William G. Gale (Tax Policy Center; Google Scholar) & Claire Haldeman (Tax Policy Center), Taxing Business: The TCJA and What Comes Next, 102 Tax Notes Int'l 1759 (June 28, 2021):
In this article, the authors propose reforms that would repeal and amend various business tax provisions of the Tax Cuts and Jobs Act and would raise revenue while making business taxation more efficient, equitable, and resistant to profit shifting. ...
The business tax reforms in the TCJA were largely motivated by concerns that business taxation was too burdensome on businesses and workers and that the tax system discouraged companies from locating, investing, and reporting profits in the United States. The TCJA cut the corporate tax rate from 35 percent to 21 percent, provided a 20 percent deduction for some forms of passthrough income, moved the business tax base toward a cash flow measure, eliminated the taxation of repatriated foreign earnings (with a one-time transition tax on previously accumulated but unrepatriated foreign earnings), and enacted the GILTI, BEAT, and FDII provisions.
Some of the TCJA’s reforms promote efficiency, primarily by reducing and compressing the range of METRs on new investments across asset types, financing methods, and organizational forms. But many other reforms are either ill-conceived or substantially flawed. How should policymakers respond?
Making the temporary provisions in the TCJA permanent would be expensive — costing about $1.7 trillion in revenue between 2026 and 2040.132 And it would generate little of policy value. In prior works,133 we showed the following: The TCJA was regressive; it reduced revenue; its effect on GDP is difficult to tease out of the data; investment growth rose after it was enacted but was driven by trends in aggregate demand, oil prices, and intellectual capital that were unrelated to its supply-side incentives; growth in business formation, employment, and median wages slowed after it was enacted; and international profit shifting fell only slightly.
In light of these findings, instead of extending or leaving in place the business tax provisions of the TCJA, policymakers should focus on fixing the mistakes it made. For example, the overarching problem with the 20 percent passthrough deduction is that it does not reflect any underlying, organized economic principle. The deduction functions as an “incoherent and unrationalized industrial policy,” creating distinctions that often do not have a sound basis in tax law and create unnecessary opportunities for tax avoidance.134 But perhaps the most damning aspect of the deduction is that growth of business formation fell in 2018 and 2019 relative to prior years, even though the economy was strong. Repealing the deduction (or letting it die when it expires in 2025) would eliminate the revenue cost, remove an enormous windfall gain that accrues overwhelmingly to extremely high-income households, reduce the discrepancy between tax rates on wages and noncorporate business income, and lessen tax administration problems.
The corporate reforms in the TCJA probably went too far in terms of the rate reduction and not far enough in terms of base adjustment. An attractive alternative to the TCJA’s regime would combine (1) raising the corporate tax rate to 25 percent, (2) allowing expensing — full first-year write-offs of investment in equipment, structures, and inventories — and (3) eliminating the deduction for interest payments. The rationale is straightforward: Eliminating the interest deduction sets debt and equity financing on equal footing and removes the tax system’s distortion in favor of debt. Combined with full expensing, the changes would set the METR on all new investments to zero.
This has three important implications. First, it would lower the effective tax rate on (most) investments. Second, it would eliminate all distortions in effective tax rates across new investments, which would generate economic benefits. Third, it would make the United States very competitive internationally. For all three reasons, it would expand the size of the economy.
Once the effective tax rate is zero, raising the statutory rate to 25 percent would reduce the extent to which the tax system provides windfall gains, which are expensive and unproductive, to previous investment. To be clear, average tax rates and statutory rates matter. They affect companies’ cash flow, cross-border investment choices, incentives for profit shifting, and, if interest is deductible, leverage. But a 25 percent rate would not be uncompetitive relative to other advanced countries and would offset less than a third of the rate reduction from 2017. It merits emphasis, again, that the large changes in corporate taxation in the TCJA appear to have had little effect on investment and profit shifting, at least through 2019.
The bottom line regarding the various international provisions in the TCJA is that profit shifting has declined only slightly post-TCJA, and foreign investment by U.S. multinationals has increased. This attests to the ineffectiveness of the provisions and should motivate a rethinking of the structure of international tax rules.
For example, the concept of a global minimum corporate tax has been a constant and reasonable theme of recent international tax proposals, dating at least to the Obama administration and to proposals by former House Ways and Means Committee Chair Dave Camp. An effective global minimum tax would eliminate the “race to the bottom” and eliminate benefits to corporations booking profit in low-tax jurisdictions.
The GILTI provisions in the TCJA try to partially fulfill that role, but they are poorly designed and need significant changes. Eliminating or reducing the tax exemption of foreign returns — currently equal to 10 percent of foreign tangible assets — would remove the incentive for companies to increase low-return physical capital investments overseas. Applying GILTI provisions on a CbC basis rather than a global basis would be more consistent with the nature of a minimum tax and would eliminate the creation of “America last” incentives, in which companies with profits in high- (low-) tax foreign countries may have more incentives to invest more in low- (high-) tax foreign countries rather than in the United States. As of 2016, companies were already required to report their income, expenses, and taxes on a per-country basis, so there is no reason GILTI could not be calculated on a per-country basis. And raising the effective tax rate on GILTI (technically, reducing the 50 percent deduction) would help further, because so much of the foreign profit of U.S. multinationals is allocated to tax havens with extremely low rates.
One could go further still. Clausing, Emmanuel Saez, and Gabriel Zucman argue that in addition to its standard taxation regime, the government should collect a minimum tax on a CbC basis from each multinational corporation — without GILTI’s 10 percent deemed return.
The BEAT, like the GILTI provisions, is meant to reduce profit shifting, but it is incredibly blunt. An effective check on profit shifting should consider both inward- and outward-bound flows and should consider deviations from an appropriate transfer price, not deviations from a price of zero. The BEAT should be reformed to adhere to sensible profit-shifting rules, or it should be repealed.
The FDII provisions are the latest version in a long line of failed export subsidies. As discussed above, the rules create (presumably unintended) incentives to reduce investment in the United States and to export IP. The tax benefits associated with FDII can be obtained without producing or using intangible capital in the United States or even making a real export sale (not counting “round-tripping”). And the provisions are quite expensive. They should be repealed.
Biden administration proposals bear many similarities to the proposals above.140 The administration would raise the corporate rate to 28 percent rather than 25 percent but would not move further in the direction of a cash flow tax. The administration’s proposals for GILTI and FDII are very similar to ours, and its stopping harmful inversions and ending low-tax developments proposal — which would essentially modify the BEAT to allow deductions for expenses paid to affiliates in high-tax countries — is one example of how the BEAT could be constructively modified. The Biden administration has also argued in favor of a global minimum tax and a minimum tax on book income.
Looking more broadly at international tax structure, one possibility is to move not just to a cash flow tax, as advocated above, but to combine a cash flow tax with border adjustments — exempting tax on export sales and imposing taxes on imports — to generate a destination-based cash flow tax.
Moving to a destination-based cash flow tax would make the United States an even more attractive place to invest because it would tax sales, not profits, in the United States. It would eliminate a host of complexities in international tax policy and eliminate all U.S. tax incentives for U.S. companies to move profits, productions, or headquarters overseas. But it also would come with significant complications. Full consideration of the destination-based cash flow tax is beyond the scope of this article.
Finally, considering the regulatory issues that arose in the implementation of the TCJA, policymakers should consider creating a regulatory ombudsman who would have standing to challenge regulations that are inconsistent with law but favor the taxpayer in question at the expense of the general public.