The protectionism of Biden’s cross-border tax plan

By Daniel Bunn, Vice President of Global Projects, Tax Foundation, Washington, DC

Last week, the Biden campaign released a set of policy proposals designed to promote a “Made in America” agenda. The campaign’s summary of its proposals highlights concerns with the current US cross-border tax rules, which they say incentivize US companies to offshore investments, jobs, and profits.

The campaign is proposing new and higher taxes on US multinationals alongside tax benefits for bringing jobs or investment back to the US.

Taken together, the Biden cross-border tax proposals would increase taxes on US companies that have foreign operations or that sell products and services into the US from foreign affiliates while giving tax benefits for reshoring investment and jobs.

There are essentially four separate proposals. First, a 10 percent “Made in America Tax Credit,” which would be advanceable and available to businesses making investments that fit certain revitalizing or reshoring functions.

Second, a new 10 percent surtax will apply to US businesses whose foreign affiliates sell products or services into the US.

Third, the campaign proposes stronger rules against inversions (when a company restructures to become a foreign-based entity for tax purposes).

Fourth, the campaign is proposing structural and rate changes to the current minimum tax that applies to US companies’ foreign income.

With these proposals, Biden’s cross-border tax proposal seeks to achieve the goals of increasing investment in the US while counteracting offshoring. However, the policy proposals would not only undermine those goals but also increase protectionism in the US tax code.

With these proposals, Biden’s cross-border tax proposal seeks to achieve the goals of increasing investment in the US while counteracting offshoring. However, the policy proposals would not only undermine those goals but also increase protectionism in the US tax code.

Made in America Tax Credit

The 10 percent Made in America Tax Credit comes with a number of strings attached.

The campaign has identified several activities that would make a business eligible for the credit, including revitalizing factories that are currently closed or closing, retooling a factory to improve competitiveness and employment, reshoring job-creating production, expanding US facilities to grow employment, and expanding manufacturing payroll. Other requirements include meeting “Buy American” standards, maintaining US wage levels when growing employment, and growing US jobs rather than relocating jobs from one US location to another. Each will complicate compliance and administrability.

The credit would be advanceable, which means that it would likely be available to businesses ahead of a tax return reconciliation. Thus, eligibility for the credit could trigger a tax credit paid to a business without immediate regard to the company’s tax liability.

This would provide liquidity for the company making the investment, but it would also create administrative challenges in reclaiming unused credits and ensuring compliance with eligibility requirements.

However, if a business opens a new US factory, growing its overall US employment in 2022, but then closes another factory and lays off thousands of workers in 2023, would a credit provided in 2022 be clawed back? Currently, the answer is uncertain.

What is also uncertain is whether the benefits of the credit would be partially or fully offset by the 15 percent minimum tax the Biden campaign has proposed. That minimum tax would be based on profits reported on financial statements rather than taxable profits.

Outside these uncertainties, the credit could channel activity to eligible uses. Businesses will choose investments that qualify for the 10 percent credit in part to offset Biden’s proposed 28 percent corporate income tax rate (the current federal rate is 21 percent). However, given the narrow uses for the credit and requirements for Buy American standards and wage level maintenance, it will likely introduce greater complexity and administrative challenges, rather than new investment.

Offshoring penalty

If the Made in America Tax Credit is the carrot to attract new investment into the US, the rest of the campaign’s cross-border tax proposals are all sticks, starting with the 10 percent offshoring surtax.

The surtax would apply to US businesses that sell services or products into the US from foreign affiliates and would result in a combined tax rate of 30.8 percent (which includes the 28 percent proposed corporate rate but omits any state-level corporate taxes).

The surtax would increase the tax costs of US multinationals in a way that would not impact foreign-owned entities. It is essentially a tariff that only applies to US businesses and would incentivize US companies to rearrange their structures to contract with (rather than own) foreign service providers or manufacturers that sell on the US market.

The surtax would increase the tax costs of US multinationals in a way that would not impact foreign-owned entities. It is essentially a tariff that only applies to US businesses and would incentivize US companies to rearrange their structures to contract with (rather than own) foreign service providers or manufacturers that sell on the US market.

Because foreign affiliates can be complementary to US employment and investment, a proposal that penalizes supply chains and business models that rely on foreign operations will reduce the competitiveness of US companies relative to their foreign competitors, a theme that shows up in the other pieces of the Biden agenda.

