The Treasury Department has just released a short document, The Made in America Tax Plan, explaining and describing the main features in President Biden’s proposed tax plan that, as I understand it, would be part of the budget reconciliation infrastructure bill.
1) The New Progressive Consensus - The report and its proposals are extensively grounded in recent cutting-edge academic research. (Perhaps this should be no surprise, given the list of experts who have joined the Biden Treasury Department – even if I have personal reasons for dissenting from Paul Krugman’s statement that “it’s hard to find a tax expert who hasn’t joined the Biden team”!).
Let me dare to propose here a label for the underlying research. I think of it as the “new progressive consensus” regarding business and corporate taxation. To be clear, I don’t mean to assert that there’s a new consensus, generally shared among experts and researchers all the way across all methodological and ideological spectra, that happens to be progressive. Rather, among those who are more on the progressive side I discern this broader emerging consensus, which also has broader influence although it is by no means uncontested by those with different intellectual or ideological commitments. (Yes, despite the ideal of empirical economics as a “science,” political preferences do indeed tend to correlate with empirical beliefs, and even those of us who are looking at the empirics entirely in good faith may have unconscious biases. There is also reason to think that, insofar as empirical beliefs and policy preferences are correlated, the causal arrow does not run just from the former to the latter.)
Perhaps the core element of the new progressive consensus that the Treasury document relies upon (with extensive research citations) is that, in substantial degree, the corporate income tax falls on excess profits, not normal returns. To that degree, corporate profits can be taxed efficiently and without reducing investment, the incidence of the tax will be borne predominantly by shareholders (and, over the longer term, wealthy holders of capital more generally), and the corporate income tax is a vital tool for achieving vertical distributive justice.
Once one is looking at rents, monopoly profits, and other sources of extra-normal returns, rather than at normal returns (e.g., the pure risk-free return to waiting), policy conclusion after policy conclusion can pretty much take a 180-degree turn.
A second key element in the new progressive consensus is that the artificiality of the legal concepts that are used in corporate income taxation – for example, the notion of income as having a geographical source – means that companies often respond to tax rate differences and changes far more through formalistic profit-shifting than through real changes in where they are actually doing particular things. Losing actual domestic “investment” that might have had positive spillovers is different from losing tax revenue due to the “games they play” – especially when the success of the latter is endogenous to the legal rules’ particular details.
2) Labor, Capital, and “Capital” - A central policy aim of the report is to reverse the dramatic shift over many decades of tax burdens from labor to capital. I would note, however, that capital here includes “capital” – i.e., that which is reported as capital, for example because it takes the form of stock appreciation that the founders and other owner-employees chose not to pay out to themselves as explicit salary. In conventional speech, labor vs. capital used to denote different groups of people: the workers versus the owners. This then all got muddied, actually at least in part for good intellectual reasons, due to rising appreciation of the facts that workers have human capital and capitalists often work on their own behalf. But the old usage may be returning, for the good reason that it helps one to distinguish between groups whose income is predominantly reported as labor income versus capital income. That can make “labor vs. capital” a good proxy for “the poor and middle versus the top 1 or 0.1 percent,” even if much of what we really mean is low-wage versus high-wage.
3) The Corporate Sector Versus the Broader Business Sector - The Treasury document focuses almost exclusively on the corporate income tax, although (as it notes) the US business sector has an unusually large non-corporate component. It notes that this difference does not explain away the fact that US corporate tax revenues, as a percentage of GDP, are exceptionally low by OECD standards. (The OECD norm is about 3%, as compared to, in the US, 2% pre-TCJA and 1% post-TCJA.) While obviously the relative size of the US non-corporate business sector affects these computations, relative to the case where all US business was corporate in form, it is very far from being the whole story, especially given how high US corporate profits have been over the last 15 years.
Still, the non-corporate part of the US business sector is important, too. While presumably this was beyond the report’s assigned scope, and might also complicate the politics of enacting desired tax changes, it would certainly be a move in the right direction to supplement the document’s proposals with repeal of the egregious section 199A passthrough deduction.
