current Business, 81, July 2001, pp. 

37-81.

Composition, by Industry of U.S. Merchandise Exports, 2000

[Billions of Dollars and Percentage]

Other

$29.8 - 4%

Automobiles & parts

$80.2 - 10%

Other capital goods

$162.1 - 21%

Other industrial supplies and 

materials

$80.5 - 10%

Computers & peripherals

$55.5 - 7%

Semiconductors

$60.1 - 8%

Metals & nonmetallic 

products

$39.2 - 5%

Chemicals

$52.2 - 7%

Foods, feeds,

& beverages

$47.5 - 6%

Consumer durable

goods

$43.3 - 6%

Consumer nondurable goods

$42.6 - 6%

Telecommunications 

equipment

$31.3 - 4%

Civilian aircraft

& parts

$48.1 - 6%
93

Figure 19

Source: Bureau of Economic Analysis, Department of Commerce and JCT staff calculations.

Composition, by Industry of U.S. Merchandise Imports, 2000

[Billions of Dollars and Percentage]

Other capital goods

$150.2 - 12%

Automobiles & parts

$195.6 - 17%

Consumer nondurable goods

$130.4 - 11%

Energy products

$138.4 - 11%

Computers & peripherals

$89.8 - 7%

Chemicals

$34.4 - 3%

Telecommunications equipment

$31.9 - 3%

Civilian aircraft & parts

$26.4 - 2%

Semiconductors

$48.6 - 4%

Consumer durable goods

$136.3 - 11%

Other industrial supplies and 

materials

$70.3 - 6%

Metals & nonmetallic products

$59.8 - 5%

Foods, feeds,

& beverages

Other $32.8 - 3%

$62.6 - 5% 
94

Figure 20

Source: Bureau of Economic Analysis, Department of Commerce and JCT staff calculations.

Destination of U.S. Merchandise Exports, 2000

[Billions of Dollars and Percentage]

Latin America

$170.3 - 22%

Other Asia

$152.0 - 20%

Japan

$63.6 - 8%

Canada

$179.0 - 23%

Western Europe

$178.8 - 23%

Eastern Europe

$5.9 - 1%

Africa

$10.1 - 1%

Australia

$12.2 - 2%
95

Figure 21

Source: Bureau of Economic Analysis, Department of Commerce and JCT staff calculations.

Areas of Origin of U.S. Merchandise Imports, 2000

[Billions of Dollars and Percentage]

Latin America

$210.2 - 17%

Other Asia

$340.3 - 28%

Japan

$146.5 - 12%

Canada

$233.7 - 19%

Western Europe

$243.4 - 20%

Eastern Europe

$16.1 - 1%

Africa

$27.5 - 2%

Australia

$6.4 - 1%
96

Foreign sales corporations and U.S. exports

Data on the role of foreign sales corporations in U.S. trade is limited. Figure 22 details 

foreign sales corporation (“FSC”) and domestic international sales corporation (“DISC”) 

dividends as a percentage of the profits of all U.S. corporations. While trending upwards over 

the last several years, FSC profits constitute less than 1.5 percent of total corporate profits. 

While a relatively small part of the overall profits of U.S. corporations, sales of goods and 

services through FSCs may represent a substantial share of U.S. exports. Figure 23 below 

reports the “foreign trade gross receipts” of FSCs as a percentage of total U.S. exports of goods 

and services for 1987, 1992, and 1996. “Foreign trade gross receipts” represent the receipts from 

the sale of export property, the lease payments on qualifying export property, and payments for 

services related to qualifying sales and leases. In general, these data measure the receipts 

derived from qualified export sales.23 Figure 23 reports that qualifying FSC exports comprised 

one third of U.S. merchandise and service exports in 1996. These data give a picture of the 

scope of FSCs in U.S. exports but should not be over emphasized. On one hand, these data may 

overstate somewhat the role of FSCs as foreign trade gross receipts include the value of 

marketing and sales service performed abroad which would not normally be included as an 

export. On the other hand, the Statistics of Income Division of the Internal Revenue Service 

report that not all FSC tax returns report foreign trade gross receipts24 and the imputation of the 

missing data is likely to understate the value of foreign trade gross receipts. Another factor to 

consider is that approximately 90 percent of FSC returns represent FSCs related to 

manufacturing industries. The percentages reported in Figure 23 compare FSC sales to exports 

of goods and services. FSC sales of manufactured goods is likely to constitute a higher 

percentage of merchandise exports than the percentages reported in the figure.

 

23 “Foreign trade gross receipts also include payments for engineering and architectural 

services on foreign construction projects. In the case of a commission FSC, the foreign trade 

gross receipts of the related supplier are included in these data. FSCs reported $84.3 billion in 

foreign trade gross receipts in 1987, $152.3 billion in 1992, and $185.9 billion in 1996. Cynthia 

Belmonte, “Foreign Sales Corporations, 1996, SOI Bulletin, 19, Spring 2000, pp. 87-122.

24 A foreign sales corporation need not report “foreign trade gross receipts” in order to 

determine its tax liability.
97

Figure 22

Source: Statistics of Income, Internal Revenue Service and JCT staff calculations.

FSC and DISC Dividends as a Percentage of Corporate Profits,

1983-1998

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998

Year

Percent
98

Figure 23

Source: Statistics of Income, Internal Revenue Service and JCT staff calculations.

FSC Exports of Goods and Services as a Percentage of Total U.S. Exports of Goods and 

Services, 1987, 1992, and 1996

33.6%

24.7% 24.2%

0

5

10

15

20

25

30

35

40

1987 1992 1996

Percent
99

C. Trends in the United States' Financial Account

Overview of the United States' financial account

As explained above, when the United States imports more than it exports, the dollars the 

United States uses to buy the imports must ultimately return to the United States as payment for 

U.S. exports or to purchase U.S. assets. As Figure 10, Figure 11, and Table 6 document, the 

United States' current account has been in deficit since the early 1980s. Figure 24 plots gross 

(before depreciation) U.S. investment and gross U.S. saving as a percentage of GDP for the 

period 1960-2000.25 Figure 24 also plots net foreign investment as a percentage of GDP. In 

Figure 24, when the United States is a net exporter of capital, net foreign investment is measured 

as a positive number, and when the United States is a net importer of foreign capital net foreign 

investment is measured as a negative number. Net foreign investment became a larger 

proportion of the economy since 1982. At the same time, the United States changed from being 

a modest exporter of capital in relation to GDP to being a large importer of capital. Net foreign 

investment has become a larger proportion of the economy and a more significant proportion of 

total domestic investment than in the past. In 2000, gross investment in the United States was 

$1,741 billion and net foreign investment was $428 billion, or 24.6 percent of gross domestic 

investment. In 1993, net foreign investment comprised 8.9 percent of gross domestic 

investment.

 

25 Data for Figure 24 are from the U.S. Department of Commerce, Bureau of Economic 

Analysis and are reprinted in Appendix Table 3. 
100

Figure 24

Source: Department of Commerce, Bureau of Economic Analysis.

Saving, Investment, and Net Foreign Investment as a Percentage of GDP,

1960-2000

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

196019621964196619681970197219741976197819801982198419861988199019921994199619982000

Year

Percentage of GDP

Savings

Investment

Net foreign
101

The net foreign investment in the United States is measured by the United States' 

financial account. The financial account measures the increase in U.S. assets abroad compared 

to the increase in foreign assets in the United States. Figure 25 plots the annual increase of U.S. 

assets abroad and of foreign assets in the United States in constant dollars for the period 1960-

2001.26 Foreign assets in the United States increased by $814 billion in 1999, $1,024 billion in 

2000, and $895 billion in 2001 in nominal dollars. At the same time, foreign assets owned by 

U.S. persons increased by $437 billion in 1999, $581 billion in 2000, and $400 billion in 2001 

(nominal dollars).

Figure 25

Source: Department of Commerce, Bureau of Economic Analysis.

