The Yale Law Journal


Critiquing (and Repairing) the New International Tax Regime

25 Oct 2018

abstract. In this Essay, I address three serious problems created—or left unaddressed—by the new U.S. international tax regime. First, the new international rules aimed at intangible income incentivize offshoring and do not sufficiently deter profit shifting. Second, the new patent box regime is unlikely to increase innovation, can be easily gamed, and will create difficulties for the United States at the World Trade Organization. Third, the new inbound regime has too generous of thresholds and can be readily circumvented. There are ways, however, to improve upon many of these shortcomings through modest and achievable legislative changes, eventually paving the way for more ambitious reform. These recommendations, which I explore in detail below, include moving to a per-country minimum tax, eliminating the patent box, and strengthening the new inbound regime. Even if Congress were to enact these possible legislative fixes, however, it would be a grave mistake for the United States to become complacent in the international tax area. In addition to the issues mentioned above, the challenges of the modern global economy will continue to demand dramatic revisions to the tax system.


The Tax Cuts and Jobs Act of 2017 (TCJA)1 significantly changed the way the United States taxes multinational corporations on their cross-border income. The legislation, however, both failed to solve old problems in the international system and opened the door to new ones. Furthermore, the legislation will deplete government resources, holding the United States back in the twentieth century rather than propelling it to be a competitive force and source of general wellbeing for its citizens in the current one.

One of the most disappointing aspects of the legislation is its immense cost. The TCJA’s tax cuts will shrink revenues over the next decade by $1.9 trillion.2 The actual decrease in revenue is likely to be much greater if the law’s expiring provisions, or a portion of them, are made permanent.3 Additionally, the new legislation has created numerous tax planning opportunities that will result in a loss of further revenue. The need for international tax reform was the impetus for the legislation, but it became the proverbial tail wagging the dog. In an attempt to deal with base erosion and profit shifting strategies of multinational corporations, the United States instead created a true mess of business taxation generally. The new “pass-through” deduction, which was intended to create parity with the new lower rate available on corporate income, inefficiently and arbitrarily punishes workers and certain industries and allows for significant tax planning opportunities. Individuals may also now be able to use corporations as tax shelters to avoid the top rate, thereby undermining the individual income tax system.

Given the enormous losses of revenue and the gamesmanship the legislation will generate, it is fair to ask a lot of the new international regime. Yet the international provisions too fall short, mostly due to avoidable policy choices. Judged against possible alternative policies that Congress could have enacted, the new international provisions are quite problematic. There is a possibility that the new legislation will serve as a bridge to true reform in the international tax area; however, there is also reason to worry that 2017 was a squandered opportunity for international tax policy.

In this Essay, I address three serious problems created—or left unaddressed—by the new regime. First, the new international rules aimed at intangible income incentivize offshoring and do not sufficiently deter profit shifting.4 Second, the new patent box regime will cause problems; it is unlikely to increase innovation, can be easily gamed, and will create difficulties for the United States at the World Trade Organization (WTO). Third, the new inbound regime has too generous of thresholds and can be readily circumvented. There are ways, however, to improve upon many of these shortcomings through modest and achievable legislative changes, eventually paving the way for more ambitious reform. These recommendations, which I explore in detail below, include moving to a per-country minimum tax, eliminating the patent box, and strengthening the new inbound regime.

Together, these problems underscore that we must continue to improve the tax rules governing cross-border activity. Even if Congress were to enact these possible legislative fixes, it would be a grave mistake for the United States to become complacent in the international tax area. In addition to the issues mentioned above, the challenges of the modern global economy will continue to demand dramatic revisions to the tax system. The new regime falls short of effective international tax reform. Rather than aligning taxation with U.S. economic needs and social objectives, the new regime doubles down on archaic concepts of source and residency that have become malleable and disconnected from economic reality. The regime unwisely retains the place of incorporation as the sole determinant of corporate residency and subscribes to the fiction that the production of income can be sourced to a specific locale. These determinations should be updated or replaced, and new supplemental sources of revenue should be explored seriously. A longer-term objective should be to reach consensus on how to tax businesses selling into a domestic customer base from abroad.

I. background

The former U.S. international tax system has been described as a worldwide system of taxation because it subjected foreign earnings to U.S. taxation, whereas a territorial system of taxation exempts such earnings altogether. In reality, active earnings of foreign subsidiaries could be deferred, even indefinitely. The disparate treatment between foreign and domestic earnings meant that the old system was somewhere between worldwide and territorial.

