Abstract.
International transactions are very important as they determine the total amount of global income as well as the distribution of income among nations. This research paper analyses the international tax policy which taxes the profits accrued from international business transactions and its impact on global trade. This information is based on the current literature reviewed from books and business related journals as well as on research findings and views given by various economists on the issue of taxation of international transactions.
From the research findings it can be concluded that the international tax policy as applied in the U. S puts its multinational companies at a high tax disadvantage as compared to those located in other countries thus discouraging international trade. In addition, the policy does not raise the expected revenue and hence some reforms are needed to make it more effective.
International Tax Policy.
Tax policy is the process by which the government of a given country plans on the best way in which to collect taxes from its citizens. Nations are diversifying in terms of their business from interdependence to creating lasting business relations with the other nations in the international market. With the increased globalization and revolution taking place in the business world, the international tax environment has also greatly changed and the old taxing methods are being challenged by new modern technological systems (Grubert, 2006). With this kind of revolution, the international community has set up a tax policy to harmonize all taxing systems.
International tax policy constitute of policies aimed at taxing the international capital flows and different security transactions carried out in different countries. This taxations facilitate a rise in the amount of revenue collected by the second-world countries. In addition, the policies offer substantial benefits to these countries at a national level through macroeconomic dividends (Rosanne and Harry, 2006). Such dividends transfer an even greater financial advantage to the global markets since it is believed that a financially stable domestic market yields an even more stable global market.
However, it has been discovered that the international tax policy experiences some controversies concerning the taxation of international transactions as well as conflicts arising from other non-tax policies. Nations belonging to the OECD organization have had a change in their tax policies in the recent past and this has led to an increase in the simultaneity of the implementation of the policies. According to John (2008), an efficient tax policy should be economically efficient, should be fair when taxing domestic and foreign investments, should be simpler and lastly, it should encourage economic growth.
In addition, an international tax policy should conform with international norms set by the international community and should also promote international trade among nations.
According to Grubert (2006), there is a great need to reform the international taxation mechanisms because the domestic markets are becoming more and more globalized by the day and the increased levels of technology are likely to lead to even faster and more efficient ways of communication and exchange of transactions between nations all over the world. If this happens, the current tax policies which are mainly based on the geographical characteristics of a nation in terms of its location and the national income are more or less likely to be nullified since the nations will now be highly developed economically. For this reason, newer and more efficient systems for tax jurisdiction are needed to accommodate the fast changing economic world. All these issues have led to the establishment of an international tax policy for the 21st century. The international tax policy has the following major objectives;
To help the developed countries to maintain a competitive advantage in their foreign business investments.
To balance the tax equity between the domestic and foreign investments.
To establish a fair ground on which foreign investments can be taxed.
Facilitate fair considerations on foreign tax policies.
Promote investments in the developed nations.
Improve the efficiency of administrative policies.
Background information.
The international tax policy was established in early 1980s and its key dominant player is the U. S. Since its establishment, a controversial debate has arisen concerning this policy especially since the formation of Tax Reform Act of 1986. This is due to the existence of differences between the U. S international tax policy and the development of the global market in which the U. S is an equal competitor. This debate is mainly based on two contrasting theories related to the neutrality of taxing systems. One of these theories is the territoriality theory whose main concern is to prevent the reduction of domestic taxes and increase the competitiveness of the foreign investments made by the domestic tax-payers. According to this theory, a nation should not tax all foreign sources of income because it has already been taxed in the country where it is earned. The other theory is known as the theory of capital export neutrality and it supports a tax policy which does not tax investors who have a choice between investment opportunities available locally or internationally. This theory seeks to impose taxes on any income earned from foreign investments and allow a special discount on amount of foreign taxes paid to other countries. The international tax policy was founded on the theory of neutrality although the policy has since then been modified to fit the needs of the rapidly developing global market.
This tax policy is mainly concerned with ensuring that the amount of income earned from foreign investment is subjected to as much tax deductions as the income earned from domestic investments in the home country. The U. S international policy is highly concerned with preventing its tax code from encouraging its citizens to invest in foreign countries while at the same time, it encourages the citizens to invest in its domestic market. Experts argue that if taxes are exempted on income earned on foreign investments this would be unfair for the domestic investors and thus people would prefer to invest abroad than in the local market.