 

26 Data for Figure 25 are from the U.S. Department of Commerce, Bureau of Economic 

Analysis and are reprinted in Appendix Table 4.

Annual Increase in U.S. Assets Abroad and in Foreign Assets in U.S.,

1960-2001, in Constant 1996 Dollars

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

196019621964196619681970197219741976197819801982198419861988199019921994199619982000

Year

Dollars in Millions

U.S.-owned assets abroad

Foreign-owned assets in the U.S.
102

Growth in foreign-owned assets in the United States and U.S.-owned assets abroad

Overview

Measured in nominal dollars, the amount of foreign-owned assets in the United States 

grew more than 700 percent between 1975 and 198827 and by nearly 400 percent between 1980 

and 2000. The total amount of foreign-owned assets in the United States exceeded $8 trillion by 

the end of 2000.28 The recorded value of U.S.-owned assets abroad grew less rapidly during the 

same period. The Department of Commerce reports that in 1975 the amount of U.S.-owned 

assets abroad exceeded foreign-owned assets in the United States by $74 billion. By the end of 

1988, however, the situation had reversed, so that the amount of foreign-owned assets in the 

United States exceeded U.S.-owned assets abroad by $162 billion. By 2000, the amount of 

foreign-owned assets in the United States exceeded U.S.-owned assets abroad by $1.8 trillion.29 

These investments are measured at their so-called “current cost.”30 Some argue that the market 

value of U.S.-owned assets abroad is similar to, or greater than, the market value of foreignowned assets in the United States, if market values were measured accurately. 31

 Figure 26 and 

Figure 27 display the value of U.S.-owned assets abroad and foreign-owned assets in the United 

States for selected years measured under both current cost and based on estimates of current 

market values. Whether this argument is correct with respect to the current net investment 

position, it is clear that foreign-owned U.S. assets are growing more rapidly than U.S.-owned 

assets abroad, as depicted in Figure 25.

 

27 Russell B. Scholl, “The International Investment Position of the United States in 

1988,” Survey of Current Business, U.S. Department of Commerce, Bureau of Economic 

Analysis, June 1989, p. 43. 

28

 Ibid.

29

 Ibid.

30 The Bureau of Economic Analysis estimates the values of U.S. foreign direct 

investment abroad and foreign direct investment in the United States using three different bases: 

historical cost, current cost, and market value. Using the historical cost base, assets are 

measured according to values carried on taxpayers’ books. Thus, investments reflect the price 

level of the year in which the asset was acquired. Under the current cost measure, a parent’s 

share of its affiliates’ tangible assets (property, plant, and equipment and inventories) is revalued 

from historical cost to replacement cost. Under the market value measure, an owner’s equity in 

foreign assets is revalued to current market value using indexes of stock prices.

31 The distinction between book valuation and market valuation is only relevant for the 

category of investment labeled “direct investment,” not for “portfolio investment.” The 

distinction between direct and portfolio investment is explained in the text below.
103

Figure 26

Source: Department of Commerce, Bureau of Economic Analysis.

International Investment Position of the United States,

1982, 1990, and 2000 in Constant 1996 Dollars

(direct investment at current cost)

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

8,000,000

1982 1990 2000

Year

Billions of dollars

U.S. assets abroad

Foreign assets in the U.S.
104

Figure 27

Source: Department of Commerce, Bureau of Economic Analysis.

International Investment Position of the United States,

1982, 1990, 2000 in Constant 1996 Dollars

(direct investment at market value)

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

8,000,000

9,000,000

10,000,000

1982 1990 2000

Year

Billions of dollars

U.S. assets abroad

Foreign assets in the U.S.
105

Direct investment, non-direct (portfolio) investment, and official investment

Foreign assets in the United States (and U.S. assets abroad) can be categorized as direct 

investment, non-direct investment, and official assets. Direct investment constitutes assets over 

which the owner has direct control. The Department of Commerce defines an investment as 

direct when a single person owns or controls, directly or indirectly, at least 10 percent of the 

voting securities of a corporate enterprise or the equivalent interests in an unincorporated 

business. Foreign persons held direct investments of $1.37 trillion in the United States in 2000, 

having grown from $127 billion in 1980.32 

The largest category of investment is non-direct investment held by private (nongovernmental) foreign investors, commonly referred to as portfolio investment. For most of the 

past decade foreign portfolio investment annually has exceeded foreign direct investment, 

making portfolio investment responsible for the majority of growth in foreign ownership of U.S. 

assets. (See Figure 28) Foreign portfolio investment consists mostly of holdings of corporate 

equities, corporate and government bonds, and bank deposits. The portfolio investor generally 

does not have control over the assets that underlie the financial claims. In 2000, portfolio assets 

of foreign persons in the United States were more than triple the recorded value of direct 

investment, $4.74 trillion compared to $1.37 trillion, respectively.33 Bank deposits account for 

approximately one-quarter of this total, and reflect, in part, the increasingly global nature of 

banking activities. Figure 29 reports the dollar value of foreign holdings of selected U.S. assets, 

both portfolio investment and direct investment, for 1982, 1990, and 2000.34 Foreign investment 

in bonds, corporate equities, and bank deposits, like other types of financial investment, provide 

a source of funds for investment in the United States but also represent a claim on future U.S. 

resources.

The final category of foreign-owned U.S. assets is official assets: U.S. assets held by 

governments, central banking systems, and certain international organizations. The foreign 

currency reserves of other governments and banking systems, for example, are treated as official 

assets. Levels of foreign-held official assets have grown more slowly than foreign-held direct 

and portfolio investment of private investors.

The value of investments by private U.S. persons abroad has grown from $693 billion in 

1980 to $5.95 trillion in 2000.35 This growth has not been as rapid as the growth in the value of 

investments by foreign persons in the United States. As has been the case for foreign investors 

in U.S. assets, over the past decade U.S. investors portfolio holdings of foreign assets has 

increased more rapidly than U.S. foreign direct investment. (See Figure 30.)36 At year-end 

 

32 King, “The International Investment Position of the United States at Yearend 2000.”

33

 Ibid.

34 See Appendix Table 5.

35 King, “The International Investment Position of the United States at Yearend 2000.”

36 See Appendix Table 6.
106

2000, U.S. foreign direct investment constituted approximately one-quarter of U.S. ownership of 

foreign assets (with direct investment measured at current cost).37 Measured at current cost, the 

value of U.S. direct investment abroad has remained above the value of foreign direct investment 

in the United States. (See Figure 31.) Measured at market value, the value of foreign direct 

investment in the United States has modestly surpassed the value of U.S. direct investment 

abroad since 1998. (See Figure 32.)

Figure 28

Source: Department of Commerce, Bureau of Economic Analysis.

 

37 King, “The International Investment Position of the United States at Yearend 2000.”

Annual Increase in Foreign Direct Investment in the United States and Foreign

(Non-Treasury Security) Portfolio Investment, 1960-2001,

In Constant 1996 Dollars

(50,000)

-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000

Millions 1996 Dollars

Direct Investment

Portfolio Investments
107

Figure 29

Source: Department of Commerce, Bureau of Economic Analysis.

Selected Nongovernmental Foreign Holdings of United States' Assets, Both Portfolio and Direct Investments,

1982, 1990, 2000 in Constant 1996 Dollars

(direct investment at current cost)

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1982 1990 2000

Year

Billions of dollars

U.S. Treasury securities

Corporate and other bonds

Corporate equity

Direct investment
108

Figure 30

Source: Department of Commerce, Bureau of Economic Analysis.

 Selected United States' Holdings of Foreign Assets, Both Portfolio

and Direct Investments, 1982, 1990, 2000, in Constant 1986 Dollars

(direct investment at current cost)

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1,800,000

1982 1990 2000

Year

Billions of dollars

Corporate bonds

Corporate equity

Direct investment
109

Figure 31

Source: Department of Commerce, Bureau of Economic Analysis.

Year-End Value of Foreign Direct Investment in the United States

and U.S. Direct Investment Abroad, 1982-2000

[Billions of Nominal Dollars at Current Cost]

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Year

Billions of dollars

Foreign Direct Investment

U.S. Direct Investment
110

Figure 32

Source: Department of Commerce, Bureau of Economic Analysis.

Year-End Value of Foreign Direct Investment in the United States

and U.S. Direct Investment Abroad, 1982-2000

[Billions of Nominal Dollars at Market Value]

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Year

Billions of dollars

Foreign Direct Investment

U.S. Direct Investment
111

Cross border investment by geographic region and industry38

Most cross border investment by developed countries is located in other developed 

countries. Measured on an historical cost basis, more than 50 percent of U.S. direct investment 

abroad is located in Europe and more than 10 percent is located in Canada. (See Figure 33.) 

Similarly, European persons account for more than 70 percent of foreign direct investment in the 

United States on an historical cost basis, and Canadian persons account for more than eight 

percent of foreign direct investment in the United States. (See Figure 34.) The single largest 

country hosting U.S. foreign direct investment abroad is the United Kingdom, followed by 

Canada, the Netherlands, and Germany. The United Kingdom is the single largest source 

country for foreign direct investment in the United States, followed by Japan, the Netherlands, 

and Germany. (See Figure 35 and Figure 36.) More than one quarter of U.S. direct investment 

abroad has been devoted to manufacturing. More than 40 percent of foreign direct investment in 

the United States is in the manufacturing sectors. Other significant sectors in which U.S. persons 

make direct investments abroad and in which foreign persons make direct investments in the 

United States are finance, insurance, and petroleum. (See Figure 37, Figure 38 and Figure 39).

 

38 The data in the text below and accompanying figures is from Maria Borgo and 

Raymond Mataloni, Jr., “Direct Investment Positions for 2000: Country and Industry Detail,” 

Survey of Current Business, 81, July 2001, pp. 16-29.
112

Figure 33

Source: Department of Commerce, Bureau of Economic Analysis.

U.S. Direct Investment Abroad, 2000

[Billions of Dollars]

Middle East

$11.9

Africa

$15.8

Europe

$648.7

Latin America & Other 

Western Hemisphere

$239.4

Asia & Pacific

$199.6

Canada

$126.4
113

Figure 34

Source: Department of Commerce, Bureau of Economic Analysis.

Foreign Direct Investment in the United States, 2000 Historial Cost Basis

[Billions of Dollars]

Latin America & Other 

Western Hemisphere

$42.7

Middle East

$8.4

Africa

$2.1

Canada

Asia & Pacific $100.8

$194.0

Europe

$890.6
114

Figure 35

Source: Department of Commerce, Bureau of Economic Analysis.

15 Largest Host Countries of U.S. Direct Investment Abroad, 2000

[Billions of Dollars]

$233.3

$126.4

$115.5

$55.6

$54.8

$54.1

$53.6

$39.0

$35.5

$35.4

$35.4

$35.3

$33.3

$23.6

$23.3

0 50 100 150 200 250

United Kingdom

Canada

Netherlands

Japan

Switzerland

Bermuda

Germany

France

Brazil

Mexico

Panama

Australia

Ireland

Italy

Hong Kong

Countries

Billions of Dollars
115

Figure 36

Source: Department of Commerce, Bureau of Economic Analysis.

10 Largest Home Countries of Foreign Direct Investment

in the United States, 2000

[Billions of Dollars]

$229.8

$163.2

$152.4

$122.8

$119.1

$100.8

$83.3

$81.7

$27.4

$23.0

0 50,000 100,000 150,000 200,000 250,000

United Kingdom

Japan

Netherlands

Germany

France

Canada

Luxembourg

Switzerland

Sweden

Ireland

Countries

Billions of Dollars
116

Figure 37

Source: Department of Commerce, Bureau of Economic Analysis.

U.S. Direct Investment Abroad at Year-End 2000

by Industry on an Historical Cost Basis

[Billions of Dollars]

Finance, insurance, and real 

estate

$497.3

Depository institutions

$37.2

Wholesale trade

$88.9

Petroleum

$105.5

Manufacturing

$344.0

Services

$79.9

Other

$92.8
117

Figure 38

Source: Department of Commerce, Bureau of Economic Analysis.

U.S. Direct Investment in Manufacturing Abroad at

Year-End 2000 by Manufacturing Industry on an

Historical Cost Basis

[Billions of Dollars]

Other manufacturing

$75.3

Transportation equipment

$41.1

Electronic and other electrical 

equipment

$43.4 Industrial machinery and 

equipment

$42.5

Primary and fabricated metals

$18.7

Chemicals and alied products

$86.1

Food and kindred products

$36.8
118

Figure 39

Source: Department of Commerce, Bureau of Economic Analysis.

Foreign Direct Investment in the United States by Industry, 2000

[Billions of Dollars]

Manufacturing

$496.6

Petroleum

$92.9

Wholesale Trade

$109.6

Depository Institutions

$68.6

Finance

$88.1

Insurance

$106.4

Real Estate

$42.3

Services

$103.0

Other

$99.1
119

Cross-border merger activity

Cross-border merger activity is one means by which changes occur in the financial 

account. Figure 40 below details the dollar value of foreign investor acquisitions of U.S. 

companies and the U.S. investor acquisitions of foreign companies via merger or acquisition. 

All of these mergers would represent direct, rather than portfolio, investment, as all involve 100-

percent acquisitions.39 Figure 40 shows that the dollar value of such cross-border acquisitions 

was comparable with U.S. acquisitions slightly lower for the period 1991 through 1997. 

Subsequent to 1997 foreign acquisitions of U.S. companies has more than doubled U.S. 

acquisitions of foreign companies, although throughout the entire period U.S. acquisitions 

generally have exceeded foreign acquisitions in terms of number of companies purchased.40

The greatest plurality of cross-border mergers and acquisitions has involved U.S. 

companies and companies of the United Kingdom, consistent with the data presented above 

showing the extent of U.K. direct investments in the United States and U.S. direct investments in 

the United Kingdom. In 2000, the investors domiciled in the United Kingdom accounted for 

nearly 34 percent of foreign acquisitions of U.S. companies (valued at $114.3 billion).41 

Approximately 35 percent of U.S. investor acquisitions of foreign companies involved 

companies domiciled in the United Kingdom (valued at $47.9 billion).42 The next four largest 

foreign acquirers of U.S. companies in 2000 were France ($39.8 billion, 11.7 percent of the 

total), Switzerland ($35.6 billion, 10.5 percent of the total), the Netherlands ($31.8 billion, 9.4 

percent of the total), and Canada ($29.2 billion, 8.6 percent of the total). After the United 

Kingdom the next largest sites of U.S. investor acquisitions in 2000 were Canada ($13.8 billion, 

10.2 percent of the total), Italy ($11.8 billion, 8.7 percent of the total), Japan ($10.7 billion, 7.9 

percent of the total), and Germany ($6.7 billion, 5.0 percent of the total).43 Measured by dollar 

value, approximately 17 percent of foreign acquisitions were of U.S. firms engaged in 

investments and commodities and another 15 percent of foreign acquisitions were of U.S. firms 

engaged in providing business services.44 The foreign industry receiving the greatest U.S. 

investor purchases was telecommunications, accounting for nearly 13 percent of U.S. foreign 

 

39 An investment is considered a “direct investment,” rather than a “portfolio 

investment,” if at least a 10-percent interest is acquired. 

40 See Appendix Table 7.

41

 Mergers & Acquisitions Almanac, February 2001, pp. 38. 

42

 Ibid.

43

 Ibid.

44

 Ibid. U.S. firms in the oil and gas industry accounted for nearly 12 percent of year 

2000 foreign acquisitions and U.S. firms in the food industry accounted for nine percent of 

foreign acquisitions. No other industry accounted for more than five percent of foreign 

acquisitions measured in dollars.
120

acquisitions. Foreign utilities constituted nearly 10 percent of U.S. acquisitions of foreign 

companies in 2000.45

Table 7, Table 8, Table 9, and Table 10, below, list the 25 largest foreign acquisitions of 

U.S. companies in 2000 (Table 7) and 1999 (Table 9) and the 25 largest U.S. acquisitions of 

foreign companies in 2000 (Table 8) and 1999 (Table 10). The tables list the target company, 

the acquiring company, the domicile of the companies, the line of business of the target 

company, and estimated dollar value of the merger or acquisition.