The new regime has been described as a territorial system because a basic feature of the regime is that a broad swath of foreign profits are effectively exempt from U.S. corporate tax, since domestic corporate shareholders can deduct the foreign-sourced portion of dividends received from foreign subsidiaries in which they own at least 10% of the stock.5 Here again, however, labels like “territorial” fall short, since smaller corporate shareholders and individuals are still subject to taxation on their foreign income. Furthermore, the new minimum tax regime, along with the older subpart F rules,6 also means that the foreign income of 10% shareholders in controlled foreign corporations, or “CFCs,” is possibly subject to some U.S. taxation.7

The TCJA retained worldwide-type features because the legislation’s drafters recognized that a move to a pure territorial system would worsen profit shifting incentives by exempting foreign source income altogether rather than just allowing it to be deferred, as under the old system. The hybrid nature of both the old and new systems represents an attempt to balance investment location concerns, on the one hand, with concerns about the protection of the revenue base, on the other.8

Importantly, however, the international provisions are estimated to lose money going forward instead of bringing in revenue.9 Many of the revenues from the international provisions are front-loaded into the ten-year budget window because of the transition tax on the deemed repatriation of old earnings. This is a one-time event that will not generate revenues in the future. Moreover, the official Congressional Budget Office (CBO) estimate assumes that several far-off tax increases will go into effect, an unlikely event. Further, the CBO estimate does not take into account the possibility that some investors may, even in light of new incentives, be reluctant to invest in the United States because of possible challenges under trade and tax treaties and the political instability of the law.10 Finally, if the new U.S. taxing environment spurs other countries to engage in tax competition, as one would expect, this might reduce the anticipated growth effects of the legislation by decreasing the investment flowing into the United States.

As a general overview, the purposes of the TCJA’s international reforms are to: (1) exempt foreign income of certain U.S. corporations from taxation in the United States (the quasi-territorial, or participation exemption, system); (2) backstop this new participation exemption system with a 10.5% “minimum tax” on certain foreign-source income (the “Global Intangible Low-Taxed Income,” or “GILTI,” regime); (3) provide a special low rate on export income (the “Foreign Derived Intangible Income,” or “FDII,” regime); and (4) target profit-stripping by foreign firms operating in the United States (the “Base Erosion Anti-Abuse Tax,” or “BEAT,” regime). In the remainder of this Essay, I discuss problems presented by the latter three of these new regimes.11

II. the gilti regime

A. New Offshoring and Shifting Incentives

The existence of a partial territorial system coupled with a minimum tax could be an improvement over the prior system, which often resulted in a zero rate of taxation on foreign earnings because of deferral and other tax planning maneuvers. It is also preferable to a pure territorial system because of protections it places on the revenue base. Nonetheless, although a minimum tax can work conceptually, the current GILTI incarnation problematically incentivizes firms to offshore assets and profit shift—as I, and others, pointed out early in the legislative process.12

First, the minimum tax regime allows a 50% deduction of GILTI. At the 21% corporate rate, this amounts to a 10.5% rate on GILTI.13 Given the wide differential between the domestic rate and the minimum tax rate, there remains substantial motivation to shift profits.

The new tax legislation also presents more subtle incentives to locate investment and assets abroad. There is an exemption from the GILTI tax in the form of a deemed 10% return on tangible assets held by a CFC, as measured by tax basis. If U.S. firms have or locate tangible assets overseas,14 then they can reduce their GILTI tax commensurately. This is because the more a U.S. shareholder increases tangible assets held by the CFC, the smaller the amount of income subject to the GILTI regime.15

Take for instance, a firm that invests $100 million in a plant abroad through a CFC that will generate $10 million of income. None of that $10 million of income will be subject to U.S. tax because the firm gets to reduce its GILTI by the deemed 10% return on the CFC’s assets.16 In effect, the $10 million of income is reduced by 10% of $100 million, or $10 million, so that it is all tax-free. To compare, consider the tax consequences of the same firm investing in a $100 million plant in the United States that will generate $10 million of income. It would pay U.S. tax of $2,100,000 (21% of $10 million).17

