International tax policy in the U.S.A.
Prof. Daniel Shaviro, New York University Law School

International tax policy experts often wrongly assume that the basic choice in taxing outbound active business income lies between an exemption or territorial system on the one hand, and a worldwide system with foreign tax credits on the other. This assumption mistakenly conflates two distinct margins: (1) the overall tax burden on outbound investment, and (2) the marginal reimbursement rate (MRR) for foreign tax paid, which is 100 percent under a foreign tax credit system, but equals the marginal tax rate for foreign source income under an explicit or implicit deductibility system (such as exemption). Since the tax rate choice for foreign source income is not confined to that between zero and the full domestic rate, one could in principle devise either a foreign tax credit system that raised no net revenue (like exemption), or a deduction system that raised the same net revenue as a given worldwide-with-credits system. From a unilateral national welfare standpoint, whatever the right answer at margin (1), deductibility is clearly optimal, and creditability dangerously over-generous, at margin (2).