 

45

 Ibid. Acquisitions of foreign investment and commodity companies comprised 9.5 

percent of U.S. acquisitions abroad in 2000. Acquisitions of foreign radio and television 

companies comprised 7.5 percent of U.S. acquisitions abroad, acquisitions of foreign business 

service companies comprised 6.4 percent, acquisitions of foreign metal and metal product 

companies comprised 6.1 percent, acquisitions of foreign oil and gas companies comprised 5.3 

percent, and acquisitions of foreign electronic and electrical equipment companies comprised 

five percent of U.S. acquisitions abroad in 2000. No other sector accounted for more than three 

percent of U.S. acquisitions of foreign companies in 2000.
121

Figure 40

Source: Mergers and Acquisitions Almanac, see Appendix Table 7.

Dollar Value of Cross Border Mergers and Acquisitions, 1991-2000

$0.0

$50.0

$100.0

$150.0

$200.0

$250.0

$300.0

$350.0

$400.0

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Year

Billions of Dollars

Foreign Acquisition

of U.S. Firms

U.S. Acquisitions of

Foreign Firms
Table 7 – Top 25 Foreign Acquisitions of U.S. Companies – 2000

Acquirer

Domicile of

Acquirer Target

Target

Industry

Price

($ Billions)

BP Amoco PLC United Kingdom Atlantic Richfield Co. Oil and gas $27.2

Unilever PLC United Kingdom Bestfoods Food products 25.1

UBS AG Switzerland PaineWebber Group Inc. Investment banking 16.5

Credit Suisse Group Switzerland Donaldson, Lufkin & Jenrette Inc. Investment banking 13.5

Cap Gemini SA France Consulting business of Ernst & 

Young LLP

Consulting services 11.8

ING Groep NV Netherlands Financial services and international 

businesses of Aetna Inc.

Insurance financial services 7.6

Nortel Networks Corp. Canada Alteon Websystems Inc. Internet infrastructure products 7.1

Terra Networks SA Spain Lycos Inc. Internet search engine 6.2

ING Groep NV Netherlands ReliaStar Financial Corp Insurance 6.0

Nippon Telephone & 

Telegraph Corp. 

Japan Remaining 90% of Verio Inc. Internet service provider 5.7

France Telecom SA France 25% of NTL Inc. Cable TV systems, radio stations, 

telecom services

5.5

PowerGen PLC United Kingdom LG&E Energy Corp. Electric and gas utility 5.4

WPP Group PLC United Kingdom Young & Rubicam Inc. Advertising agency 5.0

Tyco International Ltd. Bermuda Mallinckrodt Inc. Diagnostic products 4.4

France Telecom SA France Remaining 71% of Global One Co. Telecommunications 4.3

Sema Group PLC United Kingdom LHS Group Inc. Billing and customer care services 4.3

National Grid Group PLC New England Electric System Electric utility; oil and gas 4.2

Stora Enso Oyj Finland Consolidated Papers Inc. Paper products 4.0

BASF AG Germany Agricultural products business of 

American Home Products Corp

Crop protection products 3.9

Koninklijke Ahold NV Netherlands US Foodservice Inc. Grocery products wholesaling 3.6

Rodamco North America NV Netherlands Urban Shopping Centers Inc. Mall development and management 3.4

Nortel Networks Corp. Canada Xros Inc. Fiber-optic network switching 

equipment

3.3

Nortel Networks Corp. Canada Otera Corp. Fiber-optic telecommunication 

equipment

3.3

Cia Cementos Mexicanos SA Mexico Southdown Inc. Cement; limestone mining 2.8

Global Crossing Ltd. Bermuda IPC Communications Inc. unit of 

Citigroup Inc.

Integrated communication systems and 

services

2.8

122
Table 8 – Top 25 U.S. Acquisitions of Foreign Companies – 2000

Acquirer Target Domicile of

Acquirer

Target

Industry

Price

($ Billions)

NTL Inc. CWC Consumer Co unit of Cable 

and Wireless Communications 

PLC

United Kingdom Telecommunication, cable TV, and 

internet services

11.0

Chase Manhattan Corp. Robert Fleming Holdings Ltd. United Kingdom Merchant banking 7.7

NTL Inc. Cablecom Holding AG Switzerland Cable TV services 3.7

Corning Inc. 90% of the optical components and 

device business of Pirelli SpA

Italy Optical network components 3.6

Callahan Associates 

International LLC et al

55% of the North Rhine 

Westphalia cable network of 

Deutsche Telekom AG

Germany Telecommunication services 2.8

Ford Motor Co. Land Rover business of BMW AG United Kingdom Motor vehicles 2.7

General Motors Corp. 20% of the Fiat Auto SpA unit of 

Fiat SpA

Italy Automobiles 2.4

General Electric Co. Toho Mutual Life Japan Insurance 2.3

Citigroup Inc. Worldwide investment banking 

business of Schroders PLC

United Kingdom Investment banking 2.2

Cisco Systems Inc. Fiber-optic networking operations 

of Pirelli SpA

Italy Fiber-optic network development 2.2

AES Corp. Additional 80.2% of Ca La 

Electricidad de Caracas SACA

Venezuela Electric utility 1.7

Nationwide Mutual Insurance 

Co.

Ganmore Investment Management 

PLC unit of Royal Bank of 

Scotland Group PLC

United Kingdom Investment management services 1.6

Corning Inc. Optical fiber, cable and related 

equipment businesses of Siemens 

AG

Germany Fiber-optic cables 1.4

Smurfit-Stone Container 

Corp.

St. Laurent Paperboard Inc. Canada Paperboard products 1.4

Intel Corp. Giga A/S unit of NKT Holding Denmark Telecommunication network 

components

1.3

Reliant Energy Inc. Remaining 48% of 

Energieproduktiebedrijf UNA NV

Netherlands Electric utility 1.2

Kohlberg, Kravis Roberts & 

Co.

Non-speciality organics operations 

of Laporte PLC

United Kingdom Pigments, additives, chemical 

compounds

1.2

AES Corp. Additional 35.6% of Electopaulo Brazil Electric utility 1.1

123
Acquirer Target Domicile of

Acquirer

Target

Industry

Price

($ Billions)

Metropolitena Electricidade de San 

Paulo SA

Diamond Technology 

Partners, Inc.

Cluster Consulting Spain Business consulting services 1.1

General Motors Corp. 17.7% of Fuji Heavy Industries 

Ltd.

Japan Motor vehicles 1.1

Microsoft Corp. MediaOne Group Inc.'s 60% stake 

in Titus Communications Corp.

Japan CableTV networks 0.9

ADC Telcommunications, 

Inc.

Altitun AB Sweden Semiconductor laser modules 0.9

Delphi Automotive Systems 

Corp.

Lucas Diesel Systems unit of TRW 

Inc.

France Diesel fuel-injection systems 0.9

Siebel Systems Inc. Janna Systems Inc. Canada Electronic systems services 0.9

124
Table 9 –Top 25 Foreign Acquisitions of U.S. Companies – 1999

Acquirer Domicile of

Aquirer

Target Target

Industry

Price 

($ Billions)

Merger: Vodadone Group PLC United Kingdom AirTouch Communications Mobile telecom and 

paging services

$60.3

Scottish Power PLC United Kingdom PacificCorp Electric utility company 12.6

Aegon NV Netherlands TransAmerica Corp. Insurance 10.6

Global Crossing Ltd. Bermuda Frontier Corp. Telecommunications 10.1

Deutsche Bank AG Germany Bankers Trust New York Corp. Bank holding company 9.1

HSBC Holdings PLC United Kingdom Republic New York Corp. Bank holding company 7.7

Vivendi SA France United States Filter Corp. Water and wastewater 

treatment systems

6.3

New Holland MV Netherlands Case Corp. Farm machinery 6.3

Roche Holding AG Switzerland Remaining 33% of Genentech Inc. Drugs based on DNA and 

gene, technology

4.8

General Electric Co. P.L.C United Kingdom FORE Systems Inc. Network interfaces and 

LAN products

4.2

Suez Lyonnaise des Eaux-Dumez SA France Nalco Chemical Co. Water treatment 

compounds, lubricants, 

chemicals

4.1

ACE Ltd. Bermuda U.S. and international property and 

casualty units of CIGNA Corp.

