President Joe Biden has pledged to use higher corporate taxes to pay for a $2 trillion plan to improve the nation’s roads, bridges, water supplies and other infrastructure.
The proposed changes – part of “The Made in America Tax Plan” – will indeed raise revenue, but could also compel firms to move assets to other countries and use other tax-avoidance strategies, which could distort aspects of the U.S. economy, said Scott Dyreng, accounting professor at Duke University’s Fuqua School of Business.
“If the objective of the administration is to raise more revenue from corporations, then raising the rate to 28% would accomplish that goal,” Dyreng said in a recent discussion on Fuqua’s LinkedIn page. However, “the higher the rate goes, the greater the incentives for companies to engage in strategic tax avoidance activities,” he said.
Reversing Trump Tax Cuts
U.S. companies benefited from a substantial cut via the Tax Cuts and Jobs Act (TCJA), when the Trump administration slashed the rate from 35 percent to 21 percent, resulting in an actual reduction of about 22 percent, according to Dyreng’s ongoing research on the law.
U.S. companies with purely domestic operations benefited most from the TCJA, saving about 11 percent or $19 million a year on average since the reforms took effect in 2018, while multinationals saved $49 million per year, or 5.3 percent on federal taxes, according to data available in 2020 (data subject to change as research continues).
Raising the corporate tax rