Introduction
The Unites States’ tax system has often been the subject of economic debates. Several stakeholders have called for an overhaul of the United States’ tax regime. Currently, the United States has what is often considered as an ‘odd’ tax system. The main distinction between the United States’ tax system and that of most countries is the manner in which the earnings that are made in foreign countries are handled when they are repatriated back to their parent countries. Most countries do not tax money that is earned in other countries or outside their territories of interest. This mode of taxation is known as the territorial tax system and it is commonly used by countries around the world. On the other hand, the taxation system that taxes earnings that are made in foreign countries is known as the worldwide tax system. The worldwide tax system is only used in a few countries around the world including the United States. There are big differences between territorial and worldwide tax systems. Most of these differences apply to the taxation of corporations and other multi-national companies. One of the countries that recently made the switch from worldwide to territorial tax is the United Kingdom. The fundamental differences between the United Kingdom and the United States’ tax regimes have far-reaching impacts. This paper compares the United States’ worldwide tax system with the United Kingdom’s territorial tax system.
The Worldwide Tax System
The worldwide tax system stipulates that all income from domestically headquartered entities has to be subjected to taxation even though it comes from foreign countries. However, most of the countries that use the worldwide tax system offer tax credits in order to avoid instances of double taxation. These tax breaks cover the amount of money that is paid as taxes to foreign governments. The main logic behind worldwide tax systems is to ensure that all citizens are equally taxed irrespective of their global location. Consequently, individuals and companies cannot move to destinations that offer lower tax options irrationally. For example, a company that has its headquarters in the United States is obligated to pay taxes on all its income whether it is earned in the country or through its subsidiaries in other countries.
The Territorial Tax System
The territorial tax system stipulates that countries can only collect revenue from money that is earned within their borders. Therefore, during taxation, all the income and dividends that are earned from foreign subsidiaries are exempted from domestic taxation. The main purpose of the territorial tax system is to ensure that all entities are offered a level playing field when investing. In addition, the territorial tax system ensures that individuals and companies are at liberty to invest their capital where the return on investment is best. For example, a company that is headquartered in the United Kingdom does not have to pay taxes on most or all of its income from foreign subsidiaries.
Overview of Tax Different Systems
The United States’ tax system is worldwide but no money can be taxed until it is repatriated back to the country. Taxation for non-repatriated money only occurs in special circumstances within worldwide tax systems. Taxation on foreign earnings is one of the pillars of the Unites States’ economy because it maintains a stable business environment within the country. For instance, countries cannot use profits from more conducive business environments to compete with local companies unfairly. Therefore, most countries are faced with the option of retaining their earnings in foreign countries or repatriating them to the United States where they are taxed. Companies in the United States are partially cautioned from foreign-based business instabilities through the worldwide tax system.
Most developed economies employ the territorial tax system because of its ability to foster good international business environments. Previously, worldwide tax systems were popular with most developed countries. For instance, in the year 2000, a majority of the countries under the OECD (Organization for Economic Co-operation and Development) umbrella utilized the worldwide tax system. However, the situation has rapidly changed within the last decade as only seven out of the thirty-four OECD countries are currently using the worldwide tax system. Interestingly, the United States has constantly been urged to shift to the territorial tax system by several advisory committees on the country’s taxation issues.
Comparison of the United States and the United Kingdom
A comparison of the United States and the United Kingdom’s tax systems involves exploring their effects on the respective economies. Furthermore, statistics such as foreign direct investments, unemployment rates, and tax revenues amounts are part of the comparison. About five years ago, the tax systems of both the United States and the United Kingdom were almost similar. The United Kingdom’s decision to shift from worldwide to territorial was motivated by the need to ensure that the country’s companies were competitive in the global arena. The United Kingdom’s decision was preceded by rigorous efforts to come up with a more competitive and global tax system. The efforts were prompted by a massive emigration of individuals and companies in the years before 2009. In addition, the shift involved consultations by both politicians and business leaders. In the United States, the previous and the current administrations have turned down calls to shift from the worldwide to the territorial tax system. For instance, President Obama has ignored recommendations from several commissions that have called for the shift in the tax system.
The United Kingdom’s tax system incorporates tax-exemptions on foreign-sourced dividends. In addition, the United Kingdom’s tax regime accounts for domestic-tax deductions on foreign-based expenses. This tax system is structured in a manner that caters to tax avoidance by instituting limits on deductible interests especially for entities that operate in areas with low taxes. For example, the United Kingdom’s tax regime stipulates that only entities that operate in territories whose tax rates are three quarters less than that of the home country can be taxed. The United Kingdom’s tax regime uses a ‘patent box’ or low taxes on any revenue from home-based patents. The United Kingdom’s tax system is largely territorial but the country’s taxation stakeholders have proposed a regime that exempts all foreign-earned income except the one that is artificially diverted from the country.
The United States’ tax system has three prominent features including tax credits, taxation on repatriated revenue, and deferral of foreign earnings. Under the United States’ tax system, entities are required to pay taxes on all their earnings once they are brought back to the country. Deferral refers to the practice of delaying taxation on foreign-earned revenue until it has been repatriated back to the United States. Moreover, when earnings are repatriated in the United States they are subject to a tax credit in accordance with the source country’s taxation rates. For example, the United States’ highest corporate tax rate currently stands at 39.2%. Therefore, if a company repatriates $1 million from a country with a 20% taxation rate, it will end up paying $392,000 less the $200,000 that has already been paid to the original country ($192,000). In rare instances, the United States passively taxes foreign earnings on some types of investments such as earnings on foreign bonds.
The United States’ tax system seeks to reduce foreign direct investments because they tend to displace jobs and revenue away from the country. On the other hand, the United Kingdom shifted from the worldwide to the territorial system with the view of enhancing the country’s competitive edge as a viable destination for starting, financing, and growing a business. The effects of the two tax systems on employment rates are valid. In the United Kingdom, a slight increase in unemployment rates was recorded after the shift to the territorial tax system. However, the United States recorded lower rates of unemployment as compared to other OECD countries. The United Kingdom’s tax revenues have increased since 2009 mostly because of the fact that the country’s GDP improved after the shift to a territorial system. On the other hand, the United States has recorded lower tax revenues than most of the OECD countries that use the territorial tax system including the United Kingdom.
Conclusion
The United Kingdom’s tax system used to be similar to that of the United States but economic circumstances contributed to its shift. The main defense for the United States’ tax system is that it prevents losses in investments and jobs. On the other hand, the United Kingdom’s tax regime is meant to give the country a competitive edge in the global business arena. Eventually, the United States might yield to pressure and shift to the territorial tax system.