July 17, 2018
Senior Policy Analyst
July 17, 2018
By all accounts, the international corporate tax code has been broken for a long time. A frequently cited academic study estimates that U.S. multinationals are allowed to avoid more than $100 billion each year by taking advantage of offshore loopholes. Rather than reform the system by closing the loopholes and raising revenue, the Tax Cuts and Jobs Act (TCJA) replaced old loopholes with new ones in such a way that overall the international provisions will lose an additional $14 billion in revenue over the next 10 years. It is striking that even Rep. Kevin Brady (R-TX), one of the chief architects of the legislation, admitted that these provisions are in need of change, and they did not take the time to fully “model them” before the passage of the bill.
How should lawmakers fix the system? A new ITEP report breaks down how the international corporate tax code under the TCJA works, and how lawmakers can fix it. The report lays out three key principles for reform: equalize the rates, eliminate inversions, and create transparency.
1. Equalize the Rates
The primary problem created by the TCJA is the fact that it allows multinational companies to pay a substantially lower tax rate on their offshore income than on income earned in the United States. More specifically, the TCJA gives companies two significant tax breaks on their offshore income. First, it allows companies to deduct from their offshore income an amount equal to 10 percent of their offshore tangible assets. This provision will allow many American companies to pay no U.S. taxes at all on their offshore income. In addition, because the deduction increases depending on the amount of tangible assets a company has offshore, it creates a new incentive for companies to move real operations outside the U.S. to increase the deduction they receive. Second, companies receive a 50 percent deduction on the rest of their offshore income, which means that at most a company will only be required to pay a top U.S. tax rate of 10.5 percent on their offshore income.
The solution to the problems created by the preferential rate on offshore income is simple. Lawmakers should eliminate these tax breaks for offshore income so that U.S. corporations’ foreign profits are treated the same as their domestic profits. This is the approach taken by the recently introduced No Tax Breaks for Outsourcing Act.
2. Eliminate Inversions
Another key component of international tax reform is to block corporate inversions, the practice of corporations using mergers to reincorporate abroad to avoid U.S. taxes. TCJA includes only weak provisions to curb inversions. In fact, in March the auto parts supplier Dana Inc. announced its intention to go through with an inversion.
Lawmakers should end inversions by tightening the definition of a “foreign corporation” for tax purposes. The rules should not allow a company to invert if it continues to be managed and controlled in the United States or if a majority of the U.S. company’s shareholders own the resulting company after a merger. The No Tax Breaks for Outsourcing Act also includes these provisions as part of its overhaul of the international tax code.
As the report explains, lawmakers should also crack down on the incentive to invert by further restricting the deductibility of excess interest payments and enhancing the base erosion and anti-abuse tax (BEAT) by including cost of goods sold as part of the base of the tax.
3. Create Transparency
The offshore tax avoidance system thrives on opacity. It is difficult for the public, lawmakers, and even tax agencies throughout the world to determine how much companies should pay and how they are structuring their finances to avoid taxes. To ensure that companies are paying their fair share, a critical component to any international tax reform effort should be to require companies to publicly disclose their earnings, revenues, jobs, assets, income tax paid and other financial information on a country-by-country basis. Such disclosure would allow the public and lawmakers alike to determine how much companies are paying in taxes and whether those taxes reflect a fair approximation of what they should be paying.
Both the Stop Tax Haven Abuse Act and the Corporate Transparency and Accountability Act would accomplish this goal by requiring companies to publicly disclose financial information on a country-by-country basis as part of their filing to the Securities and Exchange Commission (SEC). If Congress refuses to act to ensure transparency, the SEC and the Financial Accounting Standards Board (FASB) have a responsibility to take independent regulatory action to require companies to provide these additional disclosures.
The Choice Between Corporate Shareholders and Working People
While international corporate tax policy may appear to be as esoteric and complex, it is critical that the public and lawmakers do not cede the ground on this issue to multinational corporations and their related interest groups. It is important to remember that every dollar multinational corporations are allowed to avoid on their income tax is another dollar that has to be paid by working families in the form of higher taxes, higher deficits or cuts to critical spending programs. It should be clear to anyone watching that allowing offshore tax avoidance to flourish is a decision to reward wealthy shareholders of corporations by taking away dollars from working families.
For more details on these proposals read the full report “Understanding and Fixing the New International Corporate Tax System”