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Monday, March 29, 2010

Tax Treaty Legislation in the 111th Congress: Explanation and Economic Analysis

Donald J. Marples
Specialist in Public Finance

"Treaty shopping" occurs where a foreign parent firm in one country receives its U.S.-source income through an intermediate subsidiary in a third country that is signatory to a tax-reducing treaty with the United States. Supporters of proposals to curb treaty-shopping argue that it would restrict a practice that deprives the United States of tax revenue and that it is unfair to competing U.S. firms. Opponents maintain that proposals to curb treaty-shopping would harm U.S. employment by raising the cost to foreign firms of doing business in the United States and may violate U.S. tax treaties. In addition, some Members of Congress have objected to the use of revenue-raising tax measures under the jurisdiction of tax-writing committees to offset increases in spending programs authorized by other committees. 

In the 111th Congress, the America's Affordable Health Choices Act of 2009, H.R. 3200, the Affordable Healthcare for America Act of 2009, H.R. 3962, and the Small Business and the Infrastructure Jobs Tax Act of 2010, H.R. 4849, include tax-treaty proposals which would restrict in certain cases the use of tax-treaty benefits by foreign firms with operations in the United States. The most recent preliminary revenue estimates projected a revenue gain of $3.8 billion over 5 years and $7.7 billion over 10 years, which would be used to partially offset either the cost of health care reform or provide tax relief to small businesses and extend the Build America Bonds. These provisions are identical to the provision offered in the Tax Reduction and Reform Act of 2007, H.R. 3970, during the 110th Congress. 

Economic theory suggests there is an economically optimal U.S. tax rate for foreign firms that balances tax revenue needs with the benefits that foreign investment produces for the U.S. economy. Under current law, the treaty-shopping arrangements some foreign firms undertake may combine, in some cases, with corporate income-tax deductions to eliminate U.S. tax on portions of their U.S. investment. In these cases, economic theory suggests that added restrictions on treaty-shopping would improve U.S. economic welfare. This analysis, however, does not consider possible reactions by foreign countries where U.S. firms invest, nor does it consider possible abrogation of existing U.S. tax treaties.

Date of Report: March 17, 2010
Number of Pages: 10
Order Number: R40468
Price: $29.95

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