Gains from Trade: Is Comparative Advantage the Ideology of the Comparatively Advantaged?

Dan Alpert, et al: Sales Factor Apportionment and International Taxation

The Biggest Container Ship Ever In The U S

November 29, 2017

The Honorable Orrin Hatch, Chairman
US Senate Committee on Finance
219 Dirksen Senate Office Building
Washington, DC 20510

The Honorable Kevin Brady, Chairman
US House Committee on Ways & Means
1102 Longworth House Office Building
Washington, DC 20515

The Honorable Ron Wyden, Ranking Member
US Senate Committee on Finance
219 Dirksen Senate Office Building
Washington, DC 20510

The Honorable Richard Neal, Ranking Member
US House Committee on Ways & Means
1106 Longworth House Office Building
Washington, DC 20515

Re: Support for sales factor apportionment for international corporate taxation

Dear Chairmen Hatch and Brady, and Ranking Members Wyden and Neal:

We are writing to urge you to adopt a sales-based formulary apportionment (also called sales factor apportionment) regime for international corporate taxation as you proceed with your tax reform efforts. Solidifying the tax base should receive as much attention as setting the corporate tax rate. This is a once in a generation opportunity to improve the tax code. It should not be wasted. Sales factor apportionment (SFA) is, in our view, the best way to tax all firms-domestic, multinational and foreign-fairly in an integrated world economy.

The current tax system has incentivized corporate inversions, profit shifting, recognition deferral and other notorious ills. It relies upon separate accounting of profits on a location by location basis so that multinational corporations (MNCs) strategically allocate earnings and costs in each location in which they operate. Though our current system purports to tax MNCs worldwide income, profit-shifting allows them to evade taxation on the basis of where their net income “lands” rather than where their gross income originates. The result is tremendous incentives to “earn”-i.e. to declare-income in low-tax countries. It is a classic race to the bottom causing the US corporate income tax base to erode at an alarming rate.

Tax competition between countries is highly incentivized by the current regime. While the effective US corporate income tax rate is estimated at 27%, it is mostly avoided by MNCs which are thus systematically advantaged relative to domestic US producers. Tax haven jurisdictions, where a large proportion of corporate earnings are reported, have very low effective rates between zero and five percent. Those countries include the Netherlands (2.3%), Ireland (2.4%), Bermuda (0.0%), Luxembourg (1.1%), Singapore (4.2%), UK Islands Caribbean (3.0% and Switzerland (4.4). Lowering the US corporate tax rate to 20% does not materially change the incentive to allocate profits to these “Cayman-style” jurisdictions.


Congress cannot confidently set a tax rate until it solidifies the tax base.

Profit-shifting continues to rise dramatically. In 2001, estimated profit-shifting by US MNCs to tax haven jurisdictions reduced corporate tax haven jurisdictions reduced corporate tax revenue by less than 15 billion dollars. In 2012, that number rose to nearly 120 billion dollars. In 2016, the number is at least 134 billion dollars. These estimates do not include revenue loss from corporate inversions or profit shifting by foreign MNCs.

Domicile (country of incorporation) should not matter, but it does under the current tax system, creating troubling taxation distinctions. US domiciled MNCs use deferral to delay paying US taxes on overseas profits so long as they keep those profits offshore. Less sophisticated US companies pay taxes on all their profits. Foreign domiciled corporations doing business in the US pay taxes on a territorial basis. In other words, they pay taxes on profits actually recognized here. This territorial, versus worldwide, tax differences incentivizes corporate inversions - the practice of relocating a corporation’s legal domicile to a lower-tax jurisdiction, usually while retaining its material operations in the US and continuing to sell to US customers.

Ending deferral has been suggested as a solution. It would level the playing field between US domiciled companies that are primarily domestic versus MNCs. But it does not resolve the problem of inversions or profit shifting by foreign MNCs. The House bill includes a minimum tax of 10% on overseas profits. But the 10% domestic versus foreign earned profits differential maintains strong incentives to allocate profits offshore.

Redefining the source of income is, in our view, the key to correcting the current dysfunction. This is what the sales factor apportionment system, already in use by most US states, does. Corporations earn income from sales. Therefore income should be allocated based upon the destination of those sales. MNC income should no longer be allocated based upon the location of a a subsidiary that allegedly earned it. The location of sales is much more difficult to manipulate than the “origin of income” under the current system.

The US tax base for corporations would be calculated on the basis of a fraction of companies’ worldwide income. This fraction would be the share of each company’s worldwide sales that are destined for customers in the United States. The taxpayer, under SFA, is the whole unitary business, including all evasion-motivated subsidiaries over which the parent corporations exercise legal and economic control.

The SFA system we support is similar to the method used by many US states to allocate national income. These states adopted SFA to solve the difficulty of assigning profits, for state corporate income tax purposes, from national or international corporations to individual states. They faced an additional problem in that taxing based upon property or employees located in the state created incentives to move production out of that state. Using a sales-based taxation method solved this problem because locations of sales if far less responsive to tax differentials. Customers are far less mobile than the firm’s assets or employees.

What we are advocating is a change of the US corporate tax base that replicates the changes the states have made in relation to the nation. In effect, firms should be taxed on their access to a specific consumer market-from which they generate revenue—rather than on their cleverness at artificially allocating expenses and revenue in tax havens in which their subsidiaries “incorporate”.

By focusing upon sales as the measure of taxable economic activity, the SFA system does not rely upon or incentivize artificial legal distinctions among types of firms. Subsidiaries, branches and hybrid entities are all considered a unitary business for tax purposes-which, after all, is what they are. Whether a parent or a subsidiary is incorporated in the US or elsewhere makes.


No practical difference to production, sales or distribution. Hence it should make no difference to taxation.

An SFA system would improve America’s trade competitiveness because it provides domestic producers a further incentive to export. Profits from sales oversees would not be subject to taxation. Foreign producers who sell goods and services here would pay taxes on profits arising from the privilege of accessing our market. No corporate tax benefit would arise from moving a US plant oversees.

A recent study by the Coalition for a Prosperous America (CPA) found that SFA would deliver 34% more tax revenue from US corporations in 2016 at the current tax rate. CPA further estimated that a switch to SFA at a 20% rate would add an estimated 1.04 trillion dollar uplift to tax revenue over the next 10 years. While these numbers would have to be verified by the Joint Committee on Taxation, there is no doubt that tax revenue can be substantially improved with a solidified tax base.

SFA has features that can bridge the partisan divide to establish meaningful corporate tax reform. It achieves the Republican goal of a territorial tax on corporate income and the Democratic goals of raising revenue. SFA will eliminate tax competition because the corporate tax rates in other countries become largely irrelevant. It will treat all types of firms the same.

It is for these reasons that we ask you to establish sales factor apportionment as the basis for corporate income tax reform.


Daniel Alpert
Founder, Westwood Capital
LLC Fellow, The Century Foundation

Dean Baker Co-Director
Center for Economic and Policy Research

Robert Hockett
Edward Cornell Professor of Law
Cornell School of Law

Marshall Steinbaum
Research Director and Fellow
Roosevelt Institute

Brad DeLong
Professor of Economics
University of California, Berkeley

Gabriel Zucman
Assistant Professor of Economics
University of California, Berkeley

Michael Stumo
Chief Executive Officer
Coalition for a Prosperous America