Daniel N. Shaviro (NYU) presents The Case Against Foreign Tax Credits at Pennsylvania today as part of its Center for Tax Law and Policy Seminar Series.  Here is the Conclusion:

Among means of reducing the domestic tax burden on foreign source income that would otherwise result from worldwide taxation of resident taxpayers, foreign tax credits are decidedly problematic. They provide a 100 percent marginal reimbursement rate (MRR) for foreign taxes paid, notwithstanding that the optimal such rate, from a unilateral national welfare standpoint, equals the otherwise applicable marginal tax rate for foreign source income.

Exemption systems, under which foreign source income is not taxed, are implicitly deductibility systems for foreign taxes paid. If foreign tax credits, as a practical matter, are inevitable under a worldwide system that does not grossly overburden outbound investment by combining mere deductibility with application of the full domestic rate to foreign source income, then the problems with creditability create an additional ground for favoring exemption. However, if creditability is not inevitable in this setting, a country, such as the U.S., that imposes worldwide taxation with credits,  could improve its system by switching to deductibility on a burden-neutral basis, such as by greatly reducing the tax rate applicable to foreign source income. Better still, this could be combined with burden-neutral elimination of deferral, like that recently proposed by Harry Grubert and Rosanne Altshuler (albeit without a matching reduction in the domestic tax rate, given the magnitude of the rate cut that would be made necessary by burden-neutral repeal of creditability).

Is the advocacy herein of burden-neutral repeal of foreign tax creditability an actual proposal, or merely a suggestive thought experiment? I am honestly unsure. The big problems that I see relate to U.S. tax treaty obligations and to concern about the political stability of the low rate on foreign source income that would result from a burden-neutral shift to deductibility. In addition, the fact that the shift would eliminate one of the principal defects of the current U.S. international tax regime does not mean that it is preferable to an exemption system, which it merely matches at the overseas tax planning margin. However, it clearly merits further consideration if an exemption system is not adopted. And the defects of foreign tax creditability should be kept firmly in mind when comparing the existing regime to potential alternatives.