Where there happens to be nonexempt return to tangible assets (return in excess of 10%), this is taxed by the minimum tax regime but at a lower rate than the rate on domestic income.18 To build on the above example, assume that the $100 million foreign plant generates not $10 million, but $20 million of income. The firm will still get to exempt $10 million of the income through the deemed 10% return, but the other $10 million will be subject to the GILTI regime and given a 50% deduction (i.e., taxed at a 10.5% effective rate). This would produce U.S. tax of $1,050,000 (10.5% of $10 million), as compared to a U.S. tax burden of $4,200,000 (21% of $20 million) on a similar U.S.-based investment.19

Investors will, of course, take local foreign taxes into account, and higher taxes abroad will likely sway the decision of where to locate investment. The offshoring incentives of GILTI might then primarily be a problem when low-tax countries are a viable alternative. Although many tax havens have limitations regarding labor supply or lack the protections of the U.S. legal system, among other factors, some low-tax countries, like Ireland and Singapore, are hospitable options for investment.20

The structure of GILTI is even more problematic when considering foreign tax credits. The new legislation allows foreign taxes to be blended between low-tax and high-tax countries before offsetting GILTI from those countries (thus constituting a “global” minimum tax), rather than allowing foreign taxes to offset only the GILTI from the country in which they are paid (a “per-country” minimum tax). This structure encourages firms to locate investment in low-tax countries and combine them with income and taxes from high-tax countries, possibly to avoid GILTI liability altogether.21

Note that, through this blending technique, a firm can also shield profits in tax havens by choosing to invest in high-tax countries.22 A firm may even prefer to invest in countries with higher tax rates than the United States since income and taxes from such countries can be used to blend down the U.S. minimum tax to zero. If a firm has profits in tax havens, then the effective U.S. tax rate of investing in a high-tax country, say Sweden, which has a 22% statutory corporate rate, might only be 4.4% since most of those taxes can be used to blend down GILTI completely.23 This puts the United States at a competitive disadvantage, making it more likely that jobs and investment go to countries like Sweden.

Finally, as a general matter, the structure of the minimum tax allows multinationals to blend their high profits from intangibles with their low profits from tangibles, thereby falling below the deemed 10% rate of return on tangible investments, and escaping the GILTI regime. This ability to blend high-return with low-return income will further encourage offshoring and profit shifting.24

In summary, the deemed rate of return and global minimum features of the GILTI regime run contrary to Congress’s pronounced intention to keep investment in the United States.

B. Reform Possibilities

The CBO estimates that nearly 80% of existing profit shifting will continue under the new regime.25 It is in the United States’ interest to tolerate some degree of profit shifting. For instance, profit shifting allows multinationals to save foreign taxes, which might benefit the United States if shareholders are domestic. And multinationals are more mobile than individuals, so we may be worried about them leaving the United States if they are taxed too heavily.26 Yet, given CBO’s figures, it does not seem like Congress landed on the most desirable amount of profit shifting. This is especially the case because the recent legislation’s effect on profit shifting is likely even smaller than the CBO’s estimate, since the CBO does not take into account investor reactions to the instability of the FDII regime in response to potential WTO challenges,27 investor reactions to the political instability of the legislation in general, and the potential for tax competition from other countries. Many profit-shifting opportunities exist, as demonstrated by recent reported tax rates after enactment of the TCJA.28 The balance of payments data following the legislation also supports the view that companies‘ current incentives to book profits abroad are similar to their incentives before the new law.29

There are several options, however, to remove or reduce GILTI’s profit shifting and offshoring incentives. The most effective way to reduce profit shifting is to move to a per-country minimum tax rather than one applied on a global basis, thereby reducing opportunities to blend foreign tax credits.30 Critics of a per-country approach argue that it would be too complex to administer,31 but others disagree.32 The primary targets of GILTI are sophisticated multinational corporations that can effectively deal with the challenge of computational complexity. Moreover, the blending technique itself requires significant resources and complex tax planning, and a global minimum tax would eliminate the need for such inefficient maneuvering. Additionally, a per-country approach is even more necessary if Congress maintains other offshoring incentives in the GILTI regime.33 Moving to a per-country approach would decrease the offshoring incentives created by the legislation, at least for those countries with corporate tax rates at or above that of the United States.

Congress could also reduce the deduction for GILTI income so that the gap between the domestic corporate rate and the minimum tax rate is not so large. Decreasing the rate differential will lessen the motivation to earn income abroad. A tax burden on foreign income that is too high will cause corporations to simply locate their residence abroad, thereby escaping outbound base erosion rules. With the new lower 21% corporate rate and inbound base erosion regime, however, this is now less of a concern. Additionally, as I discuss below, the inbound rules can be strengthened.

Another way to target the offshoring incentives created by the GILTI regime could be to change the tax base, or the scope, of the regime. Congress could also eliminate the exempt return on foreign tangible assets, and instead apply the minimum tax to all foreign source (non-subpart F) income. Doing so would address one of the GILTI regime’s conceptual flaws: it seeks only to reduce the incentive to offshore intangible assets while creating incentives to offshore operations.

If policymakers are wedded to the idea that a minimum tax should only target multinationals’ intangible assets, Congress could rethink the deemed rate of return. The 10% rate is arbitrary, does not necessarily correlate to the market return on tangibles, and seems quite high, given that the average rate of return on low-risk or risk-free assets has been much lower, especially in recent years.34 Instead, the deemed normal return could be the short-term risk-free rate or such rate as adjusted by a dynamically adjusting measure of market performance.35 Finally, another way to close the gap between foreign income and domestic income would be to keep the 10% exempt return but subject the excess to the normal corporate rate of 21%, rather than the 10.5% rate.36

As discussed, Congress has several levers available to decrease profit shifting and base erosion. Moving forward, Congress’s priority should be to enact a per-country minimum tax, since this will be effective at combatting profit shifting while also reducing the offshoring incentives of the new law. The other suggested changes can be scaled up or down depending on where Congress’s policy preferences land along the territorial-worldwide spectrum. Congress should take caution in lowering the minimum tax rate further, however, since this would impact revenues and would also lead to increased profit shifting and base erosion by widening the disparity between the domestic rate and the foreign minimum rate.

III. fdii: new offshoring incentives, wto issues, and gaming opportunities

A. New Offshoring and Shifting Incentives

If GILTI is the stick that discourages earning income from intangibles abroad, then FDII is the carrot that encourages earning that income in the United States.37 To this end, FDII provides a 37.5% deduction on so-called foreign-derived intangible income, which amounts to a 13.125% effective tax.38 A domestic corporation’s FDII represents its intangible income that is derived from foreign markets. Although this income slice is defined as “intangible income,” the intangible aspect, as is the case with the GILTI regime, comes only from the excess over the deemed return on tangible investment, rather than from intellectual property in the traditional sense of the word. This also distinguishes FDII from other patent box regimes, which apply to patents and copyright software, because it instead includes branding and other market-based intangibles.39

Like GILTI, the intangible slice of income is calculated by determining a 10% return on tangible assets (but those of the domestic corporation as opposed to the CFC). Unlike GILTI, a taxpayer wants to reduce this deemed return amount because doing so increases the amount available for the FDII reduction. In contrast, in the GILTI regime, the taxpayer wants to increase their deemed return amount because this reduces the amount of income subject to the minimum tax. Unfortunately, this again creates perverse incentives. Because we are dealing with domestic assets, the FDII regime pushes taxpayers towards minimizing their investment in such assets.

For instance, assume a U.S. corporation has income of $3,000,000, $2,500,000 of which is derived from sales abroad. Further assume the corporation has a basis in tangible assets of $30,000,000. To calculate FDII, the taxpayer would calculate the ratio that the corporation’s exports bears to its income ($2,500,000/$3,000,000), or 83.33%. FDII is that percentage times the income after the deemed 10% return. Here since 10% return on $30,000,000 is $3,000,000, the taxpayer would take 83.33% of 0 ($3,000,000-$3,000,000). In this case, none of the income gets the benefit of the FDII reduction.

If the corporation instead had zero basis in tangible assets in the United States, it would have a higher FDII deduction. The taxpayer would calculate the above export ratio (83.33%). FDII is that percentage times the $3,000,0000 income less the deemed 10% return ($0 since there are no assets), or $2,500,000 (83.33% of $3,000,000). The taxpayer then gets to deduct 37.5% of FDII, here totaling $937,500, which, with the 21% corporate rate, amounts to a tax savings of $196,875 over our base case with U.S. tangible assets.