Penalties for inversions

In the early 2000s, and certainly before the 2017 tax reform, it was common to hear stories of US businesses restructuring as foreign-based entities by inverting. The tax system prior to the recent reform incentivized this activity via a high corporate tax rate and worldwide taxation that put US firms at a competitive disadvantage in the global market.

Because the Biden cross-border tax plan proposes policies that will reverse some of those 2017 changes, it is likely that US businesses will again face incentives to revoke their citizenship and become foreign entities for tax purposes.

The campaign proposal does not lay out details on how they will prevent future inversions other than to say that the anti-inversion regulations and penalties will be “strong.”

Changes to minimum tax on foreign earnings

In 2017, the US adopted a minimum tax on the foreign earnings of US multinationals or their global intangible low tax income (GILTI). The policy is designed to ensure that US companies that locate their profits overseas pay some level of US tax.

The policy allows for a 10 percent deduction for real investment and taxes foreign income at a 10.5 percent rate (the result of a separate 50 percent deduction). In practice, the tax on GILTI is quite complex, and effective rates can be as high as 18.9 percent. The policy also lets US companies blend high tax income with low tax income before applying the minimum tax.

It is worth pointing out that another feature of the US policy mix following 2017 is a participation exemption, exempting foreign dividends from US tax. This policy turned the US tax system into a partial territorial system. Instead of taxing the worldwide profits of US businesses, the current system exempts certain foreign profits from US tax when those profits are repatriated to the US

The Biden campaign sees the structure of GILTI and the territorial system as creating loopholes that allow US businesses to offshore US production and US profits without sufficient tax consequences.

While that assessment of the current system is flawed, the campaign nonetheless is proposing three key changes. First, the 10 percent deduction for foreign investment in GILTI would be removed.

 Second, the base rate would move from 10.5 percent to 21 percent.

Third, the foreign minimum tax would be calculated on a country-by-country basis rather than a blended basis. All three of these proposals would increase taxes that US companies owe on their foreign earnings.

While it is justifiable to apply US taxes on foreign earnings to combat incentives to shift profits to lower tax jurisdictions (the current tax on GILTI is exactly that), the Biden approach would eliminate the majority of the benefits of the territorial system whether a business is engaged in profit shifting or not.

Since many developed countries have moved toward territorial systems, Biden’s proposal would be a step back, putting US companies at a disadvantage in the global marketplace.

What about the goals?

As mentioned at the beginning of this article, the Biden campaign is focused on the goals of increasing investment in the US, penalizing offshoring, and reducing profit shifting. So, how do these policies measure up?

The policies work against each other when it comes to effects on investment in the US.

A higher US corporate tax rate will lower the after-tax return of investing in the US. For eligible projects, the 10 percent Made in America Tax Credit will create benefits for seeking those projects out. However, the tax increase on foreign earnings and the surtax on sales from foreign affiliates to the US will have countervailing effects.

While US investment may increase in response to the tax credit, it may decrease due to higher tax costs on other industries and businesses.

A campaign that proposes strong anti-inversion rules and penalties should reflect on why those might be needed. The reason is that US companies will be disadvantaged relative to their foreign competitors, and this will create pressure to redomicile for tax purposes.

The campaign sees that threat and is planning to counteract it by building a regulatory wall around companies with their headquarters in the US.

Overall, the proposals have a flavor of protectionism – trying to tilt the tax system to prefer investments in certain industries in the US and penalize foreign activities of US businesses.

The offshoring surtax is also close to the Trump administration’s protectionist policy approach.

Biden’s cross-border tax plan – an assessment

US cross-border tax rules were changed significantly in 2017 with the goal of attracting more business investment to the US, but the Biden campaign is interested in reversing some of those changes.

The campaign is making an explicit pitch to reshore jobs while increasing taxes on the income of US companies’ foreign affiliates. Whether this will result in significant net new investment in the US is questionable.

The protectionist elements, however, seem to be bipartisan as both parties ignore the economic consequences of that approach.

Another route, however, would be to make the US an attractive place to invest rather than increasing taxes on US multinationals and providing complex incentives for domestic investment.

— Daniel Bunn is Vice President of Global Projects at the Tax Foundation, Washington, DC.