Gary Hufbauer is the Reginald Jones Senior Fellow at the Peterson Institute for International Economics. A seminal thinker and world-renowned expert on international trade, commerce, and taxation, for the past decades, Dr. Hufbauer’s research has significantly influenced the arena of international economics. Few, if any, other scholars have the same profound understanding of the interaction between tax law and trade and commerce, in particular in the international domain. Previously, Dr. Hufbauer was the Maurice Greenberg Chair and Director of Studies at the Council on Foreign Relations, the Marcus Wallenberg Professor of International Finance Diplomacy at Georgetown University, Senior Fellow at the Peterson Institute for International Economics, Deputy Director of the International Law Institute at Georgetown University, Deputy Assistant Secretary for International Trade and Investment Policy at the United States Department of the Treasury, and Director of the International Tax Staff at the United States Department of the Treasury. A prolific writer, Dr. Hufbauer has published numerous books specifically on the subject of U.S. corporate taxation and international tax policy: US Taxation of Foreign Income , Reforming the US Corporate Tax , Fundamental Tax Reform and Border Tax Adjustments , and US Taxation of International Income . Dr. Hufbauer holds an A.B. from Harvard College, a Ph.D. in Economics from King’s College at Cambridge University, and a J.D. from Georgetown University Law Center. In this interview with the Tax Foundation, Dr. Hufbauer dissects the profit shifting phenomenon, highlighting the reasons as to why profit shifting is beneficial and how the current debate concerning the taxation of multinational enterprises is both misconceived and misdirected. Moreover, Dr. Hufbauer examines the history, status quo, and possible future of the U.S. corporate tax and international tax policy; ties together tax policy, trade, foreign direct investment, and economic growth; explores possible implications of further multilateral cooperation in international taxation; and explains why today’s corporation is the modern version of whom Senator Long referred to as, “that fellow behind the tree.” This interview is part of our Tax Foundation Forum interview series and has been edited for length and clarity. Tax Foundation: What is the origin and history of the corporate tax? Gary Hufbauer: If I focus on the U.S. system, going back to the 19th century, our tax system was basically excise taxes and tariffs, particularly on goods like whiskey and tobacco and on imports. That was the basic tax system at the federal level. At the state and local level, states and localities also charged property taxes. From the 19th century leading up to the 20th century, government responsibilities were expanding, and people began expecting more of government. So these older systems of taxation, based on excise and tariff revenue, were not generating enough revenue, and it began to be appreciated that raising tariffs quite high results in the benefits of international trade being lost and also encourages smuggling. When you reach a 30 percent or 40 percent tariff, people are going to try to smuggle the goods; and the same happens with very high excise taxes on whiskey. Everybody has heard about bootleggers, essentially an industry that was created for tax evasion reasons. So the government was casting around for different tax bases. And in 1909—the history is fairly complicated—under President Taft, a compromise was worked out with Congress to tax corporations. This was the period when corporations were particularly unpopular because of the trusts—for example, the tobacco trust and the standard oil trust—so there was a lot of populist resentment of corporations. And Congress was feeding off that sentiment as a reason for taxing corporations. The US Constitution, at that time, mandated that the federal government could not lay direct taxes on individuals, except in proportion to the population of each state. So the only way the federal government could levy a direct tax would be through a head tax or per-person tax. But the corporate tax was considered an indirect tax. So in 1909, before the 16th amendment, it was possible to levy a tax on corporations under the Constitution. The perceived advantage of the corporate tax—which was initially levied at a very low rate, around one to five percent—was that so-called giant corporations of the day, like the big tobacco and oil trusts, were taxed. So it wasn’t you and me or the ordinary people of the day that were being taxed. It was this “object,” the corporation, which was somehow separated from ordinary people; and it was widely believed that it wouldn’t impact ordinary people if corporations were taxed. So that was popular, especially because there was sympathy for punishing corporations at the time. TF: And since its inception in 1909, what have been key events in the life of the corporate tax? Hufbauer: Well, the corporate tax chugged along at fairly low rates until the Second World War. In connection with the Second World War, President Roosevelt and his economics team realized that there would be a vast expansion of government spending. And they recognized that it would be very unpopular if some companies were regarded as “war profiteers.” This sentiment came out of Senator Nye’s hearings in the 1930s. Senator Nye, from North Dakota, retrospectively looked at what firms like DuPont had earned during the First World War and argued that they were behind the U.S. getting involved in the war in the first place, because they made so much money out of it. So President Roosevelt wants to raise money. And he doesn’t want any war profiteers. So he boosts the