July 7, 2023
July 7, 2023
Earlier this year, Minnesota lawmakers came within a whisker of enacting a sorely needed corporate tax reform that would have insulated the state from the corrosive effect of offshore corporate tax dodging. This reform, known as worldwide combined reporting, is the gold standard for corporate tax sustainability at the state level. The state’s near miss, and the second-best solution Minnesota ultimately enacted this year, known as GILTI (the Global Intangible Low Taxed Income provision), each provide a blueprint for the loophole-closing strategies that other states should prioritize.
The goal and strategy of worldwide combined reporting are simple: the goal is to prevent large multinational corporations from artificially shifting their income out of the U.S. and into foreign tax havens, and the strategy is to require big multinationals to include all their income—from the biggest nation to the smallest foreign tax haven – in one big pot before determining Minnesota’s proper share of worldwide income.
Absent this reform, big multinationals can reap huge tax cuts by shifting their U.S. profits out of Minnesota—where state tax laws can, sensibly, reach those profits—to low-rate foreign tax havens that are utterly beyond the reach of states. This income shifting remains a gigantic drain on corporate taxes, as an ITEP analysis of IRS data reveals. Because worldwide combined reporting starts by putting the income of foreign subsidiaries in the same pot as domestic profits, it takes away the incentive for companies to shift their income out of the U.S. and into tax havens.
If this strategy sounds familiar, it should: it’s the same concept as water’s edge combined reporting, a vital reform half the states have now put in place to prevent corporations from artificially shifting U.S. income into low-tax states. The “water’s edge” version prevents companies from using Delaware as a tax dodge but is helpless to prevent profits from sailing across the ocean to more exotic tax havens like the Cayman Islands or Luxembourg. Extending an existing combined report beyond the water’s edge, or enacting a combined report that immediately reaches worldwide, is a reform that would put an end to aggressive profit-shifting in one fell swoop.
When Minnesota’s House and Senate passed worldwide combined reporting earlier this year (before lawmakers lost their nerve in conference committee), it took many observers by surprise. But from a worldwide perspective, this move was anything but shocking: around the world, the walls are closing in on offshore corporate tax avoidance.
More than 140 countries have now signaled their support for a multinational effort to tax corporate income where it is earned. A new corporate tax backstop enacted by Congress and the Biden administration last year promises to help mitigate corporate efforts to hide profits in tax havens. Even the otherwise-awful Tax Cuts and Jobs Act (TCJA) included provisions—most notably GILTI—designed to discourage artificial offshoring of profits. Seen through this lens, Minnesota’s move seems both predictable and welcome.
GILTI conformity is a clear second best compared to worldwide combined reporting but is nonetheless a valuable step forward. Enacted at the federal level as part of the 2017 Tax Cuts and Jobs Act, the GILTI provision is designed to discourage offshore income shifting. Rather than identifying specific foreign tax havens, GILTI applies a U.S. tax to foreign profits that are disproportionately large relative to the offshore tangible assets that supposedly are generating these profits. In particular, GILTI applies to foreign income exceeding a 10 percent rate of return on foreign tangible assets.
While the GILTI approach is less explicitly targeted to specific foreign tax havens, it’s designed to ensure that large multinationals best known for shifting profits into foreign tax havens will no longer be rewarded for doing so. And early indications are that it’s achieving this goal.
For example, Minnesota-based 3M has paid an average of $65 million a year in GILTI tax over the five years since GILTI took effect at the federal level, a clear indication that the company is reaping suspiciously large profits in foreign countries where its physical footprint is small. So the state’s move to couple with this federal provision will help ensure that GILTI tax payments made by 3M and other large multinationals will benefit Minnesota taxpayers as well, to the tune of over $400 million during the next biennium.
Minnesota’s last-minute retreat from worldwide combined reporting, and subsequent embrace of GILTI, appears increasingly a Pyrrhic victory for the business lobbyists who used misleading scare tactics to jangle lawmakers’ nerves.
These lobbyists, acting at the behest of large multinational corporations, have protested vigorously against every sustainable corporate tax reform proposal in the last quarter century. They complained when more than half the states enacted water’s edge combined reporting as the 21st century began; they have pushed for a bigger sales factor, more generous manufacturing incentives and research tax credits; and have fought against better disclosure of how this raft of tax breaks affect their own tax rates. They do it not because their arguments have merit, but because pushing for ever-lower corporate taxes is their job. And, until recently, they have done their job well.
But the qualified success of Minnesota’s GILTI conformity—to say nothing of the state’s serious dalliance with the game-changing worldwide combined reporting–sends a clear signal that the days may be coming to an end when big multinationals can scare state lawmakers into allowing them to game the tax system. For lawmakers seeking to level the playing field for small businesses against the predations of big multinationals, following in Minnesota’s footsteps should be on the short list of reform goals.