Impacts of international tax policy on global trade.
Foreign trade contributes a great deal to the economic status of many nations. This involves exportation and importation of goods and services. For instance, previous researches on the U. S economy have showed that it has in the recent past benefited greatly from the international trade where it has been identified as a net exporter and importer of many goods and services. According to a research by the U.S based Institute on International Economics, the U. S economy earns more than 15% GDP from the foreign trade and investments. Being a net importer implies that the U. S economy basically requires and invests more than what it is able to produce. Currently, the amount of foreign investments have increased greatly and so has the level of domestic investment in the country.
Additionally, it can not be disputed that international trade contributes a great deal to the overall global income and also determines the pattern of income distribution among nations. Such international investments also influence the ways in which capitals are distributed among nations. Since each government has its own way of deducting taxes, the provisions provided by the international tax policy can interfere with the international investments and may even lead to a reduction in the stability of the global economies (John, 2008). The extent of such interference depends on the policies put in place to tax income gained from any foreign or international investments. For instance, if such income is taxed only once, say at the source, a significant amount of the capital would be directed towards the low-tax jurisdictions rather than investing it in projects which would incur higher capital return before taxation. In addition, if the domestic taxation system of a nation is same as that accepted by the international community like in the case of U. S, then the low-tax countries are likely to enjoy more investments and increase their market niche by lowering their prices much to the disadvantage of the high-tax countries.
In this case, there is a shift of capital from more productive countries to less productive uses and this results in a decline in the overall global incomes and may also lead to inefficiency in the global trade. This is one of the biggest problems associated with taxation of international business transactions and according to experts, it can only be solved by equalizing the tax rates rates in all countries worldwide. However, this solution is not practical considering the differences in national preferences in relation to the tax rates across nations (Desa, Mihir and James, 2007). The other alternative to solving this problem is the use of the capital export and capital import neutrality theories which form the basis of the international tax policy.
The principle of capital export neutrality recommends a system whereby the amount of tax deducted from income earned by a given investor situated at a certain location is the same as that deducted even when he or she decides to relocate the investment to any other part of the world. In this case, the choice of where to invest is not dependent on the tax rates since the rates are the same all over.
On the other hand, the principle of capital import neutrality advocates for an international tax system which ensures that tax rates imposed on all the profits accrued from domestic investments located in all nations are the same. Experts argue that this principle is bound to promote national competitiveness of a nation. However, although these two principles form a very desirable base for taxation of international transactions, they can not be attained simultaneously if the tax rates among nations are not equalized.
Impact of International tax policy on international business transactions.
The U. S international policy based on the theory of neutrality imposes equal tax measures on income earned from foreign investment and the income earned from domestic trade. The international business transactions which are commonly carried out by MNCs are however only taxed after the all the profits collected from their different affiliates have been repatriated back to their home country. This fact causes a delay or a deferral of taxes and it also serves as an incentive for the MNCs to invest more in the low-tax countries as compared to their level of investments in the high-taxed countries including their own home country (U. S). Many international transactions likely to be affected by the international tax policies are those carried out by the MNCs (John, 2008).
Multinational companies or MNCs are businesses which carry out transactions across regional borders and they have their investments located in many different nations. Such companies are greatly affected by the international tax policy either positively or negatively. For instance, it has been found out that the current U. S international tax policy encourages its MNC firms to invest in countries which have low-tax policies thus enabling them to postpone the imposition of taxes in their home country until they gather enough profits for repatriation. This aspect encourages the companies to invest in assets, investments and provide employment opportunities in the countries where they are situated.
From the literature reviewed on this issue, it can be established that the international tax policy has the following major impacts on the global trade. One, the variation of taxation rates among nations serves as an incentive for business companies and MNCs to alter the prices of their goods and services in the countries where the tax rates are low. This is done by underpricing their products and overpricing their purchases to reflect that they have lesser taxable profits than the actual amounts. This enables them to earn high profits and evade deduction of huge taxes.
Moreover, this tax policy encourages MNCs to shift profits to the low-tax nations in which their activities are mostly centered. This fact has especially been strengthened by the recent temporary break on deduction of taxes from repatriated incomes earned by foreign investments (Kimberly, 2004). This move has been provided for by the American Jobs Creation Act of 2004.