4) Importance of cross-crediting - Turning from broad generalities to the Biden plan’s particulars, it advocates switching in GILTI from the allowance of cross-crediting, as between income earned in high-tax versus low-tax countries, to the use of a country-by-country regime. I have in recent work argued that cross-crediting has structurally undesirable tax planning effects even if one holds constant (through the use of other changes) a given regime’s overall rigor or burden imposed. The Treasury document emphasizes instead the important point that, with cross-crediting, profit-shifting from the US even to high-tax foreign countries can have a substantial tax avoidance payoff, because seemingly high-tax foreign source income, unlike what is reported as US source income, can be shielded from US tax via cross-crediting.
5) Proposed changes to GILTI - There are three of particular importance here:
(a) raising GILTI’s global minimum tax rate from 10.5% to 21% (through a reduction of the GILTI exclusion from 50% to 25%, while the corporate tax rate increases from 21% to 28%),
(b) eliminating the current rules’ exclusion of a deemed 10% return on foreign tangible assets, and
(c) as noted above, shifting from a worldwide to a per-country application of GILTI’s 80% foreign tax credit.
For reasons that I have discussed elsewhere, the latter two changes are significant structural improvements, even leaving aside their effect on the overall tax burden that GILTI imposes. There are also very good reasons to increase the tax rate on US companies foreign source income, pertaining (for example) to profit-shifting and overall US revenue needs.
The other side of the coin, obviously, is the question of whether the tax burdens that this imposes (via taxation of foreign source income) on US companies, relative to foreign companies, could redound to our national disadvantage. The Treasury responds to this concern mainly by (a) noting data and arguments that suggest limited real responses, (b) proposing to strengthen anti-inversion rules, and (c) as the question is not so much foreign source income for its own sake as the use of profit-shifting to avoid the US tax on US activity, proposing to strengthen anti-profit-shifting rules as they apply to foreign multinationals, outside the realm of GILTI. (This pertains in particular to the proposed BEAT replacement that I discuss below.)
A further possible response that may need to be considered as time goes on is expanding the definition of US corporate tax residence. As is well-known, we mainly determine US corporate residence on the basis of US incorporation, whereas most other countries rely on where management or headquarters or a large portion of operations are located. Our approach, though on its face quite formalistic, has actually proved more resilient (even with respect to new companies)than one might have expected, in part due to American incorporation’s appeal, e.g., to Americans who are starting new companies and don’t yet know if they will succeed in creating wildly successful global brands.
But, the more weight one places on US corporate residence, such as by making GILTI more effective, the stronger the case for considering a broader approach to corporate residence – e.g., extending it in the alternative to companies that are either incorporated OR headquartered here, perhaps with some provision for better coordinating our corporate residence rules with those of peer countries. The Treasury document sticks a toe in these waters, but only insofar as it would extend the anti-inversion rules to certain transactions in which the foreign acquirer is managed and controlled in the US.
6) Replacing the BEAT with “SHIELD” - The Treasury document notes the BEAT rules’ poor design and frequent avoidability, leading to their ineffectiveness in curtailing profit-shifting to low-tax jurisdictions. I agree that the BEAT is a failure and ought to be repealed (or else, at the least, be unrecognizably transformed), subject to the point that profit-shifting through the making of US-deductible payments to foreign affiliates in low-tax jurisdictions still needs to be addressed.
The SHIELD proposal that the document sketches out as a replacement certainly sounds worthy of further development. In brief, it would deny US tax deductions for payments to foreign affiliates that are subject, in their own jurisdictions, to a low effective rate of tax. Pending a multilateral agreement between countries to lay this out, the default rate trigger would be the GILTI rate (i.e., 21%).
My scholarship has raised the question of to what extent a country (such as the US) actually benefits unilaterally when it thus disfavors the payment (by a company whose owners include resident individuals) of low, rather than high, foreign taxes. These objections may diminish substantially, however, in the case of cooperative multilateral effort to discourage profit-shifting – which the proposal, in this respect among others, aims to enhance and expand.
7) Buh-bye to FDII - The proposal would repeal FDII, our ill-designed (and probably illegal) export subsidy that can actually encourage outbound profit-shifting and asset-shifting. Given the length of this blogpost already, I will simply say: Hear, hear, and good riddance to bad rubbish.
8) Minimum tax on book income - The proposal retains, but scales back, the Biden campaign’s proposal to impose a minimum tax on highly profitable companies’ financial accounting income (aka book income). As modified, the minimum tax would apply at a 15% rate to US companies with more than $2 billion of reported profits for a given year. Certain tax credits, including foreign tax credits, would be allowed to reduce this minimum tax liability (which, as a minimum tax, would be payable only to the extent that it exceeded the company’s regular corporate tax liability).
