While legislated rate cuts are responsible for the largest share of the loss in corporate tax revenues, profit shifting—corporations’ exploitation of mismatches between tax systems and the use of tax-planning strategies to move profits from high- to low-tax jurisdictions—is a major contributor as well. By 2017, the United States was losing an estimated $100 billion in annual revenues due to profit shifting—and it’s not alone. Globally, researchers estimate that more than one-third of multinational corporations’ profits are shifted to tax havens to reduce the amount of taxes paid. The erosion of corporate tax collections has forced countries to rely on more regressive sources of revenue that shift the cost of government to workers and their families.
This column explains how multilateral negotiations hosted by the Organization for Economic Cooperation and Development (OECD) would help address these problems by instituting a global minimum corporate tax rate and related reforms. It then calls on Congress to enact President Joe Biden’s Build Back Better plan that would enable the United States to implement the OECD agreement, strengthen the nation’s corporate income tax, and raise revenues to fund critical investments.
The TCJA exacerbated the erosion of corporate tax collections
The 2017 tax law lowered the corporate tax rate from 35 percent to 21 percent and fundamentally changed how the United States taxes the income of global corporations. This change moved the United States toward a territorial system that permanently excludes from taxation certain income of multinationals.*** Furthermore, as a result of the law’s lower tax rate on certain foreign profits, many corporations pay a far lower rate—often as low as zero—on foreign profits than they do on income earned domestically. Recognizing the resulting incentive to offshore jobs and investment, the law included modest efforts to limit abuse: the global intangible low-taxed income (GILTI) tax, the base erosion and anti-abuse tax (BEAT), and the foreign-derived intangible income (FDII) deduction. Research has shown that these provisions have been ineffective. Overall, the TCJA’s corporate provisions have been more costly than initially forecast.
The OECD agreement would establish a global corporate minimum tax
The scale of corporate profit shifting and the failure of multinational corporations to pay their fair share of tax has sparked global concern and fueled the search for a coordinated solution. After years of negotiations, 136 nations, including all of the world’s largest economies, reached agreement on an ambitious agenda designed to rein in corporate tax avoidance and modernize international tax rules. And on October 8, the OECD announced a final framework—the “Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy”—which would establish a global minimum tax that applies to the world’s largest corporations and make other changes to limit the incentive to shift profits to low-tax jurisdictions and ensure that countries where economic activity actually occurs receive tax revenues commensurate with that activity. The G-20’s October 30 endorsement moved the historical agreement an additional step closer to becoming a reality.
This agreement—secured with the diplomatic leadership of U.S. Treasury Secretary Janet Yellen—would help resolve international controversies over the taxation of digital services by apportioning 25 percent of certain profits of the largest multinational corporations based on the location of their customers (Pillar One) and—even more significantly—establish a global minimum tax of 15 percent that would apply to multinationals with annual revenue in excess of 750 million euros (Pillar Two).
The OECD agreement includes a detailed implementation plan and would take effect beginning in 2023. The agreement is a landmark step toward requiring the world’s most profitable global companies to pay their fair share for the public investments and services that enable them to succeed—and, in that respect, is a large step toward fairness for workers and small businesses.
Biden’s Build Back Better plan makes the changes required for the US to implement the OECD agreement and would strengthen the corporate income tax
President Biden’s Made in America Tax Plan, released in April, anticipated the changes needed to enact the OECD agreement and proposed to strengthen the U.S. corporate tax and raise revenues to help pay for critical investments. The reforms included in the Build Back Better framework announced by the White House on October 28 reflect these goals and would require multinational corporations to pay more toward their fair share; crack down on profit shifting and tax haven abuse; and level the playing field for American workers and small businesses. They are also consistent with Pillar Two of the OECD agreement and would encourage other countries to adopt their own versions of the corporate minimum tax. Congress should enact these changes as part of the Build Back Better Act:
- Impose a country-by-country minimum tax. The TCJA established a minimum tax on foreign income—the GILTI—at the current rate of 10.5 percent. That tax, however, is calculated by taking into account all of the foreign income earned and all of the foreign taxes paid by U.S. companies—effectively allowing companies to shield income earned in low-tax jurisdictions with foreign taxes paid on income earned in higher-tax jurisdictions and thus maintaining an incentive to profit shift. Perhaps the most consequential change in the OECD framework is the requirement for countries to impose the minimum tax on a country-by-country basis. Draft legislation, released by the House Rules Committee on October 28, is consistent with President Biden’s original Made in America proposal, which would shift the calculation to a country-by-country basis as required by the OECD agreement.