Insurance 3.5

Quebecor Printing Inc. Canada World Color Press Inc. Printing services 2.9

Fortis AG Belgium American Bankers Insurance Group 

Inc.

Insurance 2.8

Verengigd Bezit VNU Netherlands Nielsen Media Research Inc. TV audience 

measurement services

2.8

Koninklijke Numico NV Netherlands General Nutrition Cos. Vitamin and nutrition 

supplement stores

2.5

Buhrmann NV Netherlands Corporate Express Inc. Office supplies 2.3

General Electric Co. PLC United Kingdom Reltec Corp. Telcommunication 

systems

2.1

Stagecoach Holdings PLC United Kingdom Coach USA Inc. Motorcoach sightseeing 

services

1.8

Alcatel SA France Xylan Corp. High-bandwidth 

switching systems

1.8

News Corp Ltd. Australia Remaining 50% of Fox/Liberty 

Networks

Sports TV network 1.8

125
Acquirer Domicile of

Aquirer

Target Target

Industry

Price 

($ Billions)

Kensington Acquisition Sub Inc. Italy and Germany joint 

venture

Cellular Communications 

International

Cellular communication 

services

1.7

Atlas Copco AB Sweden Rental Service Corp. Equipment rental services 1.6

EMAP PLC United Kingdom Petersen Cos. Magazine publishing 1.5

Accor SA France Red Roofs Inns. Inc. Hotels 1.1

Dyckerhoff AG Germany Lone Star Industries Inc. Cement 1.1

Thyssen AG Germany Elevator business of Dover Corp. Elevators 1.1

126
Table 10 –Top 25 U.S. Acquisition of Foreign Companies – 1999

Acquirer Target Domicile of

Aquirer

Target

Industry

Price

($ Billions)

Wal-Mart Stores Inc. ASDA Group PLC United Kingdom General-merchandise 

retailing

$10.8

TRW Inc. LucasVarity PLC United Kingdom Engineering services; 

motor vehicle equipment

6.8

General Electric Co. Japan Leasing Corp. Ltd. Japan Business credit services 6.6

Ford Motor Co. Worldwide passenger vehicle 

business of Volvo AB

Sweden Automobiles, trucks, and 

parts

6.5

Texas Pacific Group Inc. U.K. retailing business of Allied 

Domecq PLC 

United Kingdom Pubs 4.3

Ameritech Corp. 20% of Bell Canada Canada Telecommunications 3.4

Uniphase Corp. JDS Fitel Inc. Canada Fiber-optic connectors 

polishing machinery

3.1

AES Corp. National Power Drax Ltd. unit of 

National Power PLC

United Kingdom Electricity generation 3.0

Huntsman Corp. Polyurethane, titanium dioxide, and 

selected petrochemical businesses of 

Imperial Chemical Industries PLC 

United Kingdom Industrial organic 

chemicals

2.85

CIT Group Inc. Newcourt Credit Group Inc. Canada Equipment financing and 

leasing services

2.7

Burlington Resources Inc. Poco Petroleums Ltd. Canada Oil and gas 2.5

US West Inc. 9.02% of Global Crossing Ltd. Bermuda Internet and 

telecommunication services

2.5

Weyerhaeuser Co. MacMillan Bloedel Ltd. Canada Paper, pulp products; 

freight transportation 

services

2.3

Edison International Corp. Two power stations of PowerGen 

PLC

United Kingdom Electricity-generating 

power stations

2.1

Du Pont Co. Herberts Paints GmbH unit of 

Hoechst AG 

Germany Automobile paints; 

chemical preparations

1.9

NTL Inc. Diamond Cable Communications United Kingdom Cable TV services 1.9

Electronic Data Systems Corp. MCI Systemhouse Inc. unit of MCI 

WorldCom Inc.

Canada Computer systems 1.7

Ford Motor Co. Kwik-Fit Holdings PLC United Kingdom Auto parts and repair shops 1.6

Gannett Co. Inc. Newsquest PLC United Kingdom Publish newspapers 1.4

Principal Financial Group BT Funds Management, BT Australia Investment banking 1.4

127
Acquirer Target Domicile of

Aquirer

Target

Industry

Price

($ Billions)

Portfolio Services, BT Margin 

Lending, and BT Investment 

Banking Business units of Deutsche 

Bank AG

services

Energy Partnership Group Ikon Energy/Multinet Gas Australia Natural gas distribution 1.3

Tyco International Inc. Siemens Electromechanical 

Components AG unit of Siemens 

AG

Germany Relays and 

electromechanical 

components

1.1

Global TeleSystems Group Inc. Esprit Telecom Group PLC United Kingdom Telcommunications 0.9

General Electric Co. Heavy-duty gas turbine business of 

Alstom SA

Netherlands Gas turbines 0.9

General Motors Corp. Arriva Automotive Solutions unit of 

Arriva PLC

United Kingdom Vehicle leasing; fleet 

management

0.8

128
129

APPENDIX

DATA ON U.S. FEDERAL TAX REVENUE AND U.S. INTERNATIONAL 

TRANSACTIONS

Appendix Table 1 – Federal Tax Receipts by Source, 1940-2001

(Billions of Nominal Dollars)

