December 21, 2022
Federal Policy Analyst
December 21, 2022
Where should the profits of global corporations be taxed? It is not an easy question. If a corporation has engineers in California, manufacturing centers in Asia, assembly plants in Texas, and sells to consumers across North America and Europe, there are legitimate questions about which jurisdictions they are “earning” their profits in and thus where they might owe corporate income taxes.
One thing is clear, though: they are not earning their profits in a mailbox in the Cayman Islands, a tiny British territory in the Caribbean that politicians in London and Washington treat as an independent nation for tax purposes. Yet many American corporations tell the Internal Revenue Service that they earn their profits in this island nation where they do no actual business. One office building in the Cayman Islands—just five stories tall—is home to more than 18,000 companies. Given that the British government has provided few options for real economic development, Cayman understandably welcomes the incorporation fees this generates. But is this any way to structure an international tax system?
Nearly every nation, from the United States to the United Kingdom to the Cayman Islands, has recently decided it is not. Over the past two years, the Biden administration has led negotiations of an international agreement with other leading economies ensuring the largest multinational corporations pay taxes in the countries where they do business. The plan would require any corporation earning more than €750 million (about $800 million) to pay at least a 15 percent corporate income tax rate on their global profits in the countries where they have economic activities.
Last week, the European Union reached unanimous agreement to implement this global minimum tax beginning in 2024. With the EU and United Kingdom fully on board, it is time for Congress to follow suit and implement the plan negotiated by the administration. Doing so would improve the corporate tax system here and around the world while making the United States economy stronger and more competitive.
The Current Global Tax System Favors Small Tax Havens and Large Corporations
While the official corporate tax rate in the United States is 21 percent, corporations use many tactics to effectively pay much less. The most infamous of these tactics exploit accounting gimmicks to make corporate profits appear to be earned in tax havens like the Cayman Islands or Ireland. For example, a U.S. company could place a patent or trademark in a subsidiary incorporated in a country that will impose little or no tax on its profits, even if the company has no other business activities in that country. It will then tell the IRS that its profits are generated from that intellectual property, which in turn means that the profits are generated by the tax haven subsidiary rather than in the United States.
Nike, for example, owns many subsidiaries sporting the names of popular product lines in countries like Bermuda and the Netherlands that impose no tax or one that is easily avoided. It does not take a genius to conclude that Nike placed the trademarks for each of its product lines in one of these tax haven subsidiaries and then told the IRS that the profits were therefore generated abroad in these jurisdictions where they will not be taxed.
In some cases, the discrepancy between claimed profits and real economic activity is especially egregious. In 2019, U.S. corporations claimed to earn profits in five different countries that exceeded those countries’ entire economic outputs. American companies claimed to earn over $60 billion in the Cayman Islands—ten times the entire country’s gross domestic product. The year before, American corporations claimed to have earned over 13 times the GDP of Bermuda in Bermuda.
In another demonstration of how disconnected this tax reporting is from reality, IRS data reveals these companies often have very few employees in the countries where they claim to earn their profits. If the tax filings are to be believed, then American corporations earned nearly $60 million for every employee they hired in the small British territory of Gibraltar. If multinational corporations were truly tapping that much productivity from Gibraltar’s workers, then the economic puzzle of the millennium would be how the country’s total GDP only amounts to about $60,000 per person. The real answer is obvious, however: the tax reporting does not reflect economic reality.
Corporations are not necessarily breaking the law when they report obviously implausible profits to the IRS. Rather, they are exploiting weaknesses in the global tax and legal system. The result is a tax system that works for nobody other than rich corporate shareholders (and the financial services industry). Multinational corporations take advantage of the labor of large countries like the US and China that is developed through public education, of international shipping routes that are largely protected by the U.S. Navy, of markets that are only possible through public ports and roads, and then pay none of the taxes that support these investments.
The New International Agreement Would Shut Down Offshore Tax Dodging by Corporations
Recognizing the need for international cooperation on the issue, the Biden Administration began negotiating with other major economies last year to create a more fair and effective global tax system. In October 2021, 136 countries signed on to an agreement to implement a global minimum tax system (called the “GLoBE” rules, for Global Anti-Base Erosion). If implemented, the agreement would ensure that large, multinational corporations pay a minimum tax rate of at least 15 percent.