- Raise the global minimum tax rate. The OECD framework requires the United States to increase the GILTI rate to a minimum of 15 percent, higher than the current rate of 10.5 percent. President Biden’s original proposal calls for a 21 percent rate, surpassing the floor in the two-pillar agreement. While a higher rate that narrows the gap between the GILTI and the U.S. corporate rates—such as that originally proposed by President Biden—would provide a stronger disincentive to profit shift, the October 28 Build Back Better framework complies with the OECD requirement.
- Reduce the exemption for offshore investments. The current GILTI allows companies to reduce their foreign income for U.S. tax purposes by an amount equal to 10 percent of the value of certain property held outside the United States. The provision in the October 28 House Build Back Better draft—while not as strong as President Biden’s initial proposal, which eliminated the exemption entirely—would provide a stronger incentive to maintain jobs and investment in the United States.
- Combat erosion of the U.S. corporate tax base to low-tax havens. The OECD framework protects the tax base of headquarter countries by subjecting corporations allocating profits to low-tax jurisdictions to a loss of deductions or an additional tax. This provision—known as the Undertaxed Payment Rule—is intended to ensure that countries impose a true minimum tax and to eliminate the incentive to profit shift. The TCJA’s BEAT was intended to limit profit shifting by imposing a tax on payments to foreign subsidiaries made out of U.S. earnings, acting as a form of alternative minimum tax. However, this provision has failed to work as intended and can create an uneven playing field that disadvantages U.S.-based corporations relative to counterparts headquartered in low-tax jurisdictions. The president’s original proposal would have repealed the BEAT and replaced it with a stronger set of protections—the Stopping Harmful Inversions and Ending Low-Tax Developments (SHIELD) rule. The October 28 House Build Back Better draft includes a phased-in increase in the BEAT from 10 percent to 18 percent along with other protections. This proposal is consistent with the OECD framework and helps protect the competitiveness of U.S.-based corporations as well as smaller domestic businesses.
Modest changes would build on the OECD framework, strengthen incentives for domestic investment, and further discourage profit shifting
The October 28 House Rules Committee draft of the Build Back Better framework is consistent with the OECD agreement and makes important progress toward protecting U.S. jobs and investment. However, Congress could more closely align it with Biden’s plan and improve upon the bill in several key respects:
- The proposed GILTI rate is lower than that originally proposed by President Biden. A higher rate that comes closer to equalizing the tax treatment of U.S. and foreign profits would further reduce the incentive to shift jobs and investment overseas.
- Current law allows companies to reduce their foreign income for tax purposes by 10 percent of the value of certain assets held offshore. The October 28 Build Back Better proposal improves upon the OECD standard by reducing the exemption to 5 percent; however, adoption of the president’s initial proposal to eliminate the exemption would strengthen protections against corporate investments being shifted offshore.
- The increase in the BEAT rate proposed in the October 28 proposal is an important step toward removing an incentive for low-tax jurisdictions to stay out of the OECD agreement and undermine the impact of the new global minimum tax. Increasing the BEAT rate to the U.S. domestic rate would further minimize the incentive for corporations to strip profits out of the United States or to relocate their place of incorporation in a low-tax jurisdiction through a so-called corporate inversion.
Conclusion
Congress should adopt President Biden’s Build Back Better reforms aligning U.S. corporate tax law with the new global standards established in the OECD two-pillar agreement. Taken as a whole, the Build Back Better international tax component constitutes a robust change that makes landmark progress toward stemming tax competition, leveling the playing field for global investment, and limiting the race to the bottom that prevents countries from raising needed revenues. It would also improve the U.S. tax code by ensuring that the world’s largest and most profitable corporations begin to pay their fair share.
Jean Ross is a senior fellow at the Center for American Progress.
* While the lower statutory corporate rate reduced the incentive to profit shift, the shift toward a territorial system that excludes certain income of U.S. multinationals from tax, coupled with the structure of the TCJA’s minimum tax, created an offsetting incentive to shift profits outside the United States.
** Some of the erosion is attributable to the rise of noncorporate forms of ownership. However, as noted by former Council of Economic Advisers Chair Jason Furman, “U.S. business taxes would still be low in both historical context and compared to other countries” even if this shift is taken into account, and the shift cannot explain the steep drop in corporate revenue from 2018 to 2020. While absolute loss of revenues is lower due to the TCJA’s lower corporate tax rate, recent research suggests that profit shifting has continued since the 2017 tax law. A discussion of the factors contributing to the erosion can be found here.
*** Prior to 2017, offshore profits were subject to tax upon repatriation to the United States, creating an incentive for corporations to hold profits offshore to avoid payment of tax.