corporate and personal tax rates to unheard of highs—around 70 percent, just out of this world—to supposedly address the war profiteering and to help pay for the spending during the Second World War. That was a big jump in the corporate tax rate, from rates which were in the five to ten percent range prior to the war back in the 1930s, up to a really astronomical rate in the 1940s. After the war, there was bit-by-bit relaxation. But the rates still remained pretty high until the presidency of President Reagan. I remember when I joined the Treasury in the 1970s we were dealing with a corporate tax rate of almost 50 percent. In the Tax Reform Act of 1986, the corporate rate was lowered to 35 percent, so that was a big reduction. But with state corporate taxes, if you combined the average state rate with the federal rate, you would still be near the 40 percent range. In 1986, that was a big change. But 1986 is almost 30 years ago now. Since then, there hasn’t been much change in this country at the federal level. On the contrary, foreign countries, which previously also had high corporate taxes, often inspired by the U.S., progressively cut their corporate rates over the last 30 years. This has left the U.S. corporate rate—which was rather low in 1986—at the top of the international heap of corporate taxation. And that’s where we are today. Right now, there is an intense debate on how the U.S. should tax the foreign source income of multinational enterprises. Let’s contextualize that. Has this debate occurred anytime previously in U.S. history? Yes. This debate goes back to at least the 1970s, to the so-called Burke-Hartke Act. The context of that day was that many people, including congressmen, believed that when a U.S. corporation opened up a business abroad using a subsidiary corporation or a branch, it was taking away investment and jobs from the United States. It was as simple as that. They believed that a the corporation could either invest here in the U.S. or abroad—in Mexico, Ireland, Indonesia, or China—and they believed in a one-for-one substitution between investment abroad and investment in the U.S. So they viewed foreign investment as basically a bad thing. That was the starting point. Since then, all the serious econometric research completely blows away that picture. Instead, when firms are able to invest abroad, they invest more at home, they do more R&D at home, and they export more. In other words, foreign investment by U.S. firms is a good thing for the U.S. economy. Specifically, what is the firm’s underlying rationale for foreign direct investment, and how does investment abroad benefit the U.S.? Corporations are not constrained by the shortage of capital. The corporations that are investing abroad tend to be the very large corporations, which are able to borrow both in good times and in bad times. They are able to access cash. So it’s not a matter of only having a certain pot of cash and either investing that pot at home or abroad, which is how a household might think of itself. Most households only have a certain amount of income, and they don’t have big borrowing capacity. So if they spend money in one place, they can’t spend it in another. That’s not the right model for a major corporation. It can raise all the cash it needs. The right model is that the major corporation has proprietary knowledge, some of which is patented, some of which is copyrighted, and the bigger part represents trade secrets as to how that business operates. That knowledge base, which has been acquired over time, usually at great expense, is the expertise of the corporation, and it can be applied globally with very little additional cost. When the corporation is able to operate abroad, it can use that knowledge base for doing business globally, thereby earning a better return which, in turn, inspires the firm to increase its knowledge base, venture into new products, new processes, and so forth, enabling a generalized expansion of the firm. I know that model is harder to get a grip on mentally, but that is really what happens. And that’s why when firms can go abroad, they become more profitable, more capable to expand into new lines, and do things cheaper and better at home, in the U.S. So since the 1970s when this debate ignited, how has the discourse evolved? The way that the debate evolved is via a concept called national neutrality of taxation. And what Congressman Burke and Senator Hartke wanted in the 1970s was that, when a U.S. company expanded abroad, it could only deduct the corporate taxes it paid to a foreign government on income earned in that country. The company would have been allowed to deduct foreign taxes when it reported its earnings in the U.S., but it would not have received a tax credit for foreign taxes paid. So Congressman Burke and Senator Hartke’s proposal essentially said that anything left over gets taxed in the U.S. at the standard rate, which at the time was almost 50 percent. If you go through the arithmetic, this would have been a crushing blow to doing business abroad. Let’s say the typical rate abroad at that time was close to 50 percent. So half the profits would go away to foreign governments and of the remaining profit, half of that would go to the U.S. government. The corporation would be left with about a quarter of its pre-tax earnings. But, of course, if the company had instead invested in the U.S., it would be left with half of its earnings. The idea was to kill investment abroad. That was a hotly debated proposal, but it did not get enacted. Going way back to when the 16th amendment was implemented and the corporate tax was codified as an income tax, the system allowed a credit against U.S. tax for the taxes paid abroad on foreign income. And the