The Overall Vs. the Per-Country Limitation on 

the U.S. Foreign Tax Credit 

Thomas Horst 

Comment 

George F. Kopits 
The Overall Vs. the Per-Country Limitation on 

the U.S. Foreign Tax Credit 

Thomas Horst 

The corporate income· tax introduced in 1913 was based on total 

income from domestic and foreign sources; while foreign income 

taxes could be deducted from U.S. taxable income, foreign-source 

income was initially subject to international double taxation. In 

1918 Congress allowed taxpayers to credit foreign income taxes 

against their U.S. tax liability to alleviate the double taxation, 

and shortly thereafter subjected the foreign tax credit to a limitation to assure that foreign taxes could not be used to reduce 

U.S. taxes on domestic income. 

The nature of this limitation has been altered on numerous occasions over the last 60 years. From 1954 to 1961, for example, 

corporations were required to calculate a separate limitation for 

foreign taxes paid in each country from which they derived income. Then, in 1961, they could elect a single, overall limitation on 

their creditable taxes from all foreign countries. Under the overall method, excess taxes from high-tax countries 1 could offset the 

1 A "high-tax" country, according to our use of the term, is one whose income, withholding, and other creditable taxes are larger than the tentative 

U.S. taxes on that income and, thus, one generating excess tax credits. A 

"low-tax" country is one for which the opposite is true. Because of the intricacies of foreign and U.S. tax laws, a specific country (e.g., the United 

THOMAS HORST is with the Fletcher School of Law and Diplomacy. The 

research reported herein was sponsored by the Office of International Tax 

Affairs of the U.S. Department of the Treasury, which endorses neither the 

methods nor the findings of this analysis. The author is indebted to Thomas 

Pugel for his assistance in developing the simulation model and writing the 

computer program used in its implementation. 

(213) 
---- - - -

214 COMPENDIUM OF TAX RESEARCH 

U.S. tax liability on income from low.;.tax countries. The percountry method was preferred by only those investors with large 

branch losses in certain countries and taxable income in others 

(e.g., a petroleum company with substantial drilling and ex-

- plolJ).tion expenses in areas of new production and income from 

marketing and shipping operations elsewhere.) 2 With the Tax 

Reduction Act of 1975, corporations had to use the overall method 

in computing their foreign tax credit for petroleum-related income; the Tax Reform Act of 1976 made the overall method mandatory for all foreign-source income. 

In addition to reducing corporations' ability to write off foreign 

branch losses against domesti~ income, the overall method is ·considerably easier to administer than the per-country method. 

Tran sf er prices for transactions among the foreign affiliates of 

a U.S. investor tend to have a larger impact on the foreign tax 

credit under the per-country method than under the overall 

method. When the overall 'method is usecl.t_ close adherence to· an 

"arm's length" standard is less important, and the accounting requirements on U.S. investors and the auditing demands on the 

Internal Revenue Service are eased. 

From a public policy standpoint, however, the overall method 

may have certain undesirable side effects. When corporations have 

an overall deficit of tax credits ( i.e., creditable foreign taxes are 

less than the overall limitation), foreign countries can increase 

their taxes on U.S. investors and know that some or all of the 

increase will be passed on to the U.S. Treasury. Conversely, when 

corporations have an overall surplus t>f foreign tax credits, foreign countries can attract U.S. investment with low tax rates, 

liberal depreciation allowances, tax holidays, and other such income tax incentives. The U.S. investor, after paying the minimal 

foreign taxes, can repatriate all its income to the United States 

Kingdom) may be a high-tax country for one U.S. investor and a low-tax 

country for another. 2 A corporation using the per-country method could deduct foreign branch 

losses from domestic U.S. income and thereby relieve its domestic U.S. taxes 

by 48 percent of the loss and still claim a foreign tax credit subject to the 

per-country limitation for taxes paid or deemed paid elsewhere. If the corporation elected the overall method, however, all foreign losses would have to 

be deducted from foreign income, which would reduce the overall limitation 

on the foreign tax credit. Thus, the total foreign tax credit could be higher 

under the per-country method than under the overall method. 
U.S. FOREIGN TAX CREDIT 215 

without paying any additional U.S. taxes: iU; excess tax credits 

will shelter such income from U.S. taxation. New investment patterns may reflect tax savings and not just the underlying economic 

returns. Countries may be tempted to use tax policy to compete 

with one another for a larger share of international investment to 

the mutual disadvantage of all. Under the per-country method, 

ho:wever, U.S. taxes on foreign investment income can be deferred 

only as long as earnings are retained overseas, so the significance 

of foreign tax concessions to U.S. investors is diminished. 

Analysis 

How important is the difference between the overall and the 

per-country method? What would happen if the United States 

Were to require corporations to use the per-country method? In 

theory, the difference could be substantial. If creditable foreign 

taxes in high-tax countries are considerably larger than the U.S. 

taxes tentatively due on that income, while those in lorw-tax countries are significantly less, the· spillover of excess tax credits from 

the former to the latter could be substantial. 

While individual U.S. investors may find themselves in extreme 

Positions, the available statistics on foreign income and withholding tax rates suggest the difference between high- and low-tax 

countries is often small. Column (a) of table 1 shows the "realized" income tax rate for U.S. manufacturing subsidiaries in 

various foreign countries in 197 4. 3 In determining the portion of 

foreign income taxes creditable against their U.S. tax liability, 

corporations must recompute their subsidiaries' earnings using 

U.S. Internal Revenue Service accounting concepts and definitions, 

and the realized tax rate .is the average ratio of subsidiaries' foreign income taxes to those earnings. Column (b) indicates the 

withholding tax rates applied to dividends paid to U.S. investors 

in 197 4. For example, if a typical Canadian manufacturing subsidiary earned $100 (using the IRS definitions), it would have paid 

Canadian income taxes of $41.10. If it then distributed one-half 

of its after-tax earnings of $58.90, it would have to pay 15 percent of its $29.45 dividend, or $4.42, in Canadian withholding 

taxes. The U.S. parent's net dividend would be $25.03, and total 

• 

3 The realized tax rates we·re originally computed by M. E. Kyrouz, "Foreign Tax Rates and Tax Bases," National Tax Journal, 28 :1 (March 1975), 

pp. 61-80 and were updated in the U.S. Deparbnent of the Treasury, U.S. 

