When Congress reformed the tax code by passing the Tax Cuts and Jobs Act (TCJA) back in 2017, the motivation was to make American businesses more competitive across the world. This time around, Congress is re-reforming the international tax system for a very different purpose: to raise additional revenue that can be spent on a variety of priorities. This backwards method of policymaking is likely to cause significant harm to the economy by making the American tax system unfriendly to multinational businesses choosing where to direct their activities and investments.
Senators Ron Wyden (D-OR), Sherrod Brown (D-OH), and Mark Warner (D-VA) recently put forward draft legislation intended to be just one element of a raft of proposed tax hikes to pay for a proposed $3.5 trillion spending package. When Congress is trying to scrounge up enough revenue to match that kind of price tag, you can bet your bottom dollar that sound policy considerations will come in second to potential revenue — assuming Congress hasn’t already taxed your bottom dollar as well.
One of the most significant yet underreported changes in the TCJA was the shift from a global to a territorial tax system. Prior to the TCJA, the United States effectively attempted to tax all foreign income of U.S.-based multinational corporations as if it had been earned in the U.S. (albeit after an allowance for foreign taxes paid).
This uncompetitive system had the effect of simply encouraging American businesses to shift their headquarters to other countries to avoid this tax, as29 of 35 OECD countries at the time did not attempt to impose such requirements. This was a concerning trend because the more major companies put factories, patents, and other valuable assets in the U.S., the more economic opportunities we create here at home. And indeed, after the TCJA did away with this outdated system, more than $1 trillion in assets were repatriated to the United States.
But while the TCJA stopped attempting to enforce an 18th-century mentality of punishing American businesses with overseas assets, it also attempted to curtail some of the most prevalent forms of abuse. To address the issue of multinational corporations shifting profits to tax havens by “buying” hard-to-value intangible assets from subsidiaries in low-tax jurisdictions, the U.S. created taxes on Global Intangible Low-Tax Income (GILTI).
Under current law, American multinational corporations must pay tax on foreign profits roughly equal to half of the 21 percent corporate tax rate, or 10.5 percent. This tax rate is applied to foreign profits, minus 10 percent of tangible foreign income (known as qualified business asset investment, or QBAI), and a deduction for 80 percent of foreign taxes paid, to arrive at a business’s GILTI liability. At the same time, domestically-held intangible assets are subjected to a lower tax rate as well, discouraging moving them offshore.
While President Biden has proposed to double the GILTI rate to 21 percent, Wyden is not laying down a flat number as of yet. Nevertheless, reducing the deduction on GILTI combined with raising the domestic corporate tax rate could result in a far higher rate on foreign income, making it less of an anti-avoidance provision and more of a supplemental tax.
After all, though the nominal GILTI rate is between 10.5 and 13.125 percent, the Joint Committee on Taxation found that in 2018 (the most recent year for which data is available) the effective GILTI rate on the 81 largest U.S.-based multinationals averaged 16 percent. That’s already high enough to comply with the 15 percent minimum required by the recent global minimum tax agreement.
All told, the Senators’ proposal would undo the TCJA’s progress towards making our international tax system more attractive to American-headquartered multinational businesses. Congress’s desire for more revenue to fuel its spending addiction is a poor justification for pushing multinational businesses overseas — particularly in the midst of an ongoing global pandemic.
The TCJA made a great deal of progress towards bringing the U.S. tax code into the 21st century. A territorial tax system that largely exempts normal foreign business activity from U.S. taxes makes our country more attractive to multinational businesses, and it also allows American-based multinationals to better compete on the global stage. President Biden and the Senators on the Senate Finance Committee should think twice before making drastic changes driven by a mere desire for more revenue.