foreign earnings didn’t have to be taxed until they were returned to the U.S. So that U.S. tax system was moderately favorable to foreign investment, because if a firm returned its income earned abroad to the U.S., it could claim a credit equal to the foreign taxes paid and oftentimes that would completely offset the U.S. tax on that income. And if the company wanted to just keep the income abroad, it didn’t pay any tax on the earnings. The Burke-Hartke proposal would have reversed that completely. It went nowhere. But a lot of other provisions were enacted in subsequent decades, which basically sought to trim the extent to which U.S. firms could earn money abroad and not pay taxes in the U.S. There’s the famous Subpart F provision that was actually enacted before the Burke-Hartke debate, which aims to distinguish between passive and active income. Under Subpart F, the U.S. would tax passive income currently when earned abroad. And all kinds of limitations were enacted on the ability of oil companies to claim foreign tax credits, as well as other limitations. So there was a lot of small chiseling away at the concept of deferral—that is, the concept that a firm doesn’t pay U.S. taxes on its foreign income until it repatriates the money to the United States. But now, we have another big onslaught against multinational firms coming through the proposals that the Obama administration has made. Is the debate more intense now than ever before? It’s more intense than any time since the Burke-Hartke era. So you have to go back to the 1970s, which is 40 years ago, to find an equally intense battle on this issue. Let‘s talk more specifically about profit shifting now. How is the profit shifting phenomenon changing international taxation? We have to remember that populism, which in the early 20th century was aimed against the big trusts, still comes back in various forms today. And it coalesces with the idea that multinational enterprises are harming the U.S. I completely disagree with that proposition. The evidence is completely in the other direction. But that doesn’t mean that populist beliefs, even though they go against all the evidence, aren’t strongly and widely held. And there is another feature, which is a common belief among Americans at large, and in the Congress, that if you tax a corporation, you are taxing “something else.” And the tax is not going to affect me as an individual. So the corporation today is in a sense the modern version of whom Senator Long referred to as, “that fellow behind the tree”? Yes, that’s right, the famous Senator Long statement: “Don’t tax you, don’t tax me, tax that fellow behind the tree.” And the behind-the-tree person is really the multinational enterprise. The thought is, first of all, that large corporations are not particularly good for the U.S. And, secondly, we don’t care if they have to pay high taxes. Such thoughts in turn inspires angst about firms doing what they can, within the law, to reduce their global tax burden. And what corporations do, where possible, is earn income in lower-tax jurisdictions. Now, remember, going back to the 1970s, every major country was charging pretty high taxes, like a 50 percent rate. The U.S. went down to the 35 percent rate at the federal level in the 1986 act. Other countries took notice, and they reduced their corporate tax rates, too. But they went down much further and faster. So after 1986, many countries around the world had lower tax rates than the U.S., and many countries basically didn’t have a corporate tax at all, or had a very nominal corporate tax, in the range of 5 to 10 percent. Naturally, a firm that is doing business globally will seek out the lowest tax rate that it can find and try to locate at least part of its profits in that country. Ireland was a pioneer in going to low taxes. If you hark back in the history of Ireland, the country experienced a very long, bad economic history. But Irish leaders decided to transition from a socialist economy to a capitalist economy. One of their initiatives was to cut the corporate tax rate to about 10 percent. This was so much lower than elsewhere in Europe and in the United States; moreover, Ireland was very decently run with honest courts and other institutions. Consequently, many firms decided to locate their intellectual property assets in Ireland, which meant their patents, trademarks, and trade secrets. And, to the extent possible, they sought to earn the income from those assets in Ireland, where it would be taxed at 10 percent, or now 12 percent, instead of at the prevailing rates in the rest of Europe, which were much higher. By that time, the corporate rates in Europe had come down to the 40 percent range, which was similar to the U.S. level, taking state and federal taxes together. Since 40 percent is much higher than 10 percent, it made sense from a corporate point of view to do as much business as possible in Ireland and save on taxes. In the last two years, many finance ministers have awakened to so-called “profit shifting” to countries like Ireland. And they have initiated a collaborative effort to somehow stop it—to try to keep the money from being shifted, as they say, from someplace where it ought to be to a lower-tax place where it isn’t naturally or it shouldn’t be. The problem with this massive effort is that there’s no clear logical place where intellectual property income—which is a big part of the income of any enterprise—should be based. It’s not like an individual. An individual has a citizenship or perhaps a residence in a country, and it’s pretty easy to say, “That person is based there.” There are complexities when a person moves back and forth across a border, but they’re not big problems. But, for corporations, where