Taxation of the Undistributed Income of Controlled Foreign Corporations, 

April 1976, pp. 39-41. 
TABLE 1.-A verage foreign and U.S. taxes on subsidiary earnings in various countries under the overall and the per-country 

limitation on the foreign tax credit, 1974 

Canada 

Austria 

Belgium 

Denmark 

France 

Germany 

Greece 

Ireland 

Country 

Italy 

Luxembourg 

Netherlands 

Norway 

Spain 

Sweden 

Switzerland 

41.1 

53.4 

37.5 

32.5 

48.0 

43.0 

11.9 

12.7 

41.9 

17.1 

36.0 

40.5 

30.3 

43.1 

27.1 

15.0 

5.0 

15.0 

5.0 

5.0 

15.0 

30.0 

5.0 

5.0 

5.0 

10.0 

15.0 

15.0 

5.0 

5.0 

49.9 

55.7 

46.9 

35.9 

50.6 

51.5 

38.3 

17.1 

44.8 

21.2 

42.4 

49.4 

40.8 

45.9 

30.7 

1.9 

7.7 

-1.1 

-12.1 

2.6 

3.5 

-9.7 

-30.9 

-3.2 

-26.8 

-5.6 

1.4 

-7.2 

-2.1 

-17.3 

45.5 

54.6 

42.2 

.34.2 

49.3 

47.3 

25.1 

14.9 

43.4 

19.2 

39.2 

45.0 

35.5 

44.5 

28.9 

44.6 

50.7 

42.8 

40.3 

48.0 

45.5 

29.9 

30.3 

44.9 

32.6 

42.0 

44.3 

39.l 

45.6 

37.6 

45.5 

54.6 

42.8 

40.3 

49.3 

47.3 

29.9 

30.3 

44.9 

32.6 

42.0 

45.0 

39.1 

45.6 

37.6 

0.0 

0.0 

0.6 

6.1 

0.0 

0.0 

4.8 

15.5 

1.6 

13.4 

2.8 

0.0 

3.6 

1.0 

8.6 

1.0 

3.9 

0.0 

0.0 

1.3 

,1.8 

0.0 

0.0 

0.0 

0.0 

0.0 

0.7 

0.0 

0.0 

0.0 
United Kiingdom 44.6 15.0 52.9 4.9 48.8 46.3 48.8 0.0 2.5 

Australia 42.9 15.0 51.5 3.5 47.2 45.4 47.2 0.0 1.7 

New Zealand 51.7 5.0 54.1 6.1 52.9 49.8 52.9 0.0 3.1 

Mexico 42.2 20.0 53.8 5.8 48.0 45.1 48.0 0.0 2.9 

Argentina 28.2 12.0 36.8 -11.2 32.5 38.1 38.1 5.6 0.0 

Brazil 30.3 25.0 47.7 -0.3 39.0 39.1 39.1 0.1 0.0 

Chile 39.4 40.0 63.6 15.6 51.5 43.7 51.5 0.0 7.8 

Colombia 47.3 20.0 57.8 9.8 52.6 47.6 52.6 0.0 4.9 

Ecuador 18.7 40.0 51.2 3.2 35.0 33.3 35.0 0.0 1.6 

Peru 47.7 30.0 63.4 15.4 55.5 47.8 55.5 0.0 7.7 

Uruguay 25.2 25.0 43.9 -4.1 34.5 36.6 36.6 2.1 0.0 ~ 

ri Venezuela 30.0 15.0 40.5 -7.5 35.3 39.0 39.0 3.8 0.0 l:rj 

Costa Rica 33.7 15.0 43.6 -4.4 38.7 40.8 40.8 2.2 0.0 0 

El Salvador 7.6 38.0 42.7 -5.3 25.2 27.8 27.8 2.6 0.0 ~ Guatemala 21.0 10.0 28.9 -19.1 24.9 34.5 34.5 9.6 0.0 -

G') 

z 

Honduras 25.2 5.0 28.9 -19.1 27.1 36.6 36.6 9.5 0.0 i-3 

Nicaragua 1.8 0.0 1.8 -46.2 1.8 24.9 24.9 23.1 0,.0 > 

Panama 15.4 10.0 23.9 -24.1 19.6 31.7 31.7 12.1 0.0 ~ 

n Algeria 0.0 18.0 18.0 -30.0 9.0 24.0 24.0 15.0 0.0 ~ Morocco 54.5 25.0 65.9 17.9 60.2 51.3 60.2 0.0 8.9 t:1 

Liberia 5.7 15.0 19.8 -28.2 12.8 26.8 26.8 14.1 0.0 

-i-3 

Ethiopia 38.6 0.0 38.6 -9.4 38.6 43.3 43.3 4.7 0.0 

Kenya 19.0 12.5 29.1 -18.9 24.1 33.5 33.5 9.4 0.0 

Nigeria 4.7 15.0 19.0 -29.0 11.8 26.3 26.3 14.5 0.0 

Rhodesia 30.9 15.0 41.3 -6.7 36.1 39.4 39.4 3.4 0.0 

South Africa 41.9 15.0 50.6 2.6 46.3 44.9 46.3 0.0 1.3 

Zambia 28.0 15.0 38.8 -9.2 33.4 38.0 38.0 4.6 0.0 

Iran 10.5 60.0 64.2 16.2 37.3 29.3 37.3 0.0 8.1 

Israel 44.7 30.0 61.3 13.3 53.0 46.3 53.0 0.0 6.6 ~ 

Lebanon 15.1 10.0 23.6 -24.4 19.3 31.5 

·3i.5 12.2 0.0 ..... 

~ 
TABLE 1.-A11erage foreign and U.S. taxes on subsidiary earnings in various countries under tke overall and tke per-cowntry 

limitation on the foreign tax credit, 197 4-Continued 

Country 

Sri Lanka 

India 

Malaysia 

Pakistan 

Philippines 

Sina pore 

Taiwan 

Thailand 

Hong Kong 

Japan 

Indonesia 

Bahamas 

Bermuda 

Neth. Antilles 

Dominican Republic 

21.2 

57.0 

27.9 

52.6 

29.6 

29.6 

6.0 

14.9 

15.5 

47.4 

36.4 

5.1 

0.3 

4.5 

21.7 

39.3 

25.7 

40.0 

15.0 

35.0 

40.0 

10.0 

25.0 

0.0 

10.0 

20.0 

0.0 

0.0 

0.0 

18.0 

52.2 

68.1 

56.7 

59.7 

54.2 

57.8 

15.4 

36.2 

15.5 

52.7 

49.1 

5.1 

0.3 

4.5 

35.8 

4.2 

20.1 

8.7 

11.7 

6.2 

9.8 

-32.6 

-11.8 

-32.5 

4.7 

1.1 

-42.9 

-47.7 

-43.5 

-12.2 

36.7 

62.5 

42.3 

56.2 

41.9 

43.7 

10.7 

25.5 

15.5 

50.0 

42.8 

5.1 

0.3 

4.5 

28.7 

34.6 

52.5 

37.9 

50.3 

38.8 

38.8 

27.0 

31.4 

31.8 

47.7 

42.2 

26.5' 

24.1 

26.3 

34.8 

36.7 

62.5 

42.3 

56.2 

41.9 

43.7 

27.0 

31.4 

31.8 

50.0 

42.8 

26.5 

24.1 

26.3 

34.8 

0.0 

0.0 

0.0 

0.0 

0.0 

0.0 

16.3 

5.9 

16.3 

0.0 

0.0 

21.4 

23.8 

21.8 

6.1 

2.1 

10.0 

4.4 

5.9 

3.1 

4.9 

0.0 

0.0 

0.0 

2.3 

0.6 

0.0 

0.0 

0.0 

0.0 
Jamaica 

Puerto Rica 

't'rinidad & Tobago 

22.6 

12.2 

36.7 

37.5 

15.0 

10.0 

51.6 

25.4 

43.0 

3.6 

-22.6 

-5.0 

37.1 

18.8 

39.9 

35.3 

30.1 

42.3 

37.1 

30.1 

42.3 

0.0 

11.3 

2.5 

1.8 

0.0 

0.0 

Source: Realized corporate income tax rates and withholding tax rates were obtained .from: Department of the Treasury, U.S. Taxation of 

the Undistributed Income of Controlled Foreign Corporations, April 1976, table 3, rpp. 39-41. Other rates were derived using procedures summarized in table 2. 