Fiscal

Year

Individual

Income Tax

Receipts

Total Payroll 

and SelfEmployment

Tax Receipts

Corporate

Income Tax

Receipts

Excise

Tax

Receipts

Estate & Gift

Tax

Receipts

2001 994.3 693 151.1 66.1 28.4

2000 1,004.5 653 207.3 68.9 20.0

1999 879.5 612 184.7 70.4 27.8

1998 828.6 572 188.7 57.7 24.1

1997 737.5 539 182.3 56.9 19.8

1996 656.4 509 171.8 54.0 17.2

1995 590.2 484 157.0 57.5 14.8

1994 543.1 461 140.4 55.2 15.2

1993 509.7 428 117.5 48.1 12.6

1992 476.0 414 100.3 45.6 11.1

1991 467.8 396 98.1 42.4 11.1

1990 466.9 380 93.5 35.3 11.5

1989 445.7 359 103.3 34.4 8.7

1988 401.2 334 94.5 35.2 7.6

1987 392.6 303 83.9 32.5 7.5

1986 349.0 284 63.1 32.9 7.0

1985 334.5 265 61.3 36.0 6.4

1984 298.4 239 56.9 37.4 6.0

1983 288.9 209 37.0 35.3 6.1

1982 297.7 201 49.2 36.3 8.0

1981 285.9 183 61.1 40.8 6.8

1980 244.1 158 64.6 24.3 6.4

1979 217.8 139 65.7 18.7 5.4

1978 181.0 121 60.0 18.4 5.3

1977 157.6 106 54.9 17.5 7.3

1976 131.6 91 41.4 17.0 5.2

1975 122.4 85 40.6 16.6 4.6

1974 119.0 75 38.6 16.8 5.0

1973 103.2 63 36.2 16.3 4.9

1972 94.7 53 32.2 15.5 5.4

1971 86.2 47 26.8 16.6 3.7

1970 90.4 44 32.8 15.7 3.6

1969 87.2 39 36.7 15.2 3.5

1968 68.7 34 28.7 14.1 3.1

1967 61.5 33 34.0 13.7 3.0

1966 55.4 26 30.1 13.1 3.1

1965 48.8 22 25.5 14.6 2.7

1964 48.7 22 23.5 13.7 2.4

1963 47.6 20 21.6 13.2 2.2

1962 45.6 17 20.5 12.5 2.0
130

Fiscal

Year

Individual

Income Tax

Receipts

Total Payroll 

and SelfEmployment

Tax Receipts

Corporate

Income Tax

Receipts

Excise

Tax

Receipts

Estate & Gift

Tax

Receipts

1961 41.3 16 21.0 11.9 1.9

1960 40.7 15 21.5 11.7 1.6

1959 36.7 12 17.3 10.6 1.3

1958 34.7 11 20.1 10.6 1.4

1957 35.6 10 21.2 10.5 1.4

1956 32.2 9 20.9 9.9 1.2

1955 28.7 8 17.9 9.1 0.9

1954 29.5 7 21.1 9.9 0.9

1953 29.8 7 21.2 9.9 0.9

1952 27.9 6 21.2 8.9 0.8

1951 21.6 6 14.1 8.6 0.7

1950 15.8 4 10.4 7.6 0.7

1949 15.6 4 11.2 7.5 0.8

1948 19.3 4 9.7 7.4 0.9

1947 17.9 3 8.6 7.2 0.8

1946 16.1 3 11.9 7.0 0.7

1945 18.4 3 16.0 6.3 0.6

1944 19.7 3 14.8 4.8 0.5

1943 6.5 3 9.6 4.1 0.4

1942 3.3 2 4.7 3.4 0.4

1941 1.3 2 2.1 2.6 0.4

1940 0.9 2 1.2 2.0 0.4

Source: Office of Management and Budget, Historical Tables, Budget of the United States Government, Fiscal Year 

2003.
Appendix Table 2 – U.S. International Transactions, 1960-2001

($ millions of nominal dollars)

Year

Exports

of Goods

Services

and

Income

Receipts

Merchandise

Adjusted

Excluding

Military Services

Income

Receipts

on U.S.

Assets

Abroad

Imports of

Goods

Services

and

Income

Payments

Merchandise

Adjusted

Excluding

Military Services

Income

Payments

on Foreign

Assets in

the U.S.

Unilateral

Transfers

Net

1960 30,556 19,650 6,290 4,616 23,670 14,758 7,674 1,238 4,062 

1961 31,402 20,108 6,295 4,999 23,453 14,537 7,671 1,245 4,127 

1962 33,340 20,781 6,941 5,618 25,676 16,260 8,092 1,324 4,277 

1963 35,776 22,272 7,348 6,157 26,970 17,048 8,362 1,560 4,392 

1964 40,165 25,501 7,840 6,824 29,102 18,700 8,619 1,783 4,240 

1965 42,722 26,461 8,824 7,437 32,708 21,510 9,111 2,088 4,583 

1966 46,454 29,310 9,616 7,528 38,468 25,493 10,494 2,481 4,955 

1967 49,353 30,666 10,667 8,021 41,476 26,866 11,863 2,747 5,294 

1968 54,911 33,626 11,917 9,367 48,671 32,991 12,302 3,378 5,629 

1969 60,132 36,414 12,806 10,913 53,998 35,807 13,322 4,869 5,735 

1970 68,387 42,469 14,171 11,748 59,901 39,866 14,520 5,515 6,156 

1971 72,384 43,319 16,358 12,707 66,414 45,579 15,400 5,435 7,402 

1972 81,986 49,381 17,841 14,765 79,237 55,797 16,868 6,572 8,544 

1973 113,050 71,410 19,832 21,808 98,997 70,499 18,843 9,655 6,913 

1974 148,484 98,306 22,591 27,587 137,274 103,811 21,379 12,084 9,249 

1975 157,936 107,088 25,497 25,351 132,745 98,185 21,996 12,564 7,075 

1976 172,090 114,745 27,971 29,375 162,109 124,228 24,570 13,311 5,686 

1977 184,655 120,816 31,485 32,354 193,764 151,907 27,640 14,217 5,226 

1978 220,516 142,075 36,353 42,088 229,870 176,002 32,189 21,680 5,788 

1979 287,965 184,439 39,692 63,834 281,657 212,007 36,689 32,961 6,593 

1980 344,440 224,250 47,584 72,606 333,774 249,750 41,491 42,532 8,349 

1981 380,928 237,044 57,354 86,529 364,196 265,067 45,503 53,626 11,702 

1982 366,983 211,157 64,079 91,747 355,975 247,642 51,749 56,583 16,544 

1983 356,106 201,799 64,307 90,000 377,488 268,901 54,973 53,614 17,310 

1984 399,913 219,926 71,168 108,819 473,923 332,418 67,748 73,756 20,335 

1985 387,612 215,915 73,155 98,542 483,769 338,088 72,862 72,819 21,998 

1986 407,098 223,344 86,689 97,064 530,142 368,425 80,147 81,571 24,132 

1987 457,053 250,208 98,661 108,184 594,443 409,765 90,787 93,891 23,265 

1988 567,862 320,230 110,919 136,713 663,741 447,189 98,526 118,026 25,274 

1989 648,290 359,916 127,087 161,287 721,607 477,665 02,479 141,463 26,169 

131
Year

Exports

of Goods

Services

and

Income

Receipts

Merchandise

Adjusted

Excluding

Military Services

Income

Receipts

on U.S.

Assets

Abroad

Imports of

Goods

Services

and

Income

Payments

Merchandise

Adjusted

Excluding

Military Services

Income

Payments

on Foreign

Assets in

the U.S.

Unilateral

Transfers

Net

1990 706,975 387,401 147,832 171,742 759,287 498,435 17,659 143,192 26,654 

1991 727,557 414,083 164,261 149,214 734,563 491,020 18,459 125,084 -10,752 

1992 748,603 439,631 176,916 132,056 762,105 536,528 16,476 109,101 35,013 

1993 777,044 456,943 185,941 134,159 821,930 589,394 122,281 110,255 37,637 

1994 869,328 502,859 201,031 165,438 949,312 668,690 131,878 148,744 38,260 

1995 1,005,935 575,204 219,229 211,502 1,081,776 749,374 141,447 190,955 34,057 

1996 1,077,966 612,113 240,007 225,846 1,158,822 803,113 150,850 204,859 40,081 

1997 1,195,538 678,366 256,614 260,558 1,294,553 876,485 166,260 251,808 40,794 

1998 1,191,932 670,416 262,278 259,238 1,364,962 917,112 182,410 265,440 44,427 

1999 1,242,655 684,553 272,800 285,302 1,518,106 1,029,987 189,204 298,915 48,913 

2000 1,418,568 772,210 293,492 352,866 1,809,099 1,224,417 217,024 367,658 54,136 

2001 1,298,397 720,831 283,758 293,808 1,665,325 1,147,446 204,953 312,926 50,501 

Source: U. S. Department of Commerce, Bureau of Economic Analysis, May 2001, and U.S. Department of Commerce, news release, "U.S. International Transactions: 

Fourth Quarter and Year 2001," March 14, 2002.

Note: Dollar figures in millions of current year dollars. Figures for 2001 are preliminary.

