One of the provisions of the Build Back Better Act is the introduction of a minimum tax rate of 15 percent for companies. Senator Elizabeth Warren was the loudest champion and chief cheerleader. Given that 55 high profile profitable companies paid no taxes in the past fiscal year, the introduction of a minimum tax is seen as a way to correct a tax result that many consider to be unfair.
Of course, fairness is in thate Eye of the beholder. Some argue that any taxation of corporate profits is unfair, as the same profits are taxed a second time when distributed to shareholders. The collection of corporation tax therefore primarily enables double taxation. Others argue that corporate income taxes have created an exaggerated development of special-interest lobbying, which adversely affects the relatively small contribution of corporate taxes to total federal taxes levied. (Corporate income tax accounts for around 7 percent of total federal tax revenue.)
However, both views seem to be represented by the minority. Most people advocate the idea of corporate taxation. The main debate seems to be how to determine these tax liabilities.
How did we get to the point where profitable companies manage to avoid paying the tax official? To answer this question, we need to focus on the distinct responsibilities of two major regulatory bodies: the Financial Accounting Standards Board (FASB) and the Internal Revenue Service (IRS). FASB is an independent agency authorized by the Securities and Exchange Commission (SEC) to establish the generally accepted accounting principles (GAAP) that US public companies must use when reporting financial results. The IRS is an office within the Treasury Department that is responsible for the application of the rules relating to the collection of tax revenues. These rules are set out in laws enacted by Congress.
The FASB rules require publicly traded companies to produce income statements that show net profit (profit) during the prescribed accounting period. In contrast, the IRS does not base its tax calculations on GAAP net income, but rather on taxable income as defined by Congress. This is why some profitable companies have been able to operate without federal tax liability.
Corporate profit taxation laws allow numerous deductions – well beyond the expense items permitted under GAAP. Many of these deductions are used for specific industries or companies. At the same time, the laws also exclude some forms of income that companies generate. As a result, a company’s taxable income values can be far removed from its GAAP net income.
In both theory and practice, companies could have positive net income, but no or negative value for taxable income, which puts these companies directly in the sights of Elizabeth Warren.
The separation of the two agencies has so far served to protect the FASB from pressure that could remove it from its position of independence. Should the FASB’s net income measurement become more relevant in determining corporate income taxes, the agency could face pressures from Congress and special interests trying to affect the way income and expenses are measured and reported under GAAP.
A minimum corporate income tax is not the only way to bring taxable and reported corporate income closer together. Congress clearly had, and still could have, an alternative – one that would do more to protect the independence of the FASB. That said, it could re-evaluate the IRS’s definition of taxable income. To the extent that the current definition inappropriately exaggerates expenditure or excludes income, these choices could and should be adjusted. Many of these provisions serve the narrow interests of a minority of businesses at the expense of the rest of us. Unfortunately, Congress has not shown the will or ability to change these types of rules, no matter how unfair they may seem.
The second best alternative seems to me to be the proposal to apply a minimum tax rate of 15 percent to the net income reported under GAAP. If we want to have an income-based corporate tax, it seems like a sensible adjustment to replace the current definition of taxable income with GAAP net income – an adjustment that deserves bipartisan support.
Ira Kawaller is the principal and founder of Derivatives Litigation Services. He has a Ph.D. in Economics from Purdue University, and derivatives have been a constant field of interest for most of his career. At igkawaller.medium.com, Kawaller regularly writes blog posts on topics from politics and business.