is the intellectual property income earned? We can say—if you’re pounding out metal parts or carbon fiber, making turbines in Connecticut like United Technology does—where are all the income from making the turbine and selling it is located. The wages paid there pretty much belong to Connecticut and so forth. But what about the idea of making a carbon fiber turbine: where does that income naturally belong? The ministers in high-tax countries would like to claw back this income from low-tax countries and tax it at their own high rates. That’s the current motivation. And you see all these stories in the media, where the press picks out an individual company. Starbucks is a recent example. These stories make it look as if Starbucks is somehow cheating. Well, I would say it’s not cheating. It’s just doing what any normal, rational business would want to do, which is to get the lowest tax rate possible for its overall operations. What are the unique factors or drivers underlying the profit shifting phenomenon? My main point is that there’s no rational, clear place where the income ought to be located. Using the phrase “profit shifting” implies that we know. Moses has told us that profits ought to be reported in country A. Well, with a multinational enterprise, we don’t know where profits ought to be reported for an awful lot of income. The whole concept of running a big enterprise—by applying a global knowledge base to operations in many countries—makes it unclear where income “should be” located. So there’s no natural tie to a given place. When countries have very different tax systems for corporations, some with very high tax rates and some with very low tax rates, the natural step for any treasurer, finance manager, or CFO is to say, “OK, there’s no logical reason why income ought to be reported in country A, or country B, or country C, so let’s go to country D, where the tax rate is low and report it there.” That’s the big conceptual point. The underlying driver for that decision is that corporate tax rates and corporate tax bases are very non-uniform across countries. Some countries have low rates, some have high rates, some allow a lot of credits for doing R&D, and some allow a lot of expensing for depreciation and so forth. Tax systems vary a lot. But global variations in tax rates and tax bases have existed for a long time throughout history, and profit shifting historically has not been as significant. Right, but what has happened in the last 30 years is that the amount of foreign direct investment—that is, investment whereby the corporation controls the enterprise abroad—has grown tremendously. Since 1980, it has expanded by 20 times. Trade has also expanded very rapidly, by about six times since 1980. So there is now a much denser network of investment and trade between countries than when corporate tax systems were created in their modern post-Second World War guise. Corporate tax systems around the world have been tinkered with and changed since the War, and rates have been lowered, as exemplified by the Tax Reform Act of 1986. But basically, since 1980, the structures are about the same as they were in the 1950s. The difference is that there is much more income and activity that is affected by the differences in tax law and tax rates across countries. In 1980, the amount of investment abroad was significant, but it wasn’t nearly what it is now. I think U.S. direct investment abroad is currently around $6 or $7 trillion. U.S. GDP is about $17 trillion, so about a third of our GDP relates to investment abroad. We also have a lot of foreign investment in the U.S., which is on the order of $4 trillion. These are certainly bigger magnitudes than they were, and there is therefore much more scope for deciding to report profits in a low-tax jurisdiction. Let’s approach this issue from a different angle. Does profit shifting matter? I think profit shifting is a great thing. I know what all the finance ministers have said. The picture they try to paint is that corporations are escaping their “fair share” of tax. I think Treasury Secretary Lew even used a Benedict Arnold characterization that some multinationals are “traitors.” But if he didn’t, then some congressman did. The officials have the story completely wrong. The reason is that the corporate sector, and especially the very large corporations which do most of the innovation that we see in the world, are the engines of growth. It’s as simple as that. It’s not governments that innovate. And for the most part, it’s not very small firms. It is the big firms, which are able to invest hundreds of millions of dollars for undertaking things that nobody thought of 10 or 15 years ago, whether it be the iPhone or a tailored genetic drug treatment. It takes so much money and concentrated brainpower to make these investments. So it’s a big mistake to be taxing heavily the enterprises which are delivering the growth that we want in this world, in this country, or in any other country. Everybody knows the golden goose story. This is the golden goose story right now, trying to capture all the eggs at one time and not nourishing the goose to produce a steady stream of golden eggs. That’s what our tax system is trying to do for populist reasons. And what the corporations in their own individual interest do is push back by trying to reduce their tax burden. I say, “Go for it.” This is what enables the firms to keep growing. If finance ministers in high-tax countries, such as the U.S., Japan, and France, had their way and raised effective tax rates on large corporations, the incentive and ability to create new technology and to spread new technology around the world would be curtailed. This would retard world growth. So profit shifting provides