*Rate assumes the subsidiary distributes one-half of its earnings net of foreign income taxes. 
220 COMPENDIUM OF TAX RESEARCH 

taxes paid to the Canadian government would amount to $45.52. 

(These calculations are summarized in table 2.) 

To determine its U.S. tax liability on its Canadian income, the 

U.S. investor would proceed as follows. First, the Canadian dividend would be grossed up to include that portion, 50 percent of its 

Canadian income tax that can be allocated to the dividend, so its 

Canadian-source income is $50.00 for U.S. tax purposes. Its 

creditable Canadian taxes equal 50 percent of its subsidiary's income taxes plus the entire withholding taxes; the sum of the two 

is $24.97. Its tentative U.S. tax liability on that income is 48 percent, the U.S. income tax rate, of the $50.00 grossed-up· dividend, 

or $24.00. Thus, it has a $.97 surplus tax credit. 

Under the overall method the investor goes on to determine 

whether its creditable foreign taxes from all countries exceeds or 

falls short of its tentative U.S. tax liability on all its foreignsource income. If it has an overall surplus of foreign tax credits 

(i.e., if total creditable foreign taxes exceed its tentative U.S. tax 

liability on its total foreign-source income), it pays no additional 

TABLE 2.-Canadian and U.S. taxes paid by a typical Canadian 

manufacturing affiliate distributing 50% of its after-tax earnings under 

alternative limitations on the foreign tax credit 

Item 

(1) Pre-tax earnings (U.S. IRS accounting rules) 

(2) Canadian corporate income tax 

(3) Subsidiary's after-tax earnings [ (1) minus (2)] 

( 4) Dividend paid to U.S. parent [50% of (3), by assumption] 

(5) Canadian withholding tax [15% of (4)] 

(6) Net dividend received by parent [(4) minus (5)] 

(7) Grossed-up dividend includable ·in U.S. investor's foreignsource income [(4) plus 50% of (2), or 50% of (1)] 

(8) Potential U.S. foreign tax credit [(5) plus 50% of (2)] 

(9) Tentative U.S. tax liability [48% of (7)] 

(10) Foreign tax credit surplus [(8) minus (9)] 

(11) Total Canadian and U.S. tax with overall surplus of 

tax credits [(2) plus (5)] 

(12) Total Canadian and U.S. tax with overall deficit of tax 

credits [ (11) minus (10)] 

(13) Total Canadian and U.S. tax if per-country method 

is used [larger of (11) and (12)] 

(14) Additional U.S. taxes if investor must use the per-country 

method and had an initial overall surplus of foreign tax 

credits [ (13) minus (11)] 

(15) Additional U.S. taxes if investor must use the per-country 

method and had an initial overall deficit of foreign tax 

credits [ (13) minus (12)] 

Amount 

$100.00 

$ 41.10 

$ 58.90 

$ 29.45 

$ 4.42 

$ 25.03 

$ 50.00 

$ 24.97 

$ 24.00 

$ .97 

$ 45.52 

$ 44.55 

$ 45.52 

$ .00 

$ .97 
~--...-------- - -- ~ - --- --- ---

U.S. FOREIGN TAX CREDIT 221 

U.S. tax on any of its foreign-source income. The global (Canadian plus U.S.) tax burden would equal the $45.52 paid to the 

Canadian government. If the investor had an overall deficit of foreign tax credits, however, it could apply the $.97 Canadian surplus against its U.S. tax liability on income from lower-tax countries. Thus, its global tax burden on Canadian income would be 

reduced by the $.97 surplus to $44.55. Under the overall method, 

the global tax burden on income from any one country depends 

on the investor's overall tax situation. 

Under the per-country method, however, a surplus tax credit 

could not be applied to other foreign-source income, whereas· a 

deficit must be paid to the U.S. Treasury. The global tax burden 

is the larger of the two rates calculated above: the one assuming 

an overall surplus, the other an overall deficit. If the per-country 

method replaced the overall method, th~ U.S. and the global tax 

liability on Canadian-source income would go up if and only if the 

investor initially had an overall deficit of foreign tax credits. Had 

we considered a subsidiary in a country with a deficit of foreign 

tax credits (e.g., Belgium), the U.S. and the global tax liability 

would have increased if and only if the investor initially had an 

overall surplus of foreign tax credits. 

With this in mind, let us look again at table 1. Of the 63 countries for which income and withholding tax rates are available, 26 

would tend to generate surplus foreign tax credits, and the remaining 37 a deficit of foreign tax credits. This we can see in 

column (c), which indicates the creditable foreign taxes as a percentage of grossed-up dividends, and in column (d), which shows 

the surplus (or, if negative, the deficit) of creditable foreign 

taxes over the tentative U.S. tax liability on that income. At the 

high end of the spectrum is India, whose 57 .0 percent income tax 

and 25.7 percent withholding tax combine to generate creditable 

taxes equal to 68.1 percent of grossed-up dividends; at the low end 

is Bermuda, where income is virtually untaxed. But these extremes are not very representative of high- and low-tax countries 

generally. By a straight numerical count, over half of the countries generate foreign tax credits in the range of 35 to 60 percent 

of grossed-up dividends. If countries were weighted by their importance as host to new or existing U.S. manufacturing investment, the dispersion would be even less. 

In column (e) of table 1 we have shown the total income and 

withholding tax rates paid to the foreign government when a subsidiary distributes half of its after-tax earnings as dividends. 

These rates indicat.e the global tax burden when the investor has 
222 COMPENDIUM OF TAX RESEARCH 

an overall surplus of foreign tax credits. If the investor has an 

oV'erall deficit of foreign tax credits, its global tax burden on inoome irom the high-tax countries is reduced by its surplus tax 

credits from those countries, while the global burden on income 

from low-tax countries is increased by the amount of its deficit. 

These rates are shown in column (f) of table 1. 

If U.S. corporations were required to use the per-country rather 

than the overall method, they would be unable to apply excess tax 

credits from high-tax countries against the surplus from low-tax 

countries. The qualitative impact is gummarized in table 3. If the 

corporation had an initial overall surplus, the tax burden on income from high-tax countries would be unchanged, but the tax 

burden on income from low-tax countries would increase. If the 

corporation had an initial overall deficit, the burden on income 

from high-tax countries would be increased, while the burden on 

income from low-tax countri~s would be unaffected. In either instance, U.S. taxes increase, but the impact is on low-tax countries 

in the former instance and high-tax countries in the latter. 

