June 26,2008

Baucus Hearing Statement Regarding International Tax Reform

Hearing Statement of Senator Max Baucus (D-Mont.)
Regarding International Tax Reform

The Italian Renaissance historian Francesco Guicciardini said: “Industries . . . are at their
best before . . . people recognize how profitable they are. As soon as that happens, they
decline, for strong competition makes them less profitable. Thus, in all matters, it is wise
to get up very early.”

Today we will discuss international tax competition. We’ll try to assess whether we’re at
our best — or whether strong competition is making us less profitable. Either way, we
may find it wise to get to tax reform very early.

Tax competition happens when countries compete with each other about how much they
tax multinational businesses.

To understand this competition, we need to explore how America taxes the foreign
income of U.S.-based multinational businesses now. And we need to explore the various
ways that America could tax that income in the future.

At the extremes, there are two ways to tax the foreign income of these businesses.

The first is to tax all of the activities of the business, no matter where they take place.

This is called “worldwide taxation.” A worldwide system avoids double taxation by
allowing a business to take a credit against U.S. taxes in the amount of foreign taxes paid

The second way to tax multinational businesses is for a country to tax only income
derived within its borders. This is called “territorial taxation.” In a territorial tax system,
the country taxes this income whether the taxpayer is a resident or not.

In a territorial system, any entity earning income in the resident country will owe tax on
that income. And if the entity earns income outside of the resident country, then the
entity won’t owe tax.

Our system is somewhere in between. America’s system is partly worldwide, and partly

In 1962, Congress enacted Subpart F of the Internal Revenue Code. Subpart F applies
when an American entity runs an active business in a foreign country. Subpart F allows
the entity to defer paying tax on the foreign income until it repatriates the foreign income
back to America.

Subpart F generally does not allow deferral, however, for passive income. Passive
income includes rents, royalties, and interest. This income is mobile. With the aid of the
Internet, it can move quickly from one country to another.

Critics of Subpart F argue that much has changed since 1962. In 1962, America was a
net exporter of capital. Now, we are a net importer of capital.

In 1962, manufacturing dominated America’s economy. Now, our economy is quite
diverse. Intellectual property is our most important export.

After 46 years, it’s time to consider whether Subpart F still functions properly. It’s time
to consider whether we need to make minor tune-ups to Subpart F, or start anew.

Congress and the new President will need to work together to ensure that the Internal
Revenue Code will collect the revenue that we’ll need. And at the same time, we’ll need
to ensure that American businesses are able to compete in the global economy.

Other countries are also considering changing how they tax foreign income. The United
Kingdom and Japan are looking to modified territorial tax systems. The European Union
may consider changes for business activities within the EU. We need to keep this
competition in mind.

American businesses are competing for capital and jobs. Let’s try to be at our best. Let’s
ensure that strong competition does not make us less profitable. And let us act wisely,
and get to tax reform very early.