some relief in otherwise highly oppressive tax systems. Now, if countries would come to their senses and phase out the corporate tax or dramatically lower the rates, it would be a different story. Instead, what they want to do is tax profits at their existing high rates. Let’s discuss multilateral cooperation and coordination in international taxation, which is being highlighted at this time. How can multilateral cooperation help address profit shifting or improve the status quo in international taxation? First of all, I think multilateral cooperation as presently conceived is, in fact, misconceived. The effort grows out of the great inequality debate and the fiscal deficits that some countries have—so let’s tax the fellow behind the tree—not recognizing that that’s the fellow who’s going to make the economy grow faster. So I think it’s a highly misconceived effort. The project gives the OECD, the Organization for Economic Cooperation and Development, something to do. It has launched an initiative called “BEPS,” which stands for base erosion and profit shifting, through which the OECD hopes to curb profit shifting. How are they going to try to correct what they regard bad and I regard as good? The OECD will try to tighten up on tax reporting, tighten up on the location of intellectual property and interest income, expand the jurisdiction of tax officials, encourage countries to enact stricter national tax laws, and agree to cooperate more closely with each other. That’s the effort. I think it will die of its own weight. Here are reasons why the project is misconceived and won’t gain much traction. The first reason is that every country in the world, whether developing or advanced, if it has a parliament or congress, the legislators will like to think about the tax system. And from time to time, the legislators will think: “If we provide a certain tax credit or we reduce our tax rate, we will get more business in our jurisdiction. We will get jobs. Firms will locate here and the jobs will come.” You don’t have to look any further than the U.S. states for examples. Many compete in the tax beauty contest. Some states are very business-friendly. North Carolina would be a big example. Nevada would be another example. But many states adjust their taxes from time to time to try to attract firms, or give firms special benefits. It’s very common that legislatures do this within the American states and between countries, and the underlying motivation is growth and jobs. Those incentives are not going away. No international compact will effectively require all countries to have the same tax rate and tax base. The OECD is trying to overcome the political economy objection, which I just presented, by holding all hands together. Well, China is not going to hold hands with the OECD countries. China has very favorable tax rates. Russia is not going to hold hands. Who wants to invest in Russia today? Probably nobody because of the geopolitical story. But plenty of other countries outside the OECD are not going to tie their hands. Even within the OECD, some countries are not going to subscribe. We don’t have to go any further north than to Canada. Canada has a very low federal rate at 15 percent. The U.S. federal rate is at 35 percent, a big difference. Do you think Canada is going to raise corporate taxes halfway to the U.S. rate? Absolutely not. Canadians went through their debate. They see low business taxation is good. The Canadian economy has done very nicely, thank you. And you can go right down the list. Switzerland, for example, isn’t going to raise taxes. As a result of political economy forces, the OECD can get countries to say prayers, but they won’t actually get them to change their laws. There are two other reasons why the BEPS initiative should fail. One reason is that some legislators will actually realize that taxing business at high rates is counterproductive. A high corporate tax doesn’t kill the golden goose, but it slows her down. It slows down investment and innovation. That’s not a good thing when we’re in a period of low growth, a lackluster global economy. The other reason is that the OECD should have concentrated on the taxation of individuals rather than the taxation of business. As we know, a fair number of individuals in this country—and in other countries as well—try to hide their income abroad and not pay any taxes. The Internal Revenue Service has attacked that, by zeroing in on certain banks which were collecting deposits from people who were trying to avoid taxes. There has been some progress, but there could be a lot more progress on making the taxation of individuals less evasive. A project along those lines would have made sense. The BEPS initiative doesn’t really make a lot of sense. Let me come to another aspect of corporate taxation, which I haven’t talked about yet, where the U.S. is way out of line with the rest of the world, way out of line. Other countries basically say to their firms: “What you earn abroad will be taxed abroad. We’re not going to tax it at home or if we tax it at home, it will be at a very low rate.” The U.S. says to its multinational enterprises: “What you earn abroad will be taxed at the U.S. rate after allowing a credit for the foreign tax, when you bring the money home.” Ours is called the worldwide tax system. The dominant model in the world today is the territorial system. Every country of importance has territorial taxation. Are these other countries all going to join the U.S. system and start taxing the worldwide income of their multinational corporations, whether it be Shell, Nestle, or CNOOC? Absolutely not. But the U.S. Treasury, which at the get-go was a leading motivator for the BEPS initiative, is not only trying to stick