Also note that the FDII regime essentially applies effective rates between 21% if there is no income above the exempt return, and 13.125% if there is. The GILTI regime applies effective rates between 0% if there is no income above the exempt return, and 10.5% if there is. These rate disparities privilege GILTI in comparison to FDII and incentivize U.S. corporations to produce abroad for foreign markets instead of producing exports in the United States.40

B. WTO Issues

One significant problem with the FDII regime is that it threatens to reignite a three-decades long trade controversy between the United States and the European Union that was thought to have been resolved in 2004.41 The new regime likely violates WTO obligations because it is an export subsidy on goods.42 The more the U.S. taxpayer’s income comes from exports, the more of its income gets taxed at the FDII 13.125% effective rate (after taking into account the 37.5% deduction), which is a subsidy in comparison to the normal 21% corporate rate.

Because the FDII regime benefits exports, it likely violates Article 3 of the Agreement on Subsidies and Countervailing Measures (SCM Agreement), which prohibits (a) subsidies that are contingent, in law or fact, upon export performance, and (b) subsidies that are contingent upon the use of domestic over imported goods.43 Article 1 of the SCM Agreement defines a subsidy as a financial contribution by a government, including the non-collection or forgiveness of taxes otherwise due.44

The “taxes otherwise due” language raises questions about baselines. Some have suggested that the proper baseline should be the new participation exemption system.45 Since a taxpayer could just incorporate abroad and take advantage of the exemption of foreign source income, then, judged against that baseline, the 13.125% rate should not be considered forgiveness or non-collection of taxes otherwise due. WTO rulings, however, tend to be formalistic and do not generally anticipate taxpayer responses. For instance, in judging former export subsidies, the WTO ignored the fact that a firm could indefinitely defer its expatriation of income offshore, pushing its tax rate down to zero. Instead, prior export subsidies were judged against a system of worldwide taxation without deferral. Moreover, even though other countries have ostensibly territorial systems, they, like the new U.S. system, also contain worldwide features like CFC rules. So it is uncertain why pure territoriality should be considered a baseline, as has been suggested.46

Further, it is unclear why the comparison should be the taxation of foreign subsidiaries, given that the FDII regime also benefits domestic corporations without foreign operations at all. For such corporations to receive the FDII deduction, they need only export goods. It thus seems strained to pretend they would incorporate abroad if they have no activity abroad. Instead, the proper baseline should be the applicable tax rate imposed on the domestic corporation if it had sold its goods in the United States, rather than exported them: 21%.

Although the United States may contend that intangible income lies outside the scope of the WTO agreements,47 the intangible income in the legislation is simply an arbitrary slice (determined through the 10% deemed return) of the income from the sale of tangible goods. Exports of tangible goods fall within the scope of the agreements, and likely so will the FDII regime, since it amounts to the non-collection or forgiveness of taxes otherwise due on an export. Accordingly, our trading partners may seek to impose sanctions, either unilaterally or after consent from the WTO’s Dispute Resolution Body.48 The Tax Commissioner for the European Commission has already indicated during a meeting of the European Parliament that the European Union is likely to submit challenges of the provision.49 The United States will then have to choose between abandoning the FDII regime or continuing it and paying the sanctions.

To summarize, the low rate on FDII is meant to encourage firms to keep and develop intangible property in the United States. Given its serious legal uncertainty, however, firms may be unwilling to rely upon it in making their decisions of where to place intellectual property. It is therefore doubtful that the FDII regime will accomplish its stated purpose.

C. Gaming Opportunities

The FDII regime also presents new gaming opportunities. Under some interpretations of the statute, the taxpayer may be able to get the FDII deduction by “round-tripping” transactions—that is, selling to independent foreign distributors, who then resell back into the United States. In this manner, domestic sales can masquerade as tax-advantaged export sales. The new legislation requires that taxpayers must establish to the satisfaction of the Treasury Secretary that the goods are sold for use abroad.50 Some taxpayers, however, will take the position that the intent of an initial sale to a foreign business is sufficient (like in a value-added tax (VAT) regime). Ultimately, it will be difficult for the Internal Revenue Service (IRS) to meaningfully patrol round-tripping transactions given the legal and factual ambiguity inherent in determining the meaning of “foreign use.”