In interpreting table 3, the reader should realize that our conclusions characterize not only the formula for calculating the increase in a corporation's tax liability, but also the impact on the 

tax burden on additional investments in high- vs. low-tax countries. For example, a corporation with excess foreign taxes could 

calculate the total tax saving of the overall limitation by ignoring 

its investments in high-tax countries and looking only at its investments in low-tax countries. Similarly, the tax consequences of 

additional investment in the high-tax countries would be the same 

TABLE 3.-Summary of the impact of requiring the per-country. rather than 

the overall method of calculating the limitation on the U.S. foreign ta~ credit 

Impact on U.S. corpora- Impact on U.S. corporations whose creditable tions whose creditable 

foreign taxes currently foreign taxes currently 

exceed the overall are less than the overall 

limtation limitation 

Investments in high- Tax burden unchanged Tax burden increased by 

tax countries excess of creditable 

taxes over per-country 

limitation 

Investments in low-tax Tax burden increased by Tax burden unchanged 

countries excess of per-country 

limitation over creditable foreign taxes 
- - - ---- -----~ - -~- ----- -- -~-- -

U.S. FOREIGN TAX CREDIT 223 

as it had been under the overall limitation, but the tax burden on 

additional investments in the low-tax countries would be increased 

by the application of a per-country limitation. 

The magnitude of the tax increase for a subsidiary distributing 

half of its after-tax income as dividends is shown in columns 

(h) and (i) of table 1. For a U.S. investor with a current overall 

surplus of tax credits, the increase in U.S. taxes on income from 

low-tax countries ranges from a low of 0.1 percent for Brazilian 

income to a high of 23.8 percent for Bahamian income. For a U.S. 

investor with an overall deficit of tax credits, the increase in 

global taxes on income from high-tax countries ranges from a 

low of 0.6 percent for Indonesian income to a high of 10.0 percent 

for Indian income. While these ranges are substantial, the potential increase in countries hosting the bulk of U.S. foreign investment is typically small. 

Simulation Results 

The impact of moving from the overall to the per-country 

method would vary substantially from one U.S. investor to 

another. Corporations differ in the geographical distribution of 

their global investments, in their ability to take advantage of 

various provisions of foreign tax laws, in their strategies for 

repatriating income to the United States, and in a variety of other 

respects affecting their international tax situations. To gain a 

rough idea of the consequences of the per-country limitation for a 

typical U.S. investor, we have constructed a simulation model 

based on the behavior of a typical U.S. multinational manufacturer. 

To keep the model analytically tractable and its parameters 

estimable, we have made many simplifying assumptions. Using the 

statistics in table 1, we grouped all countries generating surplus 

tax credits into a single, high-tax country and all those generating 

deficits into a single, low-tax country. Although many of the 

smaller countries in table 1 had to be excluded from our calculations for lack of sufficient data, the 32 included accounted for 97 

Percent of total capital expenditures by majority-owned affiliates 

of U.S. manufacturers in 1974. The average characteristics of the 

high- and low-tax countries are shown in table 4. 

As can be seen, realized corporate income· tax rates in the 17 

high-tax countries averaged 43.0 percent and dividend withholding rates averaged 14.6 percent, so creditable foreign taxes represented 51.3 percent of grossed-up dividends. In the low-tax coun-
224 COMPENDIUM OF TAX RESEARCH 

TABLE 4.-Aggregate characteristics of high- and low-tax countries for 

which data were available,.1974 1 

Characteristic 

Number of countries 

Average income tax rate 

Average dividend withholding tax rate 

Creditable foreign taxes as o/o of grossed-up 

dividends 

Average dividend payout rate 

Subsidiaries' before-tax earnings (billion $) 

New expenditures on property, plant, & 

equipment (billion $) 

1 Based on data on table 8. 

High-tax 

countries 2 

17 

43.0% 

14.6% 

51.3% 

44.6% 

7.73 

8.30 

Low-tax 

countries 3 

15 

34.7% 

10.3% 

4L4% 

34.1 o/o 

2.68 

3.09 

:i High-tax countries included are Canada, France, Germany, United Kingdom, 

Norway, Japan, Australia, New Zealand, South Africa, Chile, Colombia, Mexico, 

Peru, India, Indonesia, Iran, and the Philippines. 3 Low-tax countries included are Belgium, Denmark, Ireland, Italy, Netherlands, 

Spain, Sweden, Switzerland, Argentina, Brazil, Panama, Venezuela, Bahamas, 

Liberia, and Nigeria. 

tries, income tax rates averaged 34.7 percent and dividend withholding tax rates averaged 10.3 percent, which implies that 

creditable foreign taxes would represent 41.4 percent of grossedup dividends. Although a simple average of the two rates for 

grossed-up dividends (51.3 percent and 41.4 percent respectively) 

might suggest that the typical investor would have an overall 

deficit of tax credits, such is not the case. Because the larger, developed countries tend to be high-tax countries, subsidiaries' 

earnings in those countries represented almost three-fourths of 

the foreign total. Furthermore, dividend payout rates are notably 

higher in the high-tax countries (there are obvious tax advantages 

in repatriating dividends from high-, rather than low-, tax countries) , so the end result was am overall surplus of foreign tax 

credits. Under these circumstances, replacing the overall with the 

per-country method has the effect of increasing the tax burden on 

income from the low-tax countries. 

The simulation model we have constructed to study the consequences of moving from the overall to the per-country method is 

rather complex and better left for the appendix. The essential 

features of our analysis are, however, easy to summarize. The net 

impact consists of substitution and liquidity effects. If the percountry limitation raises the tax burden on income from low-tax 

coun,tries, the multinational corporation would limit new investment in those countries am.d. expand investment in the United 
- - - ~ -----~-- ----~ . --

U.S. FOREIGN TAX CREDIT 225 

States and in high-tax foreign countries. (If the investor had an 

overall deficit of tax credits., the substitution would favor investments in the United States and in low-tax foreign countries and 

hurt investments in high-tax foreign countries.) Furthermore, the 

higher taxes paid to the U.S. Treasury leave the investor with 

fewer funds to finance all new investment, and investment everywhere tends to fall. When these two effects- combine, investment 

in the low-tax country falls, while that in the United States and 

in high-tax foreign country expands as long as the substitution 

effect outweights the liquidity effect. 

Our projections of the size of these changes are shown in table 

5. On the whole, the aggregate effects are small because countries 

with truly low tax rates are of minimal economic significance. 

Domestic U.S. investment would expand by 0.8 percent, and investment in high-tax foreign countries would expand by only 0.1 percent. Investment in low-tax foreign countries, which suffers from 

both substitution and liquidity effects, falls by 6.5 percent. Taxes 

Paid in the United States increase by 1.3 percent, a gain based 

on the additional taxes on income from low-tax countries and on 

the increase in domestic U.S. investment. Taxes paid to high-tax 

foreign countries are virtua.lly unchanged, while those in low-tax 

countries fall by 1.6 percent. Because the global tax burden on the 

multinational corporation has increased slightly, consolidated 

after-tax earnings fall by 0.5 percent. 

TABLE 5.-Projected impact of replacing the overall with the per-country 

limitation on a typical U.S. manufacturer, 1974 

Induced 

change as Initial Induced % of initial 

value change value 

Domestic U.S. investment* 36.4 0.27 0.8% 

Investment in high-tax foreign 13.3 0.02 0.1% 

countries* 

Investment in low-tax foreign 4.97 -0.32 -6.5% 

countries* 

Consolidated after-tax earnings 12.42 -0.07 -0.5% 

Taxes paid in United States 6.11 0.08 1.3% 

Taxes paid in high-tax foreign 3.61 0.001 0.03% 

countries 

Taxes paid in low-tax foreign 0.99 -0.016 -1.63% 

countries 

Source: Simulations based on model describ~d in the appendix. 

