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Policy Proposals

Reforming Corporate Taxation in a Global Economy: A Proposal to Adopt Formulary Apportionment

June 2, 2007


The Problem

The current corporate tax regime is not entirely suited to a truly global economy, with the United States’ relatively high tax rate incentivizing companies to shift income and economic activity to low-tax countries—accounting for a loss of $50 billion in corporate tax revenues annually. Furthermore, from accounting and tax perspectives, the sourcing of income and expenses is convoluted and contributes to transfer pricing issues.

The Proposal

Replacing the current, geographically based tax system with a formulary apportionment system, in which a firm’s U.S. tax base would be its worldwide income multiplied by the share of its worldwide sales occurring in the United States, would be more attuned to today’s global economy and more attractive to corporations. Firms would simplify their tax accounts and would not be able to lessen their tax burden by transferring income to low-tax countries.


The current system of taxing multinational firms relies on separate accounting: firms account for earnings and costs in each location in which they operate. This system generates a large tax incentive to earn income in low-tax countries, and multinational firms respond by earning disproportionate profits in low-tax locations.

We propose a system of formulary apportionment for taxing the corporate income of multinational firms. Under our proposal, the U.S. tax base for multinational corporations would be calculated based on a fraction of their worldwide income. This fraction would simply be the share of their worldwide sales that are destined for customers in the United States.

This system is similar to the current method that U.S. states use to allocate national income. The state system arose due to the widespread belief that it was impractical to account separately for what income is earned in each state when states are highly integrated economically. Similarly, in an increasingly global world economy, it is difficult to assign profits to individual countries, and attempts to do so are fraught with opportunities for tax avoidance.

Under our proposed formulary apportionment system, firms would no longer have an artificial tax incentive to shift income to low-tax locations. This would help protect the U.S. tax base while reducing the distortionary features of the current tax system. In addition, the complexity and administrative burden of the system would be reduced. The proposed system would be both better suited to an integrated world economy and more compatible with the tax policy goals of efficiency, equity, and simplicity.