The current system for taxing foreign source income of U.S. corporations makes no sense. In theory, income earned by controlled foreign subsidiaries of American companies is taxed at the U.S. corporate rate of 35 percent; in practice, the Treasury receives no taxes on that income as long as it is held overseas. U.S. corporations now have overseas cash holdings of almost $2 trillion, which they are encouraged to deploy by acquiring companies and building facilities outside the U.S.

As an alternative, business lobbyists have advocated a so-called territorial system under which foreign source income would be taxed only in the country where it is earned. These lobbyists correctly argue that almost all advanced industrial countries now follow this system, though many don’t allow tax havens to take advantage of it.

This alternative is based on the premise that foreign source income is being taxed once somewhere, at a reasonable rate by a credible tax-enforcing government such as Germany. But this premise doesn’t apply to tax havens, like the Cayman Islands, where the tax rate is minimal, or a reasonable official rate isn’t enforced.

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