132
133

Appendix Table 3 – U.S. Gross Domestic Product, Gross Saving, Gross Investment,

and Net Foreign Investment, 1960-2000

(billions of nominal dollars)

Gross Net foreign

Year GDP Gross Saving Investment investment

1960 527.4 110.9 110.4 3.2

1961 545.7 113.9 113.8 4.3

1962 586.5 124.6 125.3 3.9

1963 618.7 132.8 132.4 5.0

1964 664.4 143.0 144.2 7.5

1965 720.1 158.1 160.0 6.2

1966 789.3 169.1 175.6 3.9

1967 834.1 171.1 175.9 3.5

1968 911.5 183.3 187.6 1.7

1969 985.3 199.8 202.7 1.8

1970 1,039.7 194.3 201.2 4.0

1971 1,128.6 211.4 222.7 0.6

1972 1,240.4 241.6 250.3 -3.6

1973 1,385.5 294.6 302.6 8.7

1974 1,501.0 304.0 314.0 7.1

1975 1,635.2 298.4 316.1 21.4

1976 1,823.9 342.7 367.2 8.9

1977 2,031.4 398.2 419.8 -9

1978 2,295.9 481.6 502.6 -10.4

1979 2,566.4 544.9 580.6 1.4

1980 2,795.6 555.5 589.5 11.4

1981 3,131.3 666.5 684.0 6.3

1982 3,259.2 625.7 628.2 -0.2

1983 3,534.9 608.0 655.0 -32.0

1984 3,932.7 769.4 787.9 -87.0

1985 4,213.0 772.5 784.2 -110.9

1986 4,452.9 735.9 779.8 -140.6

1987 4,742.5 810.4 813.8 -152.0

1988 5,108.3 936.2 894.0 -113.2

1989 5,489.1 967.6 983.9 -86.7

1990 5,803.2 977.7 1008.2 -69.2

1991 5,986.2 1015.8 1035.4 14.9

1992 6,318.9 1007.4 1051.1 -38.7

1993 6,642.3 1039.4 1103.2 -72.9

1994 7,054.3 1155.9 1214.4 -108.3

1995 7,400.5 1257.5 1284.0 -98.0

1996 7,813.2 1349.3 1382.1 -110.7

1997 8,318.4 1502.3 1532.1 -123.1

1998 8,790.2 1654.4 1629.6 -199.1

1999 9,299.2 1717.6 1645.6 -313.2

2000 9,963.1 1825.1 1741.3 -427.9

Source: U.S. Department of Commerce, Bureau of Economic Analysis.
134

Appendix Table 4 – Increase in U.S. Assets Abroad and

Foreign Assets in the United States, 1960-2001

(millions of nominal dollars)

Year

Increase in U.S.

Assets Abroad

Increase in Foreign

Assets in U.S.

1960 4,099 2,294 

1961 5,538 2,705 

1962 4,174 1,911 

1963 7,270 3,217 

1964 9,560 3,643 

1965 5,716 742 

1966 7,321 3,661 

1967 9,757 7,379 

1968 10,977 9,928 

1969 11,585 12,702 

1970 8,470 6,359 

1971 11,758 22,970 

1972 13,787 21,461 

1973 22,874 18,388

1974 34,745 35,341 

1975 39,703 17,170 

1976 51,269 38,018 

1977 34,785 53,219 

1978 61,130 67,036 

1979 64,915 40,852 

1980 85,815 62,612 

1981 113,054 86,232 

1982 127,882 96,589 

1983 66,373 88,694 

1984 40,376 117,752 

1985 44,752 146,115 

1986 111,723 230,009 

1987 79,296 248,634 

1988 106,573 246,522 

1989 175,383 224,928 

1990 81,234 141,571 

1991 64,388 110,808 

1992 74,410 170,663 

1993 200,552 282,040 

1994 176,056 305,989 

1995 352,376 465,684 

1996 413,923 586,038 

1997 487,599 759,290 

1998 359,632 504,464 

1999 437,067 813,744 

2000 580,952 1,024,218 

2001 439,563 895,459 

Source: U.S. Department of Commerce, Bureau of Economic Analysis.

Note: Data for 2001 are preliminary.
135

Appendix Table 5 – Selected Nongovernmental Foreign Holdings

of U.S. Assets, Both Portfolio and Direct Investment, 1982-2000

(billions of nominal dollars)

Year

U.S.

Treasury

Securities

Corporate

and Other

Bonds

Corporate

Equity

Direct

Investment

1982 25,758 16,709 76,279 184,842 

1984 62,121 32,421 96,056 223,538 

1986 96,078 140,863 168,940 284,701 

1988 100,877 191,314 200,978 401,766 

1990 152,452 238,903 221,741 505,346 

1992 197,739 299,287 300,160 540,270 

1994 235,684 368,077 371,618 617,982 

1996 502,562 588,044 611,417 745,619 

1998 729,738 902,153 1,110,276 912,187 

2000 639,684 1,374,259 1,589,714 1,369,505

Source: Harlan W. King, "The International Investment Position of the United States at Year end 2000,

"Survey of Current Business, 81, July 2001, pp. 7-29.

Note: Direct investment at current cost.
136

Appendix Table 6 – Selected United States Holdings of Foreign Assets,

Both Portfolio and Direct Investment, 1982-2000

(billions of nominal dollars)

Year

Foreign

Corporate

Bonds

Foreign

Corporate

Equity

Direct

Investment

1982 56,604 17,442 374,059 

1984 62,810 25,994 348,342 

1986 85,724 72,399 404,818 

1988 104,187 128,662 513,761 

1990 144,717 197,596 616,655 

1992 200,817 314,266 663,830 

1994 321,208 627,460 786,565 

1996 465,057 1,002,928 989,810 

1998 576,745 1,476,184 1,196,765 

2000 577,694 1,828,810 1,445,177

Source: Harlan W. King, "The International Investment Position of the United States

at Yearend 2000," Survey of Current Business, 81, July 2001, pp. 7-29.

Note: Direct investment at current cost.
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Appendix Table 7 – Cross Border Mergers and Acquisitions, 1991-2000

Foreign Acquisitions of United States Acquisitions

U.S. Companies of Foreign Companies

Year

Number of 

Transactions

Dollar Value 

(billions)

Number of 

Transactions

Dollar Value 

(billions)

1991 539 $30.8 482 15.3

1992 406 16.1 548 15.6

1993 394 21.0 635 18.2

1994 513 48.2 762 23.4

1995 634 55.2 1,032 46.8

1996 684 79.7 1,160 62.0

1997 837 80.9 1,401 79.8

1998 982 234.0 1,688 119.7

1999 1,151 266.5 1,617 153.8

2000 1,196 340.0 1,502 135.2

Source: Mergers and Acquisitions Almanac, February 2001, p.37.
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139

GLOSSARY

Anti-deferral regimes - special sets of rules (such as the subpart F regime) that act as 

exceptions to the general rule permitting deferral of tax on income earned through a foreign 

corporation. Such special rules generally tax residents of a country on their share of certain 

types of passive or mobile income earned through the foreign corporation.

Balance of payments - balance of payments accounts are analogous to a sources and 

uses of funds statement of the United States with the rest of the world. They consist of the 

current account balance, the capital account balance, and the financial account balance. 

Business transfer tax (or subtraction-method VAT) - a form of consumption tax in 

which a statutory tax rate is applied to the difference between an enterprise’s taxable sales and its 

purchases of taxable goods and services from other enterprises.

Capital account - a component of the national income and product accounts, the capital 

account consists of capital transfers and the acquisition and disposal of non-produced, nonfinancial assets. For example, the newly defined capital account includes such transactions as 

forgiveness of foreign debt, migrants’ transfers of goods and financial assets when entering or 

leaving the country, transfers of title to fixed assets, and the acquisition and disposal of nonproduced assets such as natural resource rights, patents, copyrights, and leases.

Capital expenditure - an amount paid for permanent improvements or betterments that 

have a value to the purchaser substantially beyond the taxable year (e.g., a cost to substantially 

prolong the useful life of property). The cost of a capital expenditure is deducted over a period 

of years. 

Capital export neutrality - an economic theory that posits that income earned by a 

resident of a country should be taxed at the same rate, whether earned locally or abroad, in order 

to promote the policy that investment location decisions should be based on business rather than 

tax considerations.

Capital import neutrality - an economic theory that posits that all income earned within 

a particular country should be taxed at the same rate, regardless of the residence of the investor, 

in order to promote the ability of different investors to compete with each other.

Cascading - a consequence of providing certain exclusions from a consumption tax base 

in which the statutory exemption of a particular transaction in the production and distribution 

process results in the imposition of multiple layers of tax with respect to the total final purchase 

price. Cascading violates the fundamental VAT principle that the cumulative amount of tax paid 

with respect to a good or service at all levels of production and distribution should equal the 

sales price of the good or service to the ultima te consumer multiplied by the statutory VAT rate.

