What’s Wrong with President Obama’s Tax Proposals?

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President Obama’s recent tax reform plans faced harsh criticism from US businesses worldwide. According to trade experts if these gets implemented it will result in serious damage to US company’s global competitiveness. Two main points that could harm US businesses competitiveness include – limiting tax deferral for income earned abroad by US companies and curtailing the credit for taxes paid abroad. In this article, let us see how these tax plans can have a damaging impact on American businesses.

Before discussing on the impact of these plans, let us first understand what they mean. The US companies in order to compete in the international market establish their own subsidiaries in foreign soil. This is due to many business reasons such as to tap the potentials of the foreign market directly, to gain more international marketing exposure, or the most common of all reasons – to save cost. Even though many are against American companies putting more efforts in foreign soil rather than in US itself, companies have their own reason for the same- one of them being- it results in more employment opportunities for US citizens.

But US subsidiaries in foreign countries have to abide by the taxation rules of that country. So they have to pay taxes on their business income in that country, but in addition to it, US laws forces them to pay tax in USA also for the same income. So this is the case of double taxation. But the US tax policy is imposed on companies only when that income reaches the United States, till then it is deferred. This is known as tax deferral system. So American companies working with offices abroad, pay taxes twice – one to the country of operation and the other to US government.

Now interestingly American Government in order to ‘rescue’ US companies from this double taxation has in place a credit system which gives a tax credit which is equal to the foreign tax amount paid by these companies to the other country.  So we have just explained the deferral and credit system. Now let us see what the new plans are.

The current plan proposed by the President limits this tax credit and curtails deferral system, leading companies to pay double taxation again. With double taxation, the incomes earned by these American companies will be far less while competing with their rivals abroad. Other countries do not tax their companies for income earned in foreign soil because that income is already taxed once by the foreign country. Most leading countries have the one tax system where business income is taxed in the country where it is earned.

If the US tax laws also follow such a system, it will increase their global competitiveness and result in global economic fair play. The USA is the only largest economy which follows the double taxation on corporate income. The Presidents plans are on the assumption that these two points will lead American companies to concentrate in US rather than in foreign countries and this will lead to some employment generation. What the plan fails to see is American companies with overseas offices/subsidiaries and investments are providing more employment to US citizens with their foreign operations and also help in economic growth for the US.