Weekly SSRN Tax Article Review And Roundup: Layser Reviews Shanske's How The States Can Tax Shifted Corporate Profits

This week, Michelle Layser (Illinois) reviews Darien Shanske (UC Davis), How the States Can Tax Shifted Corporate Profits: An Application of Strategic Conformity, 93 S. Cal. L. Rev. ___ (2020).

A dangerous consequence of the economic disruptions caused by the COVID-19 pandemic has been steep declines in state and local tax revenue. As is often the case during crisis periods, these revenue shortfalls have arrived at precisely the time when many residents are in dire need of a social safety net (see here and here).  Under the circumstances, Professor Darien Shanske observes that “it would be reasonable for states to contemplate inefficient—and even regressive—revenue-raising measures.” In a new Article, Shanske cautions against such an approach and offers what he says is a more efficient, more equitable alternative that is also relatively easy to administer.

The solution: state-level conformity to a relatively new federal law aimed at curbing corporate tax avoidance. Specifically, Shanske argues that states can and should conform to the new Global Intangible Low-Taxed Income (GILTI) regime. Under GILTI, a formula is used to identify cases when taxpayers have shifted domestic (U.S. source) income abroad. Federal tax law subjects such income to U.S. taxation at 50% the regular corporate rate even though it is nominally earned abroad. The GILTI regime is intended to curb income shifting behavior that is estimated to cost the federal government about $100 billion per year—and according to some estimates, states could also raise $15 billion per year by taxing GILTI.

Of course, the actual effectiveness of the federal GILTI regime has been questioned. But according the Shanske, states can improve upon the federal law by strategically conforming to the parts that work, and by declining to conform to the parts that don’t. For example, states should not conform to federal laws providing a foreign tax credit. As Shanske explains, the foreign tax credit enables multinational corporations to dramatically reduce their GILTI liability by paying just enough in higher tax countries to zero out their GILTI liability. In such cases, “GILTI has not done much more than helped, say Germany, raise a little bit more in its corporate income.” Federal regulations further undermine the effectiveness of the GILTI regime—so states shouldn’t adopt those rules either.

Through selective conformity, Shanske says that states can protect their corporate tax bases and raise sorely needed revenue. In defense of this proposal, Shanske responds to a long list of potential objections ranging from the practical critiques (wouldn’t it be burdensome to administer?) to the legal critiques (is it even constitutional?), ticking them off one-by-one to demonstrate that states should conform to GILTI. Well, maybe they should.

It turns out that there might actually be an even better approach—one that states have tried before. According to Shanske, a preferable approach would be a return to mandatory worldwide combination, which requires unitary businesses to include their worldwide income in the tax base subject to apportionment. Some states, such as California, have experimented with mandatory worldwide combination in the past. As Shanske explains, those experiments were so successful that the federal government considered copying it, and the Supreme Court upheld its constitutionality twice. Various sources of political pressure ultimately forced states to retreat from the approach, but Shanske says “the timing for a return to worldwide combination seems pretty good.”

Despite the article’s title, Shanske seems to favor the return to worldwide combination over conformity to the GILTI regime. (Since the regimes are inconsistent, states generally can’t do both; however, Shanske does briefly consider the possibility of giving taxpayers a choice between GILTI or worldwide combination). However, perhaps the real takeaway is this: states are missing out on opportunities to tax corporate income that could help shore up their fiscal crises, both during the pandemic and in the years that follow. Shanske has identified two such opportunities—conformity to GILTI or a return to worldwide combination—and demonstrated that either approach would be an improvement over the status quo.

I recommend this essay to all tax scholars interested in state and local taxation, international taxation, tax evasion and avoidance, or constitutional law.

Here’s the rest of this week’s SSRN Tax Roundup:

• Heather M. Field (UC Hastings), Tax MACs: A Study of M&A Termination Rights Triggered by Material Adverse Changes in Tax Law, The Tax Lawyer, vol. 73, no. 4 (Summer 2020), pp. 823-859 (July 20, 2020) (published by the ABA Section of Taxation).
• Stephen G. Utz (Connecticut), Boz Among the Radicals: Dickens Records a Turning Point in Tax History (September 19, 2019).
• Kristin E. Hickman (Minnesota), Brief of Amicus Curiae Kristin E. Hickman In Support of Petitioners, CIC Services, LLC v. Internal Revenue Service, et al., No. 19-930 (U.S. Supreme Court) (July 22, 2020).
• Edward G. Fox (Michigan) and Zachary D. Liscow (Yale), A Case for Higher Corporate Tax Rates,Tax Notes, Volume 167, Number 12 (July 21, 2020).
• Hayes Holderness (Richmond), Insidious Regulatory Taxes (August 1, 2020).
• Yue Dai (Shanghai University of Finance and Economics), Taxation of Foreign Partnerships: The Chinese and French Examples, 99 Tax Notes International (July 13, 2020). 
• Johann Hattingh and John Avery Jones, De Beers Consolidated Mines Ltd V Howe (1906) Corporate Residence: An Early Attempt at European Harmonisation (2019). Copy of the final pre-copyediting and typeset version, not be cited as the final print version available at Bloomsbury dot com and originally published in D. de Cogan and J. Snape (Eds), Landmark Cases in Revenue Law (Hart, Oxford, 2019) 67-90.