* Includes investment in current assets as well as property, plant and equipment. 
226 COMPENDIUM OF TAX RESEARCH 

These projections are based, of course, on the underlying assumptions of our simulation model. If investment patterns are 

less sensitive to changes in the after-tax rates of return on investment than we have supposed, the substitution of investment 

in the United States and in high-tax countries for that in low-tax 

countries would be less than we have estimated. Likewise, if the 

multinational is less willing or able to offset higher taxes with 

higher rates of domestic and foreign borrowing, then the overall 

rate of global\nvestment would slow more than we have projected. Aggregating high- and low-tax countries tends to conceal 

some important differences; countries with truly low tax rates on 

U.S. investment income would be hit the hardest by the percountry limitation. Finally, those U.S. investors who have invested most where income is taxed least would suffer more than 

those whose primary investments are in high-tax countries. But 

on the whole, the aggregate effect of moving from the overall to 

the per-country method would be small, and the effects would be 

focused on U.S. investments in low-tax countries. 

Appendix: Technical Analysis 

In this section we set forth the microeconomic model used to 

estimate the impact of going from an overall to a per-country 

limitation. The model is an extension of that set forth by Horst.+ 

Our notation is summarized in table 6. 

Generally speaking, subscript of "l" denotes the U.S. parent's 

domestic activities, a "2" denotes those in a high-tax country, and 

a "3" those in a low-tax country. In all cases, the revenues from 

investments net of all current costs except interest on borrowed 

funds, R, are assumed to depend on the level of past investments, 

T, plus new investment, I: 

(1) 

Local borrowing costs, B, depend on the level of past borrowing, 

L, plus new borrowing, L : 

B,=B.i(L,+Li), i= 1, 2, 3. (2) 

The taxable income of the two foreign affiliates equals the difference between investment returns and borrowing costs: 

'Thomas Horst, "American Taxation of Multinational Firms," American 

Economic Review 67 :3 (June 1977). Interested readers should consult this 

article for a fuller explanation of and justification for the structural equations in the model. 
U.S. FOREIGN TAX CREDIT 227 

TABLE 6.-Summary of mathematical notation 

Symbol Definition 

Re Total revenue from investments in country i net of all costs except interest and taxes 

B' Total cost of locally borrowed funds in country i 

T. Existing stock of investments in country i 

I' New investment in country i 

L, Existing stock of borrowed funds in country i 

L, New borrowing in country i 

E' Taxable income in country i 

T, Income taxes paid in country i 

t, Income tax rate in country i 

D, Dividends paid by affiliate in country i 

Pi Constant ratio of dividends to income after taxes in country i 

EB, Income retained for reinvestment in country i 

W, Withholding taxes paid on dividends from country i 

w, Withholding tax rate in country i 

c, U.S. foreign tax credit for income received from country i 

x Binary variable equal to unity if investor has an overall surplus 

of foreign tax credits and equal to zero otherwise 

E,, After-tax income in country i 

Ee Global consolidated after-tax income of the investor 

Fie Funds advanced by parent to subsidiary in country i 

'£, See equation (20) for definition 

tu See equation (21) for definition 

t: See equation (22) for definition 

r, Marginal revenue from investment in country i 

b, Marginal cost of borrowed funds in country i 

a,, Element of A-matrix in the equations of change; see equation 

(34) 

c, Element of c-vector in the equations of change; see equation 

(34) 

z, See equation (39) for definition 

r; Derivative of the marginal revenue function for country i 

b; Derivative of the marginal cost function for country i 
228 COMPENDIUM OF TAX RESEARCH 

Ei=Ri-Bi, i=2, 3. (3) 

Foreign income tax payments, T, equal the foreign tax rate, t, 

times pre-tax income, E: 

Ti= t$i, i= 2, 3. ( 4) 

Dividends paid to the U.S. parent, D, are some constant fraction, 

p, of after-tax earnings: 

(5) 

The retained earnings available for reinvestment, ER, thus equal: 

(6) 

Total withholding taxes paid on dividends, W, equal the withholding tax rate, w, times the value of dividends: 

(7) 

The U.S. parent's taxable income, Ei, equals its return on domestic 

investment, Ri, less its domestic borrowing costs, Bi, plus its 

grossed-up dividends from its foreign affiliates, P2E2+PaEa: 

Ei =R1 -Bi +P2E2+PaEa. (8) 

Its U.S. tax payments T1 , equal the U.S. tax rate, t11 times its 

taxable income, less its foreign tax credit, C2+ Ca: 

Ti= t1E1 - (C2+Ca). (9) 

If the investor has an overall deficit of tax credits, th.e U.S. foreign tax credit from country i will equal the dividend withholding 

taxes, Wi, plus the dividend payout rate, Pi, times the foreign income taxes, Ti. If the investor has an overall surplus of tax 

credits, the foreign tax credit will equal the U.S. tax rate, ti, times 

the grossed-up dividend, piEi. If we define a binary variable, x, 

equal to unity if the investor has an overall surplus of tax credits 

and equal to zero if the investor has an overall deficit, then we can 

~xpress the value of the foreign tax credit as follows: 

(10) 

The parent's after-tax earnings will equal its revenues from 

domestic investments, less its domestic borrowing costs, plus its 

dividends from its foreign affiliates net of withholding taxes, and 

less its U.S. tax payments: 

EA1 =R1 -Bi+ (D2-W2) + (Da-Wa) -Ti. (11) 

The consolidated after-tax income of the investor can be expressed 

as the sum of the parent's after-tax income and the retained 

earnings of the affiliates: 

(12) 
U.S. FOREIGN TAX CREDIT 229 

The parent is assumed to distribute dividends to its U.S. shareholders equal to some constant fraction, pi, of its consolidated 

after-tax income: 

(13) 

The parent's retained earnings available for reinvestment, ER1 is 

the difference between its own after .. tax income, EA,, and its 

distributed dividends, D1 : 

ER1 =EA1-D1. (14) 

We assume that the objective of the firm is to maximize consolidated after-tax earnings as indicated by equation (12). The 

levels of past investment and borrowing are taken as given, so 

the firm is seeking the optimal values for new investment, new 

borrowing, etc. The multinational investor is constrained, moreover, by the requirement that the sources of funds must equal the 

uses of funds by the parent and each of. the affiliates: 

and 

11 +F12+F1a=L1 +ER1 , 

12 =F12+ L2+ ER2' 

(15) 

(16) 

la=F1a+ La+ ER3 , (17) 

Where Fi2 and F 13 are the new funds advanced by the parent to 

each of the two affiliates. All in all, the multinational has five degrees of freedom in maximizing consolidated after-tax earnings. 

We will take as our five controls. the rates of new investment in 

each country, 111 12, and Ia, and the rates at which new funds are 

advanced by the parent to the two affiliates, F12 and F13. 

