US Senate hearing foreshadows future legislative battles over international tax

By Doug Connolly, MNE Tax

US Senate Finance Committee members and speakers at a March 25 hearing advocated in favor of reforming the international tax system to better address multinational group profit shifting. They also debated raising the corporate tax rate to partially reverse cuts made in the 2017 Tax Cuts and Jobs Act (TCJA), as President Biden has suggested. Democrats and Republicans were able to find some agreement on the need for reform regarding the base erosion and anti-abuse tax (BEAT).

Committee Chairman Wyden (D-OR) – along with Senators Brown (D-OH) and Warner (D-VA) – plan to introduce international tax legislative proposals in the coming days. Corporate tax changes are anticipated to be the pay-for portion of President Biden’s infrastructure plan, also expected to be released shortly.

The hearing, titled “How US International Tax Policy Impacts American Workers, Jobs, and Investment,” followed the release of a Joint Committee on Taxation study reviewing the initial tax data post-enactment of the TCJA gleaned from country-by-country reports prepared by multinationals. The JCT study shows that the US corporate tax rate was cut in half following the legislation and that US MNEs continue to report disproportionate profits in tax havens.

Key debate points

Throughout the hearing, Democrats and Republicans sounded some recurring themes.

Democrats contended that the TCJA’s corporate tax rate cut was part of a global “race to the bottom,” with countries around the world eroding their tax base by slashing corporate taxes to stay competitive. They also expressed concerns that the TCJA’s international tax provisions, contrary to their intent, actually reward corporations for investing abroad rather than in the US.

Republicans, for their part, contended that corporate inversions, which had been a significant bipartisan concern, have come to a halt following TCJA enactment. They also argued that the corporate tax rate reduction increased US competitiveness and investment and that the TCJA global minimum tax has become a model for the OECD and other countries. 

Profit shifting and GILTI

Representing the US Treasury and the Biden Administration, Kimberly Clausing, Deputy Assistant Secretary, Tax Analysis, said that profit shifting to tax havens has continued at a steady rate despite TCJA provisions intended to curb the practice.

She argued that the global intangible low-taxed income (GILTI) minimum tax and BEAT have actually encouraged profit shifting by exempting the first 10% return on foreign assets from US taxation and by taxing foreign profits at lower rates than US profits.

Clausing explained that companies get a larger tax exemption under GILTI if they have more tangible assets located offshore. She stated that this incentivizes companies to place more assets offshore to increase that exemption. The foreign-derived intangible income (FDII) deduction essentially doubles down on this incentive, she contended

Clausing explained that companies get a larger tax exemption under GILTI if they have more tangible assets located offshore. She stated that this incentivizes companies to place more assets offshore to increase that exemption. The foreign-derived intangible income deduction essentially doubles down on this incentive, she contended.

Chye-Ching Huang, Executive Director, The Tax Law Center, New York University School of Law, said that the international tax system has flaws but could be salvaged and strengthened. She argued that a minimum tax on foreign profits, like GILTI, could be a strong tool for discouraging the shifting of profits and investment offshore, but that, in practice, the GILTI minimum tax is not robust enough to achieve its end.

James Hines, Professor of Economics and Law, University of Michigan, argued that data on foreign operations and profits of US MNEs is broadly misinterpreted. He said that the “productivity effect” of US MNEs’ foreign operations (the extent to which foreign operations enhance productivity and demand for US labor) likely exceeds the “substitution effect” (the extent by which foreign operations replace US ones).

Hines further contended that the statistics on the amount of profits located in tax havens are misleading. Such profits may be attributed to holding companies in the tax havens even though the underlying operating company may be taxed on the same income in a higher-tax jurisdiction.

Corporate tax rate

President Biden has suggested increasing the corporate tax rate to 28%. The TCJA dropped the rate from 35% to 21%.

Clausing made a case for increasing the rate. She stated that corporate tax cuts have hurt federal revenues, with corporate tax revenues decreasing from 2% to 1% of GDP post-enactment of the TCJA.

She also argued that corporate income taxes are a relatively efficient form of taxation (not creating significant economic distortion) and that a majority of voters from both parties favor higher corporate tax rates.

Pam Olson, former US Treasury Assistant Secretary for Tax Policy under President George W. Bush, argued the TCJA’s lowering of the corporate tax rate was the legislation’s single strongest move to prevent base erosion and encourage US investment.

Moreover, Ms. Olson contended the rate drop enacted by the TCJA was not as dramatic as Democrats have made it out to be, noting that the combined US tax rate (including state taxes) post-TCJA is about average among OECD countries.

Countering the competitiveness arguments against a corporate tax rate hike, Ms. Clausing made several points: that tax rates that US MNEs actually pay are lower than the statutory rate, that work on an international consensus on a minimum tax can allay competition concerns, and that competitiveness is about more than just tax rates.

Olson maintained that an increase in the federal corporate tax rate to 28%, coupled with state and local taxes, would make the US combined rate once again one of the highest in the OECD.

BEAT

Senator Tom Carper (D-DE) offered the BEAT – as opposed to GILTI and the corporate tax rate – as an area for bipartisan agreement, at least regarding its need for reform. For his part, he lamented that the BEAT seems to unintentionally disincentivize the use of clean energy credits enacted by Congress. Moreover, he noted that the JCT report has shown that the BEAT has raised revenues far below expectations.

Clausing agreed that the BEAT has failed to stem foreign profit shifting as intended and that it has caused other issues such as impacting the clean energy incentives. She added that the Biden administration is aware of all the issues with BEAT but has not yet taken a position on the direction of reforms.

Clausing agreed that the BEAT has failed to stem foreign profit shifting as intended and that it has caused other issues such as impacting the clean energy incentives. She added that the Biden administration is aware of all the issues with BEAT but has not yet taken a position on the direction of reforms.

Olson also agreed that BEAT has some “odd effects” and “room to improve.”

Huang considered the BEAT “muddled” and “bizarre.” In her opening testimony, she contended that BEAT took aim at a serious problem – shifting profits out of the US to foreign affiliates – but that in practice, it often misses its target and catches some payments that it was not intended to catch.

 Hines answered Senator Carper’s question of “Should the BEAT go on?” with a simple “No.”