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16 Economic Report 1 (1983)

handle is hein.taxfoundation/iretecr0016 and id is 1 raw text is: THE ECONOMICS OF THE FOREIGN TAX CREDIT For most U.S. taxpayers, the foreign tax credit provisions of the Internal Revenue Code are not only arcane, they are also uninteresting. But the U.S. federal income tax treatment of income produced by U.S. firms operating in foreign jurisdictions has important consequences for the efficiency with which the U.S. economy performs. Moreover, the foreign tax credit provisions raise some basic, long-standing conceptual issues. The economic fundamentals involved in addressing these issues need to be well in hand if those interested in tax policy are to grasp the economic implications of proposals and developments in this field. For example, if the current interest in broad-based, flat-rate taxes materializes as serious legislative efforts, tax policy makers should be aware of what the alternative flat-tax approaches call for with respect to income produced abroad. Role of the Foreign Tax Credit The first question to be addressed is what is the foreign tax credit supposed to do? Why is it part of the Federal income tax? Like so much of the U.S. income tax law, the foreign tax credit reflects the eclectic approach of tax policy makers. It is an uneasy compromise between two opposing principles -- the residence principle and the origin principle. The residence principle holds that the citizen's liability for tax payments to this country of citizenship doesn't depend on where the income is earned; tax liability follows the flag; the country of which one is a citizen has the right to tax one's income irrespective of where it is earned and presumably in precisely the same manner as if the income were earned domestically. The origin principle, on the other hand, holds that the jurisdiction in which the income is produced has the right to levy on it, irrespective of the citizenship of the producer. The foreign tax credit provisions affirm the right of the U.S. to levy its tax, based on its taxable income concepts, on its citizens' foreign-source income, but at the same time these provisions require the U.S. to forego the exercise of this right to the extent that (1) the foreign jurisdiction has imposed an income tax --- or what is, by regulation, deemed to be its * This paper is based on a speech delivered on June 30, 1983, at a National Foreign Trade Council Foundation conference on proposed foreign tax credit regulations. Note: Nothing written here is to be construed as necessarily reflecting the views of IRET or as an attempt to aid or hinder the passage of any bill before Congress,

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