December 19, 2017
Senior Policy Analyst
December 19, 2017
Everyone in Washington agrees that there are some major problems with our international corporate tax system. The first question is what to do about the profits that corporations have already earned and are holding offshore, which now amounts to $2.6 trillion. To be clear, this money isn’t sitting in vaults in foreign countries. In fact, much of it is invested in the U.S. already, but no U.S. taxes are being paid on it. The second question is what rules to set for profits earned offshore going forward, to ensure that American corporations cannot continue to use accounting gimmicks to claim that their U.S. profits are earned in other countries where they won’t be taxed. An estimated $100 billion in revenue has been lost each year due to such corporate tax schemes.
The tax bill on it’s way to approval by Congress was a golden opportunity to solve these problems for good—but turned out to be a colossal missed opportunity. Instead of addressing the hundreds of billions in lost federal tax revenue due to offshore tax avoidance schemes, the Trump-GOP tax bill would forgive most of the taxes owed on the profits held offshore right now and open the floodgates to even more offshore profit-shifting in the future.
Transition Rules to Deal with the $2.6 Trillion Accumulated “Offshore” Profits? Just a Huge, Unwarranted Tax Break
The biggest giveaway on the international side of the Trump-GOP tax bill is its extra low rate on the $2.6 trillion in accumulated “offshore” earnings. Under the plan, companies would only have to pay a 15.5 percent rate on offshore earnings held as cash and an 8 percent rate on all other earnings. According to the Joint Committee on Taxation (JCT), this means that companies would pay just $339 billion in taxes on the $2.6 trillion total offshore hoard.
While this might sound like a lot, it’s really a huge windfall for multinational corporations. Under current law (under the rules in place before the new law goes into effect in January), they would pay a rate of 35 percent on these offshore profits, minus a credit for any foreign taxes paid (which is sometimes almost nothing.) Based on that math, they likely owe the U.S. government $752 billion in taxes on these earnings. Allowing them to pay just $339 billion provides them with $413 billion break.
A big chunk of the tax windfall will go to infamous tax avoiders. For example, Apple currently owes $78.6 billion on its $252.3 billion in accumulated offshore earnings. Under the Trump-GOP tax bill’s repatriation tax break, the company will owe just $34.8 billion, meaning that it will receive a $43.8 billion windfall. This means that the single most widely acknowledged corporate tax dodger in America would get over 10 percent of the total take from this Christmas present to big offshoring corporations.
New Rules to Prevent Offshore Profit-Shifting Going Forward? Not So Much.
Looking forward, the Trump-GOP tax bill will, in theory, clamp down on some forms of offshore tax avoidance, but would use the revenue raised to open new and bigger holes in the tax code. The three central changes to the offshore tax system going forward are its enactment of a territorial tax system, the creation of a foreign minimum tax on excess profits, and the creation of the Base Erosion and Anti-Abuse tax.
The most significant component of the Trump-GOP tax bill on international taxes is the move to a territorial tax system, which means the active income of U.S. companies earned offshore will no longer be subject to U.S. taxes. By doing this, the Trump-GOP tax bill moves in the opposite direction of real tax reform by substantially contracting the base of the U.S. corporate tax. According to the JCT, moving to the territorial tax system would cost $223.6 billion over the next decade. Exempting offshore income from U.S. taxation would encourage further profit shifting, and would also create a tax incentive for companies to move real operations and jobs offshore to take advantage of lower tax rates.
Base Erosion and Anti-Abuse Tax
To make up for revenue losses from the territorial tax system, the Trump-GOP tax bill includes a measure called the Base Erosion and Anti-Abuse tax. This is a new alternative minimum tax through which companies would take their taxable income and add back deductions and deprecation for amounts paid to related foreign subsidiaries. If the taxes paid on this new base is less than 10 percent they would pay the difference. While this could constitute a significant anti-base erosion measure, it could be difficult to implement because it potentially violates trade and tax treaty obligations. If those issues could be dealt with, the JCT estimates that the provision would raise $149.6 billion over 10 years.
Minimum Tax on Excess Foreign Profits
The tax bill has a second measure designed to reduce the flow of corporate cash offshore: a foreign minimum tax on excess profits. The proposal would place a minimum tax of 10.5 percent on excess profits (defined as profits over 10 percent of the amount of tangible assets offshore) from offshore income and create a deduction of 37.5 percent on foreign derived intangible income. While the minimum tax could raise $112.4 billion, the new deduction and transfer rules would lose $63.8 billion, meaning that the provisions together only raise $48.6 billion. The idea behind this is to follow the failed approach of many European countries in enacting a kind of patent box that gives income earned from intellectual property a special low tax rate.
Each of these base erosion measures could help to offset at least some of the costs of moving to a territorial system. But the main reason why these new fence posts around the corporate tax system are even necessary is that the move to a territorial system opens the barn doors wide to corporate offshoring. And it’s an open question whether these safeguards will be administrable: only a fully funded and fully staffed Internal Revenue Service can meaningfully enforce these new rules. Sadly, however, bolstering our tax administration appears to interest congressional leadership even less than sustainable tax reform.
While the anti-base erosion provisions contained within the Trump-GOP tax bill are useful, they do not add up to enough to undo the revenue damage resulting from the move to a territorial tax system and the creation of new exemptions for intangible income. The JCT estimates that these provisions together would cost $14 billion over the next decade. In other words, rather than clamping down on egregious tax avoidance, the Trump-GOP tax bill would reward tax avoiders with $14 billion in additional breaks.