The five first-order conditions for maximizing consolidated 

after-tax earnings are derived by taking the partial derivatives of 

E c with respect to the five independent controls. The algebra gets 

rather messy, so we will describe only the critical steps along the 

way. The simplest procedure, we believe, begins by recognizing 

that equations (12) to (14) together imply that: 

(18) 

The after-tax retained earnings of the parent can be expressed as 

ER1 = (l-t1) (1-pi) (R1 -Bi)+ L2 ER2 +La ER3, (19) 

where 

"' Pi ( 1 - ti - tH) - P1 ( 1 - tp 

Li= (l-p,:) (l-t,) , i=2, 3, (20) 
230 COMPENDIUM OF TAX RESEARCH 

(21) 

and 

t;=Pi(ti+ti,;) + (1-pi)ti, i=2, 3. (22) 

By substituting equations (6) and (19) into (18), one can derive 

the following five first-order conditions for maximizing consolidated after-tax earnings: 

r1 =bi, (23) 

r2=b2, _(24) 

rs= ba, (25) 

(l-t1)b1= (l-t*)b2, 2 

(26) 

and 

( 1-ti) bi= ( 1-t•) ba. 3 (27) , Equations ( 23) , ( 24), and ( 25) indicate that the marginal return 

on new investment, r, should equal the marginal cost of locally borrowed funds, b, in each of the three countries in which the multinational may undertake new investment. Because t•, as defined by "' equation (22), measures the total (U.S. plus foreign) tax burden 

on income ea~ned by the affiliate in country i, ( 1- t~ ) b, measures 't 

the after-tax cost of and return on new investment in country i. 

Equations (26) and (27) thus indicate that the after-tax return 

on new investment in :the United States should equal the aftertax return on new investment in each of the foreign countries. 

To determine the impact of movin~ from an overall to a percountry limitation on the U.S. foreign tax credit, we proceed as 

follows. Let us assume that country 2 is a high-tax country, i.e., 

one for which 

t2+W2 (l-t2) >t1t 

whereas country 3 is a low-tax country, and thus 

ta+Wa(l-ta) <ti. 

(28) 

(29) 

Under a per-country method, the foreign tax credit for income 

from the high-tax country will be restricted to the U.S. taxes 

tentatively due on that income: 

(30) 

while that for income from the low-tax country will be restricted 

to the dividend withholding taxes paid and the income taxes 

deemed paid to the low-tax country: 

(31) 
U.S. FOREIGN TAX CREDIT 231 

If the investor initially had an overall deficit of tax credits, its 

foreign tax credit from country 3 will be unchanged but its foreign tax credit from country 2 will be reduced (and its U.S. income taxes increased) by an amount equal to: 

W2+P2T2-t1P2E2= [w2 (l-t2) + t2-t1]P2E2. (32) 

On the other·hand, if the investor had an initial surplus of foreign tax credits overall, then its foreign tax credits from the hightax country would be unchanged, but those from the low-tax country would be reduced (and its U.S. income taxes increased) by an 

amount: 

t1PaEa- Wa-PaTa= [t1 -ta-Wa (1-ta) ]PaEa. (33) 

To determine the impact of this tax change on the optimal strategy for the multinational, we must take the total derivatives o.f the 

five first-order conditions, equations (23) through (27) : 

~a al3 al4 a.24 ai5]25 [di d2 i l [ C1 C2 l 

aaa a34 a35 di 3 = C<3 ' 

a4a a44 a45 dF12 C4 

a5a a54 a55 dF1a C;, 

(34) 

where 

a 11 =r' -b' 1 1 (35) 

(the primes, , denote the derivatives of the marginal revenue 

or cost functions) , 

a12= 0, 

aia=O, 

a14=--1 -b'[ 1 Z1 _ 

a23= 0, 

b' ~4=-2..., 

Z2 

~5=0, 

aa1=0, 

aa2= 0, 

aaa=r' -b', 3 3 

"' L2(l-1112) (l-t2)b2] 

Z2 ' 

(36) 

(37) 

('38) 

(39) 

(40) 

(41) 

(42) 

(43) 

(44) 

(45) 

(46) 

(47) 

(48) 
232 

and 

COMPENDIUM OF TAX RESEARCH 

aa4= 0, 

b' aa5=-a, 

Za 

a4i= -(1-ti)b:, 

a42 = ( 1 - t• ) b' , '2 2 

a4a = 0, 

a44 = ( 1 - ti) au - ( 1 - t• ) a24' 2 

a 4s = ( 1-ti) au;, 

asi = a41, 

a s2= 0, 

as3= (1-t:)b:, 

as4 = ( 1 - ti) aw 

as5 = ( 1-ti) ai5 - ( 1-t: ) aas, 

Ci= b' (1-pi) [p2Ezdti2 +paEadt13], 1 

dti2= (1-x) [w2(l-t2) +t2-ti], 

dt1a = X [ti -Wa (1- ta) -ta], 

C2 =·0, 

Ca=O, 

C4 = b2p2dti2 + ( 1-ti) Ci, 

(49) 

(50) 

(51) 

(52) 

(53) 

(54) 

(55.) 

(56) 

(57) 

(58) 

(59) 

(60) 

(61) 

(62) 

(63) 

(64) 

(65). 

(66) 

C5 = baPadtia + ( 1-ti) Ci. ( 67) 

[Equations (62) and (63) are dei:iived from equations (32) and 

(33)]. 

By solving the five equations in five unknowns repre~~nted by 

equation ( 34) , one can determine the change in the rates of new 

investment, dli, dl2 and dla, and in the rates of new funds advanced to the subsidiaries, dF12 and dFia· The resulting changes in 

other variables of interest may then be determined as follows: 

dE = (1-pi) (1-ti) bi dF . . = 2 3 (68) Ri Zi l·u 'l, ' ' 

dE _ (l-t1) (1-p1)b1 (-dF -dF ) +L dE R - i2 1a 2 R2 

1 z.h 

+LadER3 - (1-Pi) (P2E2dt12+PaEadt13), (69) 

dER1 +dER2+dER3 (70) dEa= 1 , -pl 

dER. . 2 3 (71) d(Ti+ Wi) = (ti+wi(l-ti)Pi) (l-ti) ({-pi)' i= ' ' 

and 
U.S. FOREIGN TAX CREDIT 233 

dTi= tidER1 + (t1+t12-t2-_W2(l-t2) )p2dER2 

(1-p1) (l-t1) (l-P2Hl-t2) 

+ (ti+ t13-t3-W3 (1 _:t3)) p3dER3 

(1-p3) (1-t3) 

+p2E2dt12+p3E3dt13· (72) 

Our estimate of the impact of replacing the overall method 

with a per-country method of calculating the limitation on the 

foreign tax credit described in the text was 'obtained by substituting the numerical values shown in table 7 into equations (34) 

through (72). The actual calculations were made using a computer program available on request from the author. 

TABLE 7.-Parameter Estimates Used in Simulation Model of Overall vs. 

Parameter 

ti 

t2 

W2 

ta 

Wa 

Pi 

Pa 

Per-Country Limitation on the Foreign Tax Credit 

Estimated 

value 1 

.48 

.430 

.146 

.347 

.103 

.33 

.446 

.342 

$12.73 

$ 7.73 

Source of estimate 

Statutory corporate income tax rate in the 

United States. 

Weighted average of realized corporate income 

tax rates in countries generating excess foreign tax credits·. See table 6. 