The exact details are complicated, but the crux is that companies would have to start paying taxes according to where they are selling products and services rather than where they register a post office box. GLoBE rules would apply to corporations with more than €750 million in revenues in recent years—or about $800 million. The actual effective tax rate that these companies pay must be at least 15 percent (not including deductions for depreciation or certain tax credits).
The GLoBE rules eliminate the incentive for countries to engage in a race to the bottom. First, the Income Inclusion Rule (IIR) allows countries implementing the minimum tax to apply a top-up tax to corporations headquartered within their borders if the corporation is paying an effective tax rate below 15 percent in another country where it operates. This means that if a corporation is based in a country that has implemented the agreement, that country can apply an additional tax on the company's profits in a tax haven to bring the effective tax rate up to 15 percent.
Second, the Under Taxed Payments Rule (UTPR) allows countries to apply a top-up tax to foreign companies operating within their borders if the corporation’s home country has not implemented the GLoBE rules and the company is paying an effective tax rate less than 15 percent in some other country. This means that if a country is not implementing the international agreement its own corporations could nonetheless pay a tax rate of at least 15 percent because the other countries where those companies operate are imposing a top-up tax under the UTPR. And the country failing to implement the minimum tax would be allowing foreign governments to collect this revenue.
Although an agreement was signed last October by all major economies to implement the GLoBE rules, the actual implementation process is the most daunting step. Countries must work within their own political and legislative processes to adapt the international agreement into their tax systems. The European Union’s decision to implement the rules beginning in 2024 marks crucial momentum for the agreement, especially after the United Kingdom previously announced they would begin enforcing the rules that same year. The UK and EU combined represent about a fifth of the entire world economy.
The United States is the Last Major Hurdle for International Implementation
Despite negotiating the GLoBE rules, the U.S. has not yet taken the steps to fully implement them. While the U.S. does have tax rules for “global intangible low-tax income” (GILTI) that are similar to the GLoBE rules, the GILTI tax applies to a smaller portion of income and only at a rate of 10.5 percent. The U.S. also adopted a 15 percent corporate minimum tax in 2022 as part of the Inflation Reduction Act, but that tax is also not completely in line with the international agreement. For example, the IRA minimum tax considers a company’s worldwide effective tax rate rather than their per-country tax rate.
Although the U.S. signed the agreement last October, implementation will require Congress passing legislative changes to our tax laws. The prospects of the U.S. implementing the rules by 2024 look dim, with the 117th Congress coming to an end without adopting the new rules and with Republicans who are opposed to the plan set to take over the House of Representatives next year.
The basis of Republican opposition to the agreement is not clear, and their statements on the matter are vague and nonsensical. Rep. Vern Buchanan—who could become the chair of the House’s main tax writing committee—told reporters that “the United States will not be bullied into accepting an agreement that fails to protect American workers and businesses from discriminatory foreign taxes.” On the contrary, failure to implement the GLoBE rules could subject American businesses to foreign taxes under the previously mentioned UTPR top-up tax.
Recently, GOP lawmakers on key tax committees sent a letter to the President claiming that the White House does not have the authority to negotiate such international tax agreements. This assertion is hard to follow, as the Constitution plainly gives the President the power to conduct diplomacy and set foreign policy objectives.
Most astonishingly, the Republicans’ letter asserts, “We are not aware of any administration – Republican or Democrat – that has so blatantly used its role in international tax negotiations to advance its partisan political agenda.” This actually describes the Republican lawmakers’ own behavior. Earlier this year, Congressional Republicans negotiated behind the scenes with the authoritarian Hungarian government to try to kill implementation of the global minimum tax in the EU. While the tactic ultimately failed, it did present a serious hurdle to the agreement, as the EU’s rules require all member countries to consent to any tax agreement.
Contrary to Republican claims that the GLoBE rules are anti-competitive, or that the US is being bullied into accepting some agreement that will hurt the country, the plan was negotiated by our own diplomats to make the international system work for all Americans rather than for the shareholders who are concentrated among our richest one percent and among foreign investors. Multinational corporations should not be able to skirt their taxes by “earning” all their money in a post office box while American workers dutifully pay their taxes every paycheck. The governments of the United States and Europe should stop using tiny British territories as pawns to allow corporations to avoid contributing to fund schools, roads, and public safety. Moving forward with implementation will make the United States economy stronger and more competitive, not less.