with the worldwide tax system, it’s trying to end deferral so that all income earned abroad is taxed at the U.S. rate this year, not in some distant future. So countries are going in very different directions within the BEPS framework. It seems to me it will be very hard to come up with agreed rules that will make a big difference in the extent of profit shifting. So I’m inferring that you’re saying this: Theoretically, a higher degree of multilateral cooperation could be a solution to address profit shifting, but it’s practically infeasible and probably undesirable. Right. It could work, in some kind of dreamland, where countries all agreed to the same tax base and the same rate or close to the same rate, let’s say within a 5 percent range. On that basis, theoretically, it could happen. However, as I noted, the political economy is against that outcome. You just have to look at the states of the United States. They have very different tax systems. New York, for example, has very high tax rates. Florida has no income tax. So we don’t even have any uniformity within the U.S. How could you expect uniformity across countries in terms of the base and the rate? That’s problem number one. Problem number two is strong evidence that it doesn’t make any sense to be taxing corporations at all. What makes sense is to concentrate on the personal income tax. And there the weakness is exchange of information across borders so that authorities can actually collect personal income tax from individuals. But we have multilateral cooperation across countries in trade, of which the General Agreement on Tariffs and Trade (GATT) and the World Trade Organization (WTO) are prime examples. So how is multilateral cooperation in taxation different compared with trade? That’s an excellent question. There is very strong cooperation in trade, as you say, but the cooperation in trade means reducing barriers to foreign companies exporting their products to other countries. That’s the heart of cooperation, reducing barriers—whether they be behind-the-border barriers, tariffs, or quotas. And there’s general agreement amongst firms and countries that reducing those barriers is a good thing because of incentives to greater productivity at home, the mechanisms of comparative advantage, and scale economies. So that kind of cooperation, on the whole, works with multinational business. Most firms appreciate the opportunity to do business on a global scope because they have high overhead cost to maintain their knowledge base which they can spread over a larger domain. That’s the engine driving trade agreements in the World Trade Organization, the Transpacific Partnership, the Transatlantic Trade and Investment Partnership, and many others. In the tax area, it’s not corporations that are the driving force. It’s finance ministers who are responding to their desire to raise more money in a way that doesn’t seem to affect their own domestic populations. Or if it affects them, it’s in a way that’s hard to see. So tax cooperation is essentially a revenue-driven effort, and that’s a completely different motivation. In one case, cooperation is working with the forces of globalization, and in the other case, attempted cooperation is actually working against the forces of globalization. The BEPS project is running right into head winds, and that‘s a big difference. But in a formal sense, you could say trade and tax are both efforts at multilateral cooperation. In the trade area, some countries for their own particular reasons want to maintain very high trade barriers. They don’t see the advantage to their firms of access to foreign markets or the advantage to their own economies of foreign access to their home markets. Therefore, they maintain high barriers. Those countries simply do not participate in trade agreements in an effective way. They don’t join in. They will be free riders if foreign markets are open. But they’re not going to open theirs. What are countries that match that description? Well, a very big case is Brazil. Great country—it has a lot of natural attributes and some good policies, but open trade is not one of them. So with respect to Brazil, multilateral cooperation just doesn’t work because many Brazilians don’t see the advantage to them of engaging in the global economy. There are other countries, too. I would put South Africa and Indonesia in the same camp as Brazil. And India is very much in that camp right now, though maybe moving away from that camp slowly. But most countries and companies do see the benefits of getting rid of trade barriers. Assuming that there would be more multilateral cooperation in international taxation, what would that mean for U.S. lawmakers, U.S. firms, and U.S. tax revenues? If there was multilateral cooperation, I really think the U.S. would have to come more towards the world norm. In practice, that would mean the U.S. would have to come closer to a territorial system, meaning taxing income earned abroad at a much lower rate than it now attempts to tax income earned abroad. The U.S. would also have to lower its federal corporate tax rate. People have talked about a federal rate between 28 percent and 25 percent, and I’ve said 20 percent. In any event, the rate needs to be lowered significantly. I think that’s the only basis for multilateral cooperation. If that happened, the short-term effect would be pretty good for the U.S., because the U.S. would be reducing its overall tax burden on multinational enterprises. It’s conceivable that the U.S. could persuade other countries to raise their rates and abandon their territorial systems. But it’s very hard for me to imagine that scenario. Nevertheless, you can paint such a picture, but the results would be bad for the world