As I have discussed elsewhere, I am a bit skeptical about the use of a minimum tax structure here. Also, financial accounting experts, who know a lot more about book income than I do, tend to be resoundingly hostile to giving book income any sort of tax implications. I’m inclined to be respectful of their views on a subject that they know so much about, although I wonder every now and then about whether there might be a bit of a NIMBY aspect to their thinking. (In fairness, tax policy experts are subject to exactly the same thing.)
Even if one concludes that they are wrong, or at least that their concerns are overstated – but equally, if one agrees with them but takes it as given that some such provision is going to be enacted – a lot of hard design work needs to be done to make a minimum tax on book income the best overall instrument that it can be. For example, one issue posed by an annual exemption amount is year-by-year fluctuations in the relationship between annual book income and that amount. This concern extends, of course, to companies that report a financial accounting loss in a particular year, and huge profits in other years. There are also such questions as whether divergences between book income and taxable income that appear entirely “innocent” – i.e., as not actually suggestive (once properly understood) of either tax avoidance or financial reporting manipulation – should be backed out of the computation. But once one allows any of that, what about the danger of further empowering lobbyists to take aim either at financial accounting rules themselves or to their modified use in the book income minimum tax?
One obvious question about the proposal – which the Treasury document describes only in very general terms – is whether there is a notch problem here. For example, does the proposal (a) wholly exempt a company with $1.999 billion of book income in a given year, yet (b) potentially impose a tax liability of just over $300 million on a company with $2.001 billion of book income?
I would presume that the answer is No, and that, as good design sense would suggest, $2 billion is an exemption amount, with the result that only book income above the threshold would face the 15% minimum tax. But the document as written does not (at least to me) make this entirely clear.
9) The broader aim of calling off the race to the bottom and curtailing tax competition - Among the document’s key responses to concern that the US would suffer competitive loss, relative to peer countries as well as tax havens, if it raised the effective rate both on US source income and on the foreign source income of US companies, is its advocacy of greater global tax cooperation. It’s easy to be skeptical about the prospects of achieving such an aim. But the US has surprised skeptics on this front before, such as in the aftermath of FATCA’s enactment. OECD BEPS-related global cooperation has also perhaps, on balance, exceeded the more pessimistic expectations that many (including me) may have had at the time.
The SHIELD proposal is the document’s most direct response to these concerns. As in the case of FATCA, the US would be deploying its global economic clout towards rewarding cooperation relative to noncooperation. Plus, as was the case with FATCA, other countries have something to gain as well, if cooperation in discouraging profit-shifting becomes sufficiently widespread. And it simply is not the case that, say, a lone holdout necessarily undermines the whole thing.
Suppose, for example, that a given tax haven holds out, while everyone else cooperates. It’s a matter of OUR law, not the tax haven’s, whether we afford legal respect for tax purposes to its determinations that a given company is its resident or that certain global income arose there. Moreover, only so much actual economic activity (if any) can shift to the haven, and what remains in our country – whether it involves production, consumption, residence, or anything else that it is costly to shift – can have its tax consequences depend on what we discern about the company’s entire range of global activities.
10) The broader issue of “competitiveness” - There is surely no buzzword more commonly found in discussions of tax, trade, and global economic activity in general than that of “competitiveness.” Unsurprisingly, the words “competitive” and “competitiveness” appear in the Treasury document no fewer than ten times.
Reflecting the terns’ multifacetedness and ambiguity, the usages vary. For example, the document notes that making the US more productive, such as through well-designed infrastructure investment, would increase the appeal of investing and operating in the US, and employing US workers. Of course, making US people and assets more productive would be desirable (all else equal) even in the absence of global competitive concerns. But it is certainly fair play to invoke competitiveness rhetoric in favor of something that is more broadly desirable.
Otherwise, the document’s main uses of “competitiveness” rhetoric are twofold. First, existing tax incentives to offshore investment actually make the US less competitive in the standard use of the term. Second, the competitive pressures in the global race to the bottom can be countered, at least to a significant degree, due both to the market power that the US has, and to the prospects for inducing greater multilateral cooperation.
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