W cighted average of withholding tax rates in 

countries generating excess foreign tax credits. 

See table 6. 

Weighted average of realized corporate income 

tax rates in countries generating deficit foreign tax credits. See table 6. 

Weighted average of withholding tax rates in 

countries generating deficit foreign tax credits. 

See table 6. 

Parent's dividend payout rate. This is the ratio 

of all United States manufacturers' dividends 

to after-tax earnings. See Survey of Current 

Business 55:10 (October 1975), p. S-20. 

Dividend payout rate for high-tax affiliates . 

See table 6. 

Dividend payout rate for low-tax affiLiates. See 

table 6. 

Parent's domestic income before taxes. Estimate derived in C. Fred Bergsten, Thomas 

Horst, and Theodore H. Moran, American 

Multinationals and American Interests, forthcoming, table 6-9. 

High-tax affilfates' earnings before taxes. Estimate obtained by grossing up after-tax earnings by realized corporate income taxes. See 

table 6. 
234 COMPENDIUM OF TAX RESEARCH 

TABLE 7.-Parameter Estimates Used in Simulation Model of Overall vs. Per-Country Limitation on the Foreign Tax Credit-Continued 

Estimated 

Parameter value 1 

Rr-B:i $ 2.68 

/2 $13.3 

l:i 

Fu 

Fl3 

b1, b2, bs 

r' l 

r' I 

r' a 

b' 1 

b' I 

b' a 

$ 4.97 

$ 

$ 

1.70 

.90 

.09 

-.00124 

-.00338 

-.00906 

.00247 

• 00675 

. 01812 

1 $ values given in billions. 

Source of estimate 

Low-tax affiliates earnings before taxes. Estimate obtained by grossing up after-tax earnings by realized corporate income taxes. See 

table 6. 

New investment by U :S. parent. See Bergsten, 

Horst, and Moran, op. cit., table 6-9. 

New investment by affiliates in high-tax countries. The "capital outlays" shown in table 6 

include only property, plant and equipment expenditures of majority-owned affiliates; investments in current assets are excluded. In 

Bergsten, Horst, and Moran, op. cit., new investment by all manufacturing affiliates was 

estimated to be $18.3 billion. Because table 6 

indicates that new capital outlays by affiliates 

in high-tax countries represented 42.4 percent 

of such outlays by all affiliates, our estimate of 

$7 .8 biUion equals 42.4 percent of $18.3 billion. 

New investment by affiliates in low-tax countries. Estimate derived by procedures described immediately above. 

Net capital outflow from U.S. parent to affiliates iin the high-tax countries. See table 6. 

Net capital outflow from U.S. parent to affiliates in the low-tax countries. See table 6. 

Marginal coat of borrowed funds in domestic 

and foreign capital markets. We have arbitrarily assumed this to be 9 % per annum. 

Slope of the marginal revenue from new investment schedule. There are no econometric estimates of the elasticity of foreign or domestic 

investment opportunities. We have arbitrarily 

assumed that the elasticity equals minus two, 

which would imply the value of r' indicated. 

See previous note. 

See previous note. 

Slope of the marginal costs of new borrowing 

schedule. Here, too, there are no econometric 

estimates of the elasticity of the cost of new 

foreign or domestic borrowing. We have arbitrarily assumed that the elasticity equals plus 

two, which would imply the value of b' indicated. 

See previous note . 

See previous note . 
U.S. FOREIGN TAX CREDIT 235 

TABLE 8.-After-tax earnings, retained earnings, realized corporate income 

tax rates, withholding tax rates, net capital outflows, and capital 

expenditures of manufacturing affiliates of U.S. corporations in 

selected countries, 197 4 

Realized Net corporate With- capital Capital 

After-tax Retained income holding outflow 2 expendi Country earnings 2 earnings 2 tax rate :i tax rate• tures 5 

COUNTRIES GENERATING EXCESS TAX CREDITS 1 

Canada 1.792 1.289 .411 .151 .415 2.669 

France 0.305 0.185 .48 .05 .277 0.922 

Germany 0.768 0.141 .430 .151 .211 1.603 

United Kingdom 0.447 0.173 .446 .151 .399 1.639 

Norway 0.038 0.032 .405 .151 .007 0.040 

Japan 0.219 0.077 .474 .101 .015 0.581 

Australia 0.306 0.188 .429 .151 .092 0.303 

New Zealand 0.018 0.013 .517 .051 .011 0.011 

South Africa 0.098 0.067 .419 .151 .055 0.100 

Chile 0.001 -.001 .394 .401 -.007 0.003 

Colombia 0.060 0.038 .473 .201 .014 0.047 

Mexico 0.257 0.185 .422 .201 .162 0.243 

Peru 0.012 -.003 .477 .301 .005 0.006 

India 0.025 0.017 .570 .257 .001 0.023 

Indonesia 0.009 0.008 .364 .201 .026 0.045 

Iran 0.005 0.003 .105 .601 .010 0.006 

Philippines 0.045 0.029 .296 .351 .016 0.058 

Total 4.406 2.441 ~- 1.709 8.299 

Average .430 .146 
236 COMPENDIUM OF TAX RESEARCH 

TABLE 8.-After-tax earnings, retained earnings, realized corporate income 

tax rates, withholding tax rates, net capital outflows, and capital 

expenditures of manufacturing affiliates of U.S. corpora.tions in 

selected countries, 197 4-Continued 

Realized 

corporate With- Net Capital 

After-tax Retained income holding capital expendi 

Country earnings 2 earnings 2 tax rate a tax rate 4 outflow 2 tures 5 

COUNTRIES GENERATING DEFICIT TAX CREDITS 

Belgium 0.305 0.177 .375 .15 .141 0.522 

Denmark 0.004 0.004 .325 .05 .013 0.017 

Ireland 0.105 0.066 .127 .05 .038 0.071 

Italy 0.322 0.222 .419 .05 .137 0.681 

Nether lands 0.301 0.231 .36 .10 .106 0.439 

Spain 0.113 0.080 .303 .15 .083 0.254 

Sweden 0.091 0.072 .431 .05 .025 0.168 

Switzerland 0.141 0.028 .271 .05 .069 0.036 

Argentina -.004 -.023 .282 .12 .014 0.095 

Brazil 0.275 0.241 .303 .25 .221 0.710 

Panama 0.013 0.008 .154 .10 .018 0.007 

Venezuela 0.085 0.047 .300 .15 .040 0.086 

Bahamas 0.002 .002 .051 .00 -.006 0.002 

Liberia -.004 -.004 .057 .15 .003 0.000 

Nigeria 0.002 0.002 .047 .15 .001 0.004 

Total 1.750 1.152 .903 3.092 

Average .347 .103 

1 A country was deemed to generate surplus tax credits if the withholding tax 

plus the deemed-paid income tax as a proport10n of "grossed-up" dividends exceeded 48 percent, the statutory U.S. income tax rate. See table 1. . 2 After-tax earnings, retained earnings, and net capital outflow are reported in 

Survey of Current Business 55: 10 (October 1975), pp. 63, 57, and 55, respectively. 3 The average realized corporate tax rates are computed using countries' grossedup dividends (the difference between after-tax earnings and reinvested earnings 

divided by one minus the realized corporate tax rate) as weights. Countries' realized corporate income tax rates are identical to those shown in table 1. 