D. Reform Possibilities

In light of the troubling incentives for offshoring, the likely incompatibility with WTO rules, and the potential for round-tripping strategies, the best course of action is to repeal FDII entirely.51 This is more emphatically the case considering the mixed evidence as to whether even better designed patent boxes increase research and development (R&D) or employment and given the inefficiencies that result from privileging exports.52 Problematically, FDII provides tax incentives to marketing intangibles, goodwill, and going concern, rather than just R&D. Although there is a strong argument for incentivizing R&D because it generates positive spillover effects, the rationale for extending government subsidies to these other kinds of IP is attenuated.53

Note, however, that repealing FDII would create a wider differential between the domestic rate on exports (which would then be 21%) and GILTI (10.5%), and this could increase incentives for profit shifting. For this reason, and for others previously discussed, if FDII is repealed, Congress should strongly consider raising the rate on GILTI.

If FDII is maintained, new legislation or regulation should tighten limitations on round-tripping. The Treasury Department could turn to the foreign base company sales rules that determine the destination of a sale. Problems with those rules, however, illustrate just how difficult it is to police the line between foreign and domestic use.54

IV. the beat regime

A. Threshold Matters

One of the more interesting provisions in the new legislation is the base erosion and anti-abuse tax (BEAT), which strengthens U.S. source-based taxation. The BEAT applies to certain U.S. corporations that excessively reduce their U.S. tax liability by making deductible payments, such as interest or royalties, to a foreign affiliate in which the U.S. corporation owns at least a 25% stake. These payments are referred to as “base erosion payments.” Importantly, the BEAT applies to all multinationals with U.S. affiliates, whether a U.S. or foreign parent owns them. Accordingly, the BEAT is a step towards equalizing the treatment between U.S. and foreign multinationals, the latter of which could previously reduce their U.S. tax liability through earnings stripping in a way that was unavailable to U.S. multinationals.

Unfortunately, the scope of the BEAT allows many multinationals with significant base-shifting activity to avoid the tax. This is because the regime only applies to corporations that have average annual gross receipts in excess of $500 million over three years. Outside of some enumerated exceptions, BEAT is also not triggered until a multinational makes base erosion payments that exceed 3% (2% for financial groups) of the overall deductions taken by the corporation.55

Assume for instance, a U.S. corporation makes base erosion payments to its foreign affiliate producing deductions in the amount of $300,000. Further assume other deductions amount to $9,700,000 (so total deductions are $10,000,000). In this case, the corporation would be subject to the BEAT since it meets the 3% threshold. But if it were to reduce its base erosion deductions by just one dollar, or increase its other deductions by the same amount, it would entirely escape the BEAT. The corporation could further game the denominator of overall deductions by entering into hedged transactions.56

Both features have the unfortunate consequence of creating a cliff effect. Multinationals with $499 million in average annual gross receipts avoid BEAT altogether, as do such companies with a base erosion percentage of 2.99%. This has implications for horizontal equity, since two similarly situated taxpayers will be taxed very differently.57 It also produces efficiency losses, since cliff effects push the marginal tax rate on the activity in question very high.58

Another problem with cliff effects is that they reward taxpayers who are resourceful enough to create structures so that they fall just on the right side of the line. For instance, taxpayers may check the box with regard to foreign affiliates so that they become disregarded entities and payments to them are disregarded. Although the taxpayer would lose out on deductibility for purposes of their regular tax liability, the cliff effect in the BEAT may mean such a tax increase is outweighed by the benefit of avoiding BEAT liability.59

B. Gaming Opportunities with Cost of Goods Sold

Importantly, base-erosion payments generally do not include payments for costs of goods sold, except if the company inverted. If a foreign parent incorporates the intellectual property of a U.S. affiliate into a product and then sells the complete product back to a U.S. affiliate, the cost of the product sold does not fall within BEAT. Even if the U.S. subsidiary pays a royalty to the foreign parent for the right to use a trademark on goods purchased by the subsidiary from the parent, pre-existing regulations require that the royalty be capitalized into the costs of goods sold. This means that these royalty payments skip the BEAT entirely.60 This gap in the law creates significant planning opportunities, allowing a large amount of base shifting to escape BEAT liability.61

C. Reform Possibilities

The BEAT thresholds established by the 2017 legislation should be revisited. It may be reasonable to exempt some smaller corporations from the regime’s scope since such companies may not be able to profit shift as effectively and BEAT poses a greater challenge for them as an administrative matter. Instead of a cliff effect, however, the BEAT could be phased in at different income levels. This would reduce the loss in social welfare by lowering the marginal tax rate below 100%.62