Classical income tax - an income tax in which corporate earnings are taxed twice: first to 

the corporation when it earns income, and second to the corporation’s shareholders when they 

receive dividends or sell their shares.
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Consumption tax - a generic description for a system that taxes purchases of goods and 

services by consumers rather than taxing income.

Controlled foreign corporation - a foreign corporation controlled by residents of a 

particular country (for U.S. tax purposes, more than 50 percent (by vote or value) of the foreign 

corporation must be owned by U.S. 10-percent shareholders).

Corporate expatriation - the ability of corporations to move their country of residence 

to another country (through mergers or acquisitions with another company or through other 

means), often to take advantage of more beneficial tax rules provided in the other country (see 

also “Inversion Transaction”).

Credit-invoice value added tax - a form of consumption tax in which a statutory tax rate 

is applied to gross sales with credits provided for taxes previously paid on gross purchases.

Cross-validation - a compliance feature of some (but not all) consumption tax systems in 

which the proper amount of tax liability at a particular point in the production and distribution 

process can be verified by reference to the amount of tax already paid at earlier stages in the 

process.

Current account - a component of the national income and product accounts, the current 

account measures the trade surplus or deficit; the current account measures the value of imported 

goods and services, the value of exported goods and services, payments made to foreign persons 

as a return on their investment in assets located in the United States, and payments made to U.S. 

persons by foreign persons as a return on U.S. investment in assets located abroad.

Deferral - the ability of a resident of a country to earn income through a foreign 

corporation and defer paying tax to the residence country until the earnings are repatriated in the 

form of a dividend.

Destination principle - a consumption tax principle pursuant to which imports are taxed 

and exports are exempt from tax through border tax adjustments, on the premise that goods and 

services should be taxed where they are consumed.

Direct investment - investment is labeled a “direct investment” when a single person 

owns or controls, directly or indirectly, at least 10 percent of the voting securities of a corporate 

enterprise or the equivalent interests in an unincorporated business.

Dividend exclusion - one type of integration method to reduce or eliminate double 

taxation of corporate earnings. Under this method, a shareholder simply excludes from gross 

income dividends received from a corporation.

Domestic corporation - a corporation that is incorporated within the United States.

Domestic international sales corporation (“DISC”) - a regime that was a predecessor 

to the foreign sales corporation regime and that provided deferral from U.S. tax for certain export 

transactions. The regime was thought to violate trade rules under the General Agreement on 

Tariffs and Trade.
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Domestic-source income - income that a taxpayer earns or is treated as earning for 

purposes of a country’s tax laws within such country’s borders. For U.S. tax purposes, it is 

income earned or treated as earned within the United States.

Economic depreciation - the actual decline in the value of a capital expenditure over a 

specified period of time taking into account all relevant factors.

Economic incidence of tax - the financial burden of a tax as determined by changes in 

market price, wages, and rates of return on investment. For example, although the statutory 

incidence of a retail sales tax requires actual collection and payment of the tax by retailers, retail 

customers may actually bear the economic incidence of tax to the extent that retailers can pass 

the tax that they collect on to customers by increasing prices without losing sales.

Extraterritorial income exclusion (“ETI”) - an exclusion from U.S. tax for certain 

foreign-source sales income. The exclusion was recently held to violate WTO rules.

Financial account - a component of the national income and product accounts, the 

financial account measures U.S. investment abroad and foreign investment in the United States.

Foreign corporation - a corporation that is incorporated outside the United States.

Foreign direct investment - ownership or control, directly or indirectly, by a single 

foreign person of at least 10 percent of the voting securities or equivalent interests of a business 

or assets located in the United States.

Foreign sales corporation (“FSC”) - a regime that provided certain exemptions from 

U.S. tax for export transactions derived through a foreign corporation. The WTO ruled that the 

regime violated WTO rules.

Foreign-source income - income that a taxpayer earns or is treated as earning for 

purposes of a country’s tax laws outside such country’s borders. For U.S. tax purposes, it is 

income earned or treated as earned outside the United States.

Foreign tax credit - a method employed by many countries to mitigate the possibility of 

double taxation of foreign-source income through the allowance of a credit against taxes 

imposed by one country for foreign taxes paid to another country.

Foreign tax credit limitation - a limitation on the amount of foreign tax credits allowed 

by a country to preserve the taxation of income earned within its borders.

Gross Domestic Product (“GDP”) - the value of all final goods and services produced

within a country.

Gross National Product (“GNP”) - GNP is GDP plus the net factor income received by 

residents of the United States from abroad. For example, wages earned by a U.S. resident from 

temporary work abroad constitutes part of GNP but not GDP. Similarly, the returns from 

investment abroad constitute part of GNP but not GDP.
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Imputation credit - one type of integration method to reduce or eliminate double 

taxation of corporate earnings. Under this method, shareholders of a corporation that receive 

dividends are entitled to a credit for corporate taxes paid with respect to the dividend.

Integration - an income tax system that significantly reduces or eliminates double 

taxation of corporate earnings.

Intra-firm trade - trade between related parties. For example, a domestic company 

might ship components manufactured in the United States to its foreign subsidiary for final 

assembly and sale. Such shipments would be counted as exports from the United States. A 

domestic company might produce components abroad and ship them to the United States for 

final assembly and sale. Such shipments would be counted as imports to the United States.

Inversion transaction - a transaction in which a U.S. corporation effectively 

reincorporates as a foreign corporation, perhaps in a tax haven, in part to remove its foreign 

operations from U.S. taxing jurisdiction. 

Merchandise trade - imports and exports of goods.

Origin principle - a consumption tax principle pursuant to which domestic production of 

goods and services is taxed and imported goods are exempt from tax, on the premise that goods 

and services should be taxed where they are produced.

Participation exemption systems - a feature of some countries’ tax systems in which 

dividends received by a resident company from certain foreign subsidiaries are exempt (either 

partially or fully) from tax in the residence country.

Portfolio investment - portfolio investment consists mostly of holdings of corporate 

equities, corporate and government bonds, and bank deposits. The portfolio investor generally 

does not have control over the assets that underlie the financial claims.

Retail sales tax - a form of consumption tax in which a statutory tax rate is applied to 

retail sales (i.e., sales to end-use consumers) of taxable goods and services.

Statutory exemption - a means of providing an exclusion from the tax base of a 

consumption tax whereby a sale is exempt from the imposition of tax.

Statutory incidence of tax - the legal burden to collect and remit tax. For example, the 

statutory incidence of a retail sales tax requires actual collection and payment of the tax by 

retailers, who may not necessarily bear the economic incidence of the tax if they can pass the tax 

on to customers by increasing prices without losing sales.

Subpart F- a U.S. anti-deferral regime in which U.S. 10-percent shareholders of a 

controlled foreign corporation are currently taxed on certain mobile or passive income earned by 

the foreign corporation.
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Subtraction method value added tax - a form of consump tion tax in which a statutory 

tax rate is applied to the difference between an enterprise’s taxable sales and its purchases of 

taxable goods and services from other enterprises, also referred to as a business transfer tax. 

Territorial tax system- a tax system in which a country taxes only income derived 

within its borders, irrespective of the residence of the taxpayer.

Transfer pricing rules - rules established to ensure that transactions between commonly 

controlled entities are based on arm’s-length terms.

Value added tax (“VAT”) - a form of consumption tax (using either the credit-invoice 

method or the subtraction method) in which tax is imposed and collected on the “value-added” at 

every stage in the production and distribution process of a good or service.

World Trade Organization (“WTO”) - a multilateral body based in Geneva that 

oversees international trade.

Worldwide tax system- a tax system in which a country taxes its citizens or resident 

individuals and entities on their worldwide income.

Zero-rating - a means of providing an exclusion from the tax base of a consumption tax 

whereby a sale is considered to be taxable, but the statutory rate of tax is zero percent.