' The average withholding tax rates are computed using countries' dividends (the 

difference between after-tax earnings and reinvested earnings) as weights. Withhplding tax rates are identical to those shown in table 1. 6 Capital expenditures are shown in Survey of Current Business 56:3 (March 1976) , 

p. 22. 
U.S. FOREIGN TAX CREDIT 237 

COMMENT 

George F. Kopits, International Monetary Fund 

With his analysis of the methods of computing the ceiling on 

the U.S. foreign tax credit, Thomas Horst makes yet another welcome contribution to the literature on the taxation of foreignsource corporate income. His paper focuses on the measurement 

of the impact of a hypothetical shift from the currently used overall limitation to the per-country limitation. To this end, Horst 

first extends the model on the multinational firm that he developed 

earlier 1 to a three-country case (the parent operating in the home 

country, a subsidiary in a high-tax host country, and another in 

a low-tax host country) and then simulates the effect of the tax 

change on investment, earnings, and tax payments of U.S. multinational companies. 

The model compares very favorably with others of its kind,2 

Particularly in that it allows for the simultaneous determination 

of several of the firm's principal decision variables at home and 

abroad (investment in each location and outflow of funds from 

the parent to each subsidiary). There are, of course, certain simplifying assumptions, such as fixed dividend-payout ratios and 

fixed financial structure. 3 As for the simulation, there is a potential danger in the use of a parametric approach rather than the 

direct estimation of behavioral relationships subject to statistical 

significance tests. Nevertheless, the numerical results seem plausible in terms of both direction and magnitude. Notably, as a consequence of the switch to the per-country limitation in 197 4, U.S. 

tax payments would have increased by $80 million, equivalent to 

a rise of about 1.5 percentage points in the tax burden on taxable 

foreign-source income of American manufacturing enterprisesthe principal users of the overall limitation until the recent elimination of the per-country limitation. This is far smaller than the 

1 See Horst (1977 and Bergsten, Horst, and Moran (forthcoming, ch. 6). 2 See the review by Kopits (1976). 11 A less severe constraint is the absence of intrafirm payments of interest 

and head-office charges, provided for in the earlier version of the model. 

The views expressed do not necessarily represent those of the International 

Monetary Fund. 
238 COMPENDIUM OF TAX RESEARCH 

revenue estimates from two previous studies that failed to take 

into account the companies' response to the tax change.4 

Horst's computations also indicate that the switch would lead 

tcnm insignificant rise in taxes paid in high-tax host countries and 

a slight decline in low-tax host countries. These effects on the tax 

liability would be accompanied by a very small increase in investment (less than 1 percent) in the home country and in high-tax 

host countries, and a larger drop ( 6.5 percent) in investment in 

low-tax host countries. This is an interesting outcome that, as the 

author points out, is consistent with a priori expectations according to which, given the enterprises' iuitial surplus of tax credits-, 

the U.S. tax burden on marginal income from low-tax countries 

increases, while that on income from high-tax countries remains 

unchanged. If, instead, the firms initially had insufficient tax 

credits to offset the U.S. tax under the overall limitation, the tax 

burden would rise only on m1;1.rginal income from high-tax host 

countries, thus causing an expansion of investment in the United 

States and in low-tax countries, and a reduction of investment in 

high-tax countries. 

Although clearly the thrust of the paper is the simulation exercise, it is appropriate to explore (in light of the reported findings) 

the merits of different methods of tax credit limitation, particularly under various efficiency and equity criteria. The size of the 

tax-induced changes estimated. with the model suggests that only 

a modest distortion in global resource allocation is attributable to 

alternative limitation methods; yet, given a wide dispersion of tax 

rates across some countries, the distortion is likely to be concentrated among particular host countries and investors. 

In this regard, it might be interesting to identify the optimal 

limitation method from the standpoint of worldwide efficiency, 

ordinarily to be maximized through capital-export neutrality.5 

Curiously, the latter is approximated under the per-country limitation with respect to income from low-tax countries (assuming 

current taxation of foreign-source income), but not from high-tax 

countries because of the lack of a home refund for the excess of 

the host tax over the home tax. On the other hand, the overall 

limitation coupled with the carryover provisions (which permit 

'Although their results are only roughly comparable to Horst's estimates, 

Musgrave (1972, p. 217) found that in 1964 the changeover to the percountry limitation would have raised U.S. tax payments by $150 million, or 

2.7 percent of taxable foreign-source income, and Shapiro and Klock (1973-

1974, p. 138) calculated for 1978 a tax increase of $180 million, or 2.9 percent 

of taxable foreign-source income. 11 For a discussion of necessary conditions, see Musgrave (1969, pp. 109-

121). 
U.S. FOREIGN TAX CREDIT 239 

the carryforward of surplus credits to five suceeding years and 

carryback to two preceding years) tend to average the tax burden 

on all foreign-source income. This may amount t;o a refund for the 

excess host tax, thus approaching capital-export neutrality for the 

decision between home investment and all foreign investments 

taken as a whole. At the same time, however, on a country-bycountry basis, the overall limitation may result in a departure 

from neutrality with respect to low-tax country income, shielded 

from the home tax by tax credits generated with high-tax country 

income. But this nonneutral element can be mitigated to an extent 

by elimination of the tax deferral on foreign subsidiary earnings, 6 

as the firm is likely to incur an overall deficit of tax credits after 

such a move. It is unfortunate that whatever neutrality is brought 

about by the overall limitation is done at the cost of sacrificing 

equity between the large, geographically diversified investor who 

can make much better use of the limitation, and the investor who 

operates in only a handful of countries. 

In conclusion, the Treasury Department must be commended 

for sponsoring the building of versatile policy-oriented models. It 

is hoped that this effort will be sustained and thus materialize in 

an operational model (periodically improved and run on up-todate information), that could become a useful contribution to 

Policymaking in the international tax area. 

References 

Bergsten, C. Fred, Thomas Horst, and Theodore Moran. American Multinationals and American Interests. Washington, D.C.: Brookings Institution, forthcoming. 

Horst, Thomas. "American Taxation of Multinational Firms." American 

Economic Review 67 :3 (June 1977), pp. 376-389. 

Kopits, George F. "Taxation and Multinational Firm Behavior: A Critical Survey." IMF Staff Papers 23:3 (November 1976), pp. 624-673. 

Musgrave, Peggy B. United States Taxation of Foreign Investment Income: Issues and Arguments. Cambridge, Mass: Harvard Law School, 

1969. 

Musgrave, Peggy B. "Tax Preferences to Foreign Investment." In Joint 

E.conomic Committee, U.S. Congress, The Economics of Federal Subsidy Programs: Part 2-lnternational Subsidies. Washington, D.C.: 

U.S. Government Printing Office, 1972, pp. 176-219. 

Shapiro, Harvey, and David Klock. "Some Aspects of U.S. Tax Treatment 

of Foreign-Source Income." Journal of Economics and Business 26 

(1973-1974),pp.134-139 . 

• 

8 

Current taxation of certain subsidiary earnings under the Subpart F 

l~come provisions of the U.S. Internal Revenue Code comprises a step in this 

irection.