Separate and apart from the cliff effect, however, another criticism of the $500 million threshold is that it is simply too high. In the section 385 regulations, which also focus on base erosion, large multinationals are defined as having either $50 million in annual revenues or assets exceeding $100 million.63 These levels are much more appropriate for identifying multinationals with sufficient base shifting activity, and the BEAT threshold should be lowered to similar amounts.64

The 3% threshold for the base erosion percentage should simply be eliminated because of the efficiency and equity costs of the cliff effect. Even if the 3% base erosion percentage is maintained for administrative reasons, it should be restructured to turn on a threshold of base erosion payments as a percentage of taxable income rather than a percentage of total deductions. A small percentage of total deductions could be a large percentage of taxable income, thereby representing a significant degree of base erosion in relation to the company’s overall operations.

Solving the cost of goods sold issue is not so easy. This is because there is no proven method to separate out the intangible component of a tangible sale.65 Additionally, the inclusion of cross-border sales of inventory would present trade and tax treaty issues, similar to those presented by the originally proposed House excise tax.66 Indeed, the inherent difficulty in designing an inbound regime like BEAT raises the argument that more fundamental changes to business taxation may be necessary.

V. going forward: true international tax reform

It is not only necessary to deal with the flaws in the recent tax legislation, but the United States must also manage larger challenges stemming from changes to the global economy. Taxing corporate income will continue to be a formidable challenge given the global nature of today’s economy, the mobility of capital and intellectual property, and strategic responses from other countries. Because of these pressures, corporate income tax revenues are likely to shrink. In fact, as previously mentioned, if one ignores the one-time repatriation tax, the new international tax provisions lose revenue going forward.67

Our international tax system badly needs reform to strengthen rules governing corporate residence. Rather than follow the place of incorporation as the sole determinant of corporate residency, a notoriously artificial and gameable definition, corporate residency could account for factors such as the location of a company’s headquarters or be linked to the residency of its shareholders.68 Our source rules also fall far short in reflecting modern economic reality, and should be thoroughly reexamined. For instance, the rules might be revised to reflect a more destination-based approach, perhaps assigning income to the jurisdiction of the customer base.69

Given the nation’s bleak fiscal outlook and tax competition from other countries,70 it may also be necessary to explore other sources of revenue. Destination-based taxes, which tax where goods are consumed, are of particular interest given the relative immobility of the customer base. Origin-based taxes, like our current corporate income tax, instead levy taxes based on where income is produced or earned—an artificial, easily manipulated, and mobile construct.

Other developed nations have increasingly relied on consumption taxes, like VATs, as supplements to traditional business income taxes. A VAT would not only raise badly needed revenues, but it could apply to the sale of inventory without causing trade or tax treaty issues, therefore helping with inbound base erosion.71 A VAT is often dismissed as a political nonstarter in the United States, but the destination-based cash flow tax proposal of the House is essentially a modified VAT with a deduction for wages. This new type of consumption tax progressed surprisingly far in the reform process.72

Finally, the international system of taxation is predicated on divisions of taxing jurisdiction that have no bearing in the modern global economy. A longer-term objective should be to develop a consensus as to how to tax remote businesses selling into markets from abroad. This should include serious re-examination of our double tax treaty regime, which reinforces archaic conceptions of how income should be allocated among states.73


Although there are reasons to like some aspects of the 2017 tax legislation’s international tax regime, it also has several serious flaws and will continue to be challenged by base erosion and tax competition. If the U.S. rules on international tax remain stagnant, then the TCJA will have been a wasted chance to tackle serious problems posed by the modern global economy. If, instead, the new provisions are an incremental step on the path to true reform, the international provisions in the Act can be judged more leniently. Only time will tell what that verdict will be.

Rebecca M. Kysar is a professor of law at the Fordham University School of Law. This Essay is based on testimony I presented before the U.S. Senate Committee on Finance on April 24, 2018.74 I am grateful to Cliff Fleming, Chye-Ching Huang, David Kamin, Edward Kleinbard, Mike Schler, and Steve Shay for helpful comments and suggestions on that testimony. Thanks also to Molly Klinghoffer for excellent research assistance.