The corporate tax plan presented Wednesday by President Joe Biden to offset the cost of his infrastructure priorities would be the most significant corporate tax reform of a generation if it came into effect.
Biden’s proposal to increase the statutory corporate tax rate from 21 percent to 28 percent will be remembered by most people. However, the statutory tax rate means little if companies don’t pay it. Biden’s plan would remove many particular breaks and loopholes and, as a result, likely end the corporate tax evasion that ITEP has established under the Trump Tax Act and previous bill.
The techniques companies use to avoid taxes can conceptually be divided into two categories: offshore corporate tax relief and domestic corporate tax relief. Biden’s suggestions are limited to both.
Biden suggests ensuring that American corporations’ offshore profits are all taxed at an aggregate rate (including foreign taxes and U.S. taxes) of at least 21 percent. This is true regardless of whether a company claims to make those profits in Canada, a country where US companies do a lot of business, or in the Cayman Islands, where companies claim to make incredibly high profits, even though there are almost no real business opportunities there .
Similar to similar proposals in Congress, this would address the long-standing problem of American companies using accounting gimmicks to claim that their profits are made by subsidiaries in countries with very low or no corporate taxes (countries known as tax havens) .
The Trump Tax Bill drafters could have stopped this, but instead put in place rules that continue to encourage offshore tax evasion by taxing offshore profits far more easily than domestic profits. They arguably made things worse because these rules encourage American companies to move real assets and operations – and the jobs that come with them – offshore.
The Trump Tax Act exempts American corporations’ offshore profits from U.S. taxes unless they exceed a 10 percent return on offshore property, plant and equipment. In other words, a U.S. company does not pay U.S. taxes on profits from its offshore subsidiaries unless those profits exceed 10 percent of the property, plant and equipment (machinery, factories, office buildings, oil wells) the company makes offshore. As a result, a company could avoid US taxes by moving more property, plant and equipment offshore.
For example, imagine an American company that does business in the United States and Ireland. The company has $ 1 billion worth of property, plant and equipment in Ireland and makes around $ 150 million there for most years. Of that $ 150 million, $ 100 million is exempt (because 10 percent of $ 1 billion is $ 100 million), but the remaining $ 50 million is subject to US taxes. The company could avoid US taxes altogether by moving more business to Ireland. An increase in the fixed assets held there from USD 1 billion to USD 1.5 billion would result in an exemption of USD 150 million (10 percent of USD 1.5 billion) from US taxes.
Meanwhile, even offshore profits that are subject to US taxes (profits that Trump Law calls Global Intangible Low-Taxed Income, or GILTI) are treated more favorably than domestic profits. Domestic corporate profits are subject to a tax rate of 21 percent, while GILTI is effectively taxed at half that tax rate, only 10.5 percent.
It gets worse. Companies can effectively pay less for their GILTI. American companies can request a credit on their US taxes for taxes they paid to foreign governments on their offshore profits, the Foreign Tax Credit (FTC). This is useful because it prevents double taxation. However, a long-standing problem is that American companies can pool their profits and losses overseas to calculate their FTCs and US taxes. In fact, it means that they use the taxes they pay in high tax countries to protect their tax haven profits from US taxes.
The bottom line is that the corporate tax system created under the 2017 Act rewards companies that can convert U.S. profits into foreign profits, whether that means moving profits on paper or moving business activities overseas.
Biden’s proposals would bring all of this to a halt. He proposes abolishing the 10 percent yield exemption and subjecting all offshore profits of American companies to a quota of 21 percent. They would continue to receive the FTC when paying taxes to the foreign country they operate in, but only on a country basis. If their foreign tax rate is less than 21 percent, they would pay the rest to the United States. You would not benefit from having profits passed through subsidiaries in Bermuda or the Cayman Islands, as those profits would effectively be taxed at 21 percent.
Biden’s plan would also address the problem of foreign companies streaking profits from the United States, and the related problem of inversing American companies “alien” so they can do the same.
American subsidiaries of overseas companies sometimes engage in tricky transactions to make payments to their parent companies – such as an interest payment or a royalty – that the American subsidiary subtracts from the revenue it reports to the IRS. This effectively sends profits out of the country for tax purposes.
The Trump Tax Act applies a weak minimum tax (called BEAT (Base Erosion and Anti-Abuse Tax)), which is said to be a deterrent. Biden’s plan replaces the BEAT with a stronger measure that “refuses to allow foreign companies to deduct payments that could allow them to withdraw profits from the United States if they are located in a country that does not have a strict minimum tax regime.”
We’ll need more details before we understand exactly how effective this would be, but it appears that American subsidiaries can only deduct these payments if the parent company is in a country that has a strong minimum tax (maybe even one comparable to the 21 percent tax the United States would impose on offshore profits). This would eliminate the benefit of eroding the revenue from the land.
Corporations can also avoid taxes on profits they clearly deserve in the United States, often through tax breaks enacted by Congress that allegedly promote a socially desirable activity.
For example, Congress has long allowed accelerated depreciation, depreciating the cost of investing in equipment faster than it depreciates. Trump Act temporarily allows full expense allowance, which means companies can deduct the entire cost of an investment in the year it is made. This is the most extreme version of accelerated depreciation. This is supposed to help the economy by encouraging investment, but it often rewards companies for making investments that they would have made anyway.
Some companies also take advantage of a tax break for executive stock options. This enables companies to write off stock option-related expenses for tax purposes far in excess of the expenses they report to investors.
These are just two examples of many. For the most part, Biden doesn’t suggest changing them directly. Instead, he would make sure that even if companies take advantage of these tax breaks, they pay at least some tax each year for telling their investors that they are profitable.
He would do this through a minimum tax of 15 percent on companies’ book income, that is, on the profits they report to the public and investors. Corporations would pay their tax bill under regular corporate tax rules or 15 percent of their book profit, whichever is higher.
While business leaders enjoy low profits reporting to the IRS for tax purposes, they never want to make low profits reporting to investors they want to attract, which could make it difficult for businesses to avoid minimum taxes.
In many cases, Biden’s corporate tax proposals do not go as far as they could, but they are still a revolutionary change from the status quo that has hardened over the decades.
For example, an ideal reform could tax offshore and domestic profits at the same rate, but under his plan the offshore profit rate would be three-quarters of domestic profits (21 percent versus 28 percent). An ideal plan could also rule out more tax breaks at the root, such as the stock option tax break and accelerated depreciation, while Biden instead suggests limiting the worst effects of those tax breaks through a minimum tax.
But Biden’s plan would still be a fundamental change if it came into effect. It would dramatically shrink the vast world of fictional business transactions between thousands of Shell companies that only exist on paper to channel profits beyond the reach of the society that makes those profits. This would end the spectacle of companies making huge profits for years while paying effective tax rates that are in the single digits, if not nil. That alone would be worth celebrating.