economy. It wouldn’t maybe change the situation here in the U.S., but it would mean that other countries would be choking their own golden geese, taking away so many engines of growth, and condemning themselves to slower growth than they would otherwise experience. If there is some kind of multilateral agreement to have similar tax rates and tax bases, that would weaken the competitive force between countries to further reduce their corporate tax rates or further narrow their corporate bases, for example, by allowing expensing of all investments. An important competitive dynamic would be removed. Even if you went to lower rates to begin with, the long-term outcome would be unfortunate because harmonization would weaken the long-term dynamic to reduce rates—hopefully, down to the 5-10 percent level over another 15-20 years. Since 1986, there has been a big reduction in corporate tax rates globally. That would come to an end under any multilateral harmonization arrangement—a move in the wrong direction. But something else would happen—and this is more obscure—but quite important. Suppose we froze all the corporate rates and corporate tax bases in the world and we actually made them uniform. So there was a uniform 25 percent rate and a uniform definition of the corporate tax base, including tax credits, and so forth. What would happen then is that countries that wanted to attract business, since they couldn’t change their tax rates or their tax bases, they would give subsidies. Governments would increasingly give subsidies to corporations to locate activity in their country. There are many ways to dispense subsidies. You can build dedicated roads, you can create a nice plant location, build housing for the staff, and so on. Many things can be done. That would be unfortunate, because subsidies are always less uniform than taxes. Even though taxes are not uniform, subsidies are very much less uniform. They depend on the lobbying strength of the firm. Big firms can get them, small firms cannot. So tax harmonization wouldn’t eliminate competition for attracting business. It would drive it in a different direction than currently exists—and in a less fortunate direction. So that‘s my view of the outcome of a truly successful BEPS initiative. But wouldn’t a higher degree of multilateral cooperation make it easier for firms to operate on an international basis? I don’t know. It would make it easier in the sense of filling out a single form and then paying out the money. That’s easier in a world that doesn’t have computers. If you had to fill out forms by hand with pencils, the simplification is easier. But today it’s all done through technology, and there are many clever people who can deal with different forms very quickly. So the paperwork burden is more than offset by that the consequences of what would happen with tax uniformity. Could multilateral cooperation, if we move in that direction, be an impediment to lawmakers? Oh, sure. What it supposedly does is tie the hands of lawmakers to reconsider the tax system and change it as needed from time to time. I don’t think they’ll like it. I don’t think they’ll go for it. We do tie our hands on tariffs. We agree to bind them in the GATT, which means we’re not supposed to increase them. If we do increase them, we pay a penalty to countries that export to us. Are you going to impose that same kind of system for changes in the tax law? It boggles my mind that legislatures worldwide would accept that kind of limitation on their freedom of action. In a directional sense, what are possible implications of multilateral cooperation for U.S. tax revenues? In a directional sense, it depends so much on whether the multilateral cooperation moves our rates down significantly; in which case, it’s going to improve revenues, because the U.S. will get more investment. And more investment will mean better-paid jobs and an increase in the overall revenue stream. So, in that sense, it would be great if that were the outcome. If multilateral cooperation moves effective tax rates up, then it’s just the reverse. It may seem to be a better tax revenue pay off, but what will happen is that business will migrate to so-called pass-through forms. And it will increase the incentive for U.S. firms to relocate their headquarters abroad. Firms might say: “If you want to attribute the intellectual property to company headquarters, oh, well, if that’s what you want to do, Mr. Uncle Sam, we’ll just move our headquarters to the Netherlands.” So it really depends on how the cooperation comes out in terms of what it means for tax revenues. But the important thing is that higher rates do not mean more revenue. What they mean is more incentive for firms to leave or take important parts of the corporate enterprise abroad. But aren’t there other positive spillover effects or benefits in general of multilateral cooperation, for example, in how we determine taxing jurisdiction, in arm’s-length pricing, and in reporting? There are other areas than just looking at the tax rate and tax base. Yes. That’s right. There are areas where it could be quite constructive. And, as I noted, the area where it could be most constructive is general disclosure of personal income for persons moving back and forth across borders. That reporting system is very creaky and doesn’t really work at the moment. But multilateral cooperation could also be beneficial for determining taxing jurisdiction, transfer pricing, and reporting. All of those areas could be substantially improved. Now, company reporting is on an ad-hoc, company-by-company basis. When there’s some suspicion that there’s funny transfer pricing, the Internal Revenue Service comes in and asks for the books and records and then launches a case, which might last 5 or 10 years. So a more systematic and efficient reporting system would pay benefits. I agree that as long as multilateral cooperation is stuck with better-informed reporting, that would be an improvement. It’s when multilateral cooperation involves coordination of tax bases and tax rates that the mischief begins. How should profit shifting be addressed from a U.S. perspective? For the U.S., what is defined as profit shifting in some of the academic articles that I’ve read suggest that it’s a bad thing. But it has actually been a great thing, because it has enabled multinational enterprises based in the U.S. to have lower effective rates than otherwise. And it has reduced the incentive to move headquarters or even production facilities abroad. It’s been a good thing for the U.S. Not appreciated, but it has been a good thing, because if we really taxed all corporate income at our high statutory rate, firms would be inverting or bought out by foreign firms at a massive rate. That’s happening, but so far, it’s at a modest rate. We would be so much worse off if we didn’t have profit shifting because we haven’t been willing to reduce our corporate tax rate to the level of other competing countries or narrow the corporate tax base. So it has been a great thing for the U.S. to be as competitive as we are. Now, if we tighten up domestically and try to prevent this—whether we get foreign cooperation or not—what is going to happen is that there will be many U.S. enterprises which would have a much lower tax rate if they were owned by a foreign company, at least with respect to their foreign subsidiaries, and they will be sold off over time. Our foreign direct investment footprint will probably still grow, but it will grow at a slower rate. It could conceivably even shrink. What this is going to mean, in turn, is a reduction of the amount of headquarters, R&D activity, and brainpower in the U.S. running these global enterprises. That would be very unfortunate. We might collect a little more revenue in the short-run, but in the long run, we’ll collect less. But that certainly could happen, and it could be very unfortunate for the U.S. in the long-term. So if we’re concerned about profit shifting, all else constant, we need to reduce the rate? Dramatically. If we reduce the tax rate dramatically, there will be profits shifted in to the U.S. It will mean jobs shifted in to the U.S. It will reverse the flows. What major developments do you expect in the next 1-2 years with respect to international taxation? As I’ve indicated, I don’t think the BEPS initiative is going to produce much more than general hortatory guidelines that countries ought to follow. Countries will follow or not, according to their own decisions as to what’s useful for them. I expect—not this year nor next year, but after the next administration comes into office—a serious look at our corporate tax system. I expect the corporate tax system to go towards a territorial system and a general reduction of the rate from 35 percent down at least to 25 percent, and it’s conceivable it might go down to 20 percent. And there will perhaps be some measures implemented that make our corporate tax system more competitive than it is now—in particular, provisions such as accelerated depreciation or even 100 percent depreciation. Given the very lethargic investment we’ve had, why not encourage companies to invest more? I think that’s the outlook in 2017 for the corporate tax system. We started this interview by focusing on the origin and history of the corporate tax. Let’s end by looking ahead: What is the future of the corporate tax? My vision of the future is to eliminate the corporate tax—thanks to tax competition between countries and thanks to its own illogic in the way it discourages investment and innovation. It discourages the fastest growing companies. By definition, it taxes heavily those companies which are very successful, so naturally it’s going to slow down growth. Companies which don’t earn much money don’t pay much corporate tax. The system discourages both investment and innovation. These ideas are gradually taking hold in legislatures around the world. And I think in time—perhaps 20 years from now—the corporate tax will be history. In the U.S., we’re beginning to make it history because we have created a huge variety, about six different kinds, of so-called “pass-through business entities,” which do not pay corporate tax. They currently account for about 50 percent of U.S. business activity. So another way that the corporate tax can gradually wither away is for the definition of pass-through entities to be enlarged, with more Subchapter C corporations becoming pass-through entities, like master limited partnerships. In 20 years time, I think the corporate tax will be seen as an historic relic. It may not disappear completely, but it will be confined to a small sector of the U.S. economy. So the person who is behind the tree right now, the corporation, probably won’t be behind the tree nor be taxed in 20 years? Not the way that person is taxed now. Individuals will still be taxed. We might have a national value added tax. That’s another way that the U.S. is completely out of the norm because virtually all other countries have the value added tax. But the tax on corporate profits, I think, is on its way out. For more of Dr. Hufbauer’s perspective on these issues, see: Farewell to the Federal Corporate Income Tax: Part I , Farewell to the Federal Corporate Income Tax: Part II , Four Questions About the OECD’s BEPS Project , and his comments submitted (p. 7) to the OECD’s “Action 11” public discussion draft regarding the establishment of methods to better collect and analyze data on base erosion and profit shifting.