In addition to this, the MNCs can also borrow money from their affiliate businesses in the highly-taxed nations and invest it in the low-tax countries thus shifting their overall income benefits. This will help the businesses to register higher profits in the countries where they are taxed less. Other studies have shown that the decisions made by the MNCs on where, when and how much to invest are largely dependent on the international tax rates reflected by the tax policies of different countries.
Effect of the the international tax policy on the international competitiveness of a nation.
International competitiveness can be defined as the ability for domestic firms to compete favorably with the other firms in the global markets. It can also be defined as the nation’s ability to sustain a positive balance in its international financial accounts as compared to the other nations in that region.
The U. S international tax policy has not had a significant direct contribution on the national competitiveness but it has indirectly led to an increase in the national competitive advantage of the country by making U. S to appear more attractive and viable for foreign investments, establishment of production plants as well as a source of employment opportunities for both skilled and unskilled personnel.
On the other hand, the international tax policy has however failed to encourage the establishment of MNC firms as well as their headquarters in the U. S due to the high tax rates as compared to the other countries abroad such as the Irish. For this reason, the MNCs prefer to establish their headquarters in other countries where their foreign incomes are not highly taxed. This factor has weakens the U. S national competitiveness and at the same time, the competitiveness and viability of the multinational companies is also highly influenced by the international tax policy. In this case, the tax policy helps the MNCs to choose the countries where its best to invest, the country where they should locate their headquarters and so forth.
According to Alan (2007), there are several undesirable impacts of the international tax policy which indirectly contribute to a weaker national competitiveness of U. S in the international market. Some researches carried out by the Institute for International Economics in U. S have indicated that the tax policy is likely to favor investments within the U. S as compared to investments in other overseas countries. This policy has two major drawbacks in that for one, it leads to double taxation of income earned from foreign investments and this reduces the number of foreign investments because such investments are put at a higher tax disadvantage as compared to the domestic investments. Secondly, this U. S policy is likely to encourage other neighboring countries to practice the same and this would lead to a reduction in the number of people investing in the U. S thus affecting the welfare of international trade.
In addition, some economic experts have argued that the concerns over the competitiveness of U. S MNCs firms are often based on the assumptions that such firms often benefit the economies of the nations where they are located through spillovers. If at all this is the case then, the use of the international tax policy by the U. S government should be adjusted to favor income earned from foreign investments and ensure that their MNC firms are not at a tax disadvantage compared to those located in other low-tax countries (Allan, 2007).
Conclusion.
From the findings of this research paper, it is clear that the implementation of international tax policy in U. S and the imposition of taxes on income earned from foreign investments has had many positive as well as negative impacts on the international trade and the country’s national competitiveness in the global market.
The current system of international taxation has provided incentives for the MNC firms to invest and develop their economic activities in the low-tax countries as well as their headquarters and this has weakened its international competitive advantage. In addition, this policy is highly complex and it does not raise as much revenue as would be expected. This implies that there is a need for this policy to be modified in order to promote international trade between the U. S and other countries in the world.
Several reforms which might help to improve the efficiency of this international tax policy according to Gary (2005) include, avoiding deferral of taxes when taxing income earned by the MNCs foreign investments or replacing this policy with a more flexible policy which exempts foreign income from taxation to encourage more people to invest in the foreign markets.
References.
Alan, D. (2007). Border Adjustments Won’t Promote Competitiveness. Boston: MacGraw Hill.
Desai, R., Mihir A., and James R. (2007). Value Added Taxes and International Trade: The Evidence. Harvard: Harvard Business School.
Gary, C. (2005). International Economic Policy Briefs PB02-10. Washington, D.C: Institute for International Economics.
Grubert, H (2006). Enacting Dividend Exemption and Tax Revenue. National Tax Journal 54, no. 4 : 811-27.
John, M. (2008). Taxing Multinationals in a World with Portfolio Flows. New York: Macmillan Publishers.
Kimberly, A. (2004). The American Jobs Creation Act of 2004: Creating Jobs for Accountants and Lawyers. Tax Policy Issues and Options Brief 8 (Washington: Tax Policy Center, December 2004).
Rosanne, I. and Harry, G. (2006). Dividend Exemption and the Location Decisions of U.S Multinational Corporations. National Tax Journal of U.S 54, no. 4 : 787-809.
