By Alex M. Parker, Principal, Capitol Counsel LLC, Washington, D.C.
Without the political support for raising the individual or corporate tax rates, Democrats and the Biden administration are looking to an overhaul of the international tax system to help pay for the USD 1.75 trillion spending package. But some recent estimates say the proposed changes will bring in relatively little revenue, despite White House predictions.
The disparity is due not only to a lack of data about how much income is offshore, but strong disagreements between experts on what those numbers mean about the scope of global tax avoidance.
Even as President Biden has made offshore tax havens the center of his rhetoric on how the tax code needs to be changed, provisions to stem international profit-shifting will likely end up being a small part of the bill’s revenue side.
This may come as a surprise to those following the political discourse, which has focused on alleged tax avoidance by the wealthy.
In nearly every speech on the reconciliation bill, Biden has brought up the 55 profitable Fortune 500 companies with 0% or lower effective tax rates in 2020, based on a report from the left-leaning Institute on Taxation and Economic Policy. In a recent CNN town hall, Biden said those companies needed to “pay their fair share … chip in a little bit.”
Biden isn’t just arguing that the 21% rate is too low– it’s that companies are manipulating their reported taxable income to avoid paying even that.
Likewise, Senator Kyrsten Sinema (D-AZ) has explained her opposition to increasing the corporate rate by claiming that avoidance is the bigger issue.
“She has told her colleagues and the president that simply raising tax rates will not in any way address the challenge of tax avoidance or improve economic competitiveness,” Sinema’s office told The Hill.
And a key culprit for this base erosion is offshore profit-shifting, according to the White House – companies realizing earnings in the US, or through their US operations, but using tax structures to shift that income to a jurisdiction where little real activity occurs, other than to record profits. In an address to Congress on April 29, Biden decried companies that “evade taxes through tax havens in Switzerland and Bermuda and the Cayman Islands.” The same month, the Department of the Treasury released a report outlining the president’s tax proposals and blaming “offshoring incentives,” as well as “significant gaps” in the law, for low corporate effective tax rates.
The numbers, though, reveal nuances in this narrative.
The Institute on Taxation and Economic Policy report notes that immediate expensing of new investments, research and development credits, and the expensing of stock options are the primary reasons why companies have reported disparities from their taxable income and financial profits – in other words, why they are paying 0% tax rates. This is based on the very stock filings which the institute analyzed to compile its report of which companies paid no taxes in 2020.
As for global profit-shifting, the data we do have is hotly disputed by many of the top academics in the field – producing estimates so widely divergent, it seems impossible that they’re even looking at the same planet.
For instance, University of California Berkeley assistant economics professor Gabriel Zucman wrote in 2015’s “The Hidden Wealth of Nations: The Scourge of Tax Havens” that the US loses USD 130 billion in revenue annually due to corporate profit-shifting. Former UCLA law professor Kim Clausing, who is now Treasury deputy assistant secretary for tax analysis, estimated in a 2020 paper that the US loses $60 billion annually, after the 2017 Tax Cuts and Jobs Act lowered the corporate tax rate to 21%.
But a paper released in 2020 by Jennifer Blouin of the University of Pennsylvania and Leslie Robinson of Dartmouth College criticizes Clausing’s methodology and claims that the real amount of lost annual revenue could be as small as USD 10 billion.
The roots of this academic disagreement are mostly complex and technical, including whether the researchers are “double-counting” income which goes through a chain of multiple subsidiaries in a single parent corporation.
But they also reflect more fundamental disagreements about how to define shifted income.
While Internal Revenue Service data shows that US companies still hold a significant amount of income in jurisdictions considered to be tax havens, it’s not necessarily true that they do so purely for tax reasons. And, crucially, it’s also not necessarily true that it’s US taxes they’re trying to avoid – most complex tax structures will involve several nations. Preventing US companies from avoiding foreign taxation may be a policy worth pursuing, but it won’t necessarily result in more US revenue.
Furthermore, data about an offshore entity’s foreign earnings doesn’t necessarily reveal how much US income that entity is generating. When a US corporate group uses a multinational tax structure to place intangible assets – such as intellectual property – in a low-tax foreign jurisdiction, the foreign entity will normally need to make royalty or cost-sharing payments back to the US. Those payments must be tied to fair market value, although many question whether Treasury is getting the rightful amount due to the subjective nature of these assessments. But it’s another reason why a large amount of foreign income in low-tax jurisdictions may be creating a proportionately smaller amount of tax savings.
The 2017 law included a provision, the tax on global intangible low-taxed income (GILTI), meant to curb offshore profit-shifting through intangibles. The 10.5% GILTI tax targets the foreign income of US companies, if that income is taxed lower than 13.125% and if it reflects a profit return of 10% or more of its offshore tangible assets.
Since before it was even enacted, Democrats have criticized GILTI as an inadequate tool to combat global tax avoidance. They noted that the tax is based on an aggregate percentage of global profits – even if a company has income in a jurisdiction without a corporate income tax, it may not have any GILTI liability if enough of the rest of its income is earned in high-tax jurisdictions. This allows companies to continue using havens, Democrats claimed.
The Biden administration proposed raising the GILTI tax rate and changing it to a country-by-country system.
Just as there isn’t a clear picture of the magnitude and scope of global profit-shifting, it is also unclear whether GILTI, or the other Tax Cuts and Jobs Act anti-abuse measures, are working. (Or, whether earlier initiatives to address these issues, such as the Organization for Economic Cooperation and Development’s 2015 base erosion and profit shifting project, are producing results.) While the data does show that some companies have been slow to move income back to the US, this could be due more to lethargy and uncertainty than to continued tax savings.
When Biden proposed these GILTI changes on the campaign trail, independent analysts estimated that its 10-year revenue haul could be anywhere between USD 300 billion to USD 700 billion. But when Democrats on the House Ways & Means Committee released their own proposal to overhaul the GILTI system, the Joint Committee on Taxation estimated that it would only raise about USD 200 billion over 10 years – about 11% of the $1.75 trillion in spending that Democrats hope to offset. (And this figure includes other changes, such as the domestic tax incentive for foreign-derived intangible income, or FDII.)
A draft of the complete bill, released by the House Rules Committee on October 28, trimmed the GILTI changes even further, only raising the rate to 15%. The White House promises that all of the combined international changes will bring in $350 billion – but many outside experts wonder if this may be an overly optimistic prediction.
The Tax Foundation, a conservative-leaning economic think tank, estimated that the changes to GILTI and related provisions may bring in less than half of what the White House and Joint Committee on Taxation have predicted.
“I do think it’s optimistic,” said Daniel Bunn, vice president of global projects at the Tax Foundation.
One reason is that estimators may not be considering the effects of the recent international 15% global minimum tax, which the administration strongly pushed for.
“Right now the numbers may look like there is a decent amount of revenue to be raised, but if jurisdictions where U.S. companies have low-taxed profits begin adopting the 15 percent minimum tax, then some of the revenue will flow to those countries rather than the U.S. Treasury,” Bunn said.
Democrats will have very little room to tighten the GILTI changes if they need more revenue while pushing the package through Congress. Already, some moderate House Democrats have pushed back on the proposed GILTI tax hikes, arguing that the US should not go further than the OECD agreement. Tightening the rules further to bring in extra revenue may not be an option.
Policymakers face many tough choices as they try to guide this legislation through a closely divided Congress. And, as they are learning, there isn’t a giant offshore treasure chest that would make these decisions any easier.
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