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A Global Tax System Is Good for the US

The US system for taxing international corporate income has long been dysfunctional. It is needlessly complex and distorts business decisions while failing to raise much revenue, thus forcing higher taxes elsewhere to make up the difference. Policy makers have the best chance in generations to reform and improve this system while bringing the rest of the world along. Treasury Secretary Janet Yellen has already helped craft an international agreement signed by more than 130 countries. Congress now needs to do its part and lock it in.

The two approaches to international taxation are worldwide taxation, in which a corporation’s home country taxes its entire global income, and territorial taxation, in which income is taxed only by the country where it is earned. Neither system is perfect, and both inevitably create some distortions.

A worldwide system can impede the competitiveness of American companies by raising their costs relative to those of competitors legally domiciled in other countries. A territorial system, on the other hand, creates an incentive to locate production and shift reported profits overseas.

Before 2017 the US followed a third approach that combined some of the worst features of both, which I call a “stupid territorial” tax system. It intended to tax US corporations on their worldwide foreign earnings but in practice afforded them tremendous opportunity to defer those taxes permanently, in effect allowing them to create a territorial system for themselves while leading to massive buildups of overseas income.

President Trump and the Republican Congress reformed this system, replacing it with a hybrid system that included a minimum tax called Global Intangible Low-Taxed Income, or Gilti, for companies that earned a high rate of return and also paid low taxes overseas. This plan took some steps toward a more rational system, recognizing the necessity of a compromise between worldwide and territorial. But it also took some backward steps on rates and in technical details, like allowing companies to apply the minimum tax based on their worldwide average rate instead of on a country-by-country basis.

The arguments for building on and fixing Mr. Trump’s reforms were already strong, but the global agreement secured by Ms. Yellen makes them much stronger. In particular, the global agreement removes the main objection to more aggressively taxing overseas income because other countries have all agreed to adopt similar systems. The concerns that US companies would be less competitive or would try to avoid US taxes by incorporating overseas are considerably smaller than they would otherwise be.

Conversely, the risks of inaction have increased. The global minimum tax agreement includes an undertaxed payments/profits rule, or UTPR. This mechanism would allow any country to enforce the agreement against companies headquartered in countries without minimum tax laws. In other words, if the US leaves the agreement, American companies could find themselves at a disadvantage. Even without this enforcement mechanism, the absence of an agreement would risk replacing the recent spirit of cooperation with messy tax and trade wars.

Last year the House passed a set of international tax reforms that are a good starting point for continued congressional consideration. As a large economy, the US has the scope to go modestly beyond the international agreement with relatively little downside. Some provisions should be updated to match the global agreement better, particularly the one that implements the undertaxed payments rule.

The global minimum tax agreement signals the dawn of a new era of international economic cooperation. It will be good for the countries involved and may even be popular. It is pragmatic and, if anything, relatively minimal in only establishing a 15% rate floor. If Congress doesn’t pass legislation to implement it in the US, we could end up with something even worse than the stupid territorial system we had before President Trump.

Mr. Furman, a professor of the practice of economic policy at Harvard University, was chairman of the White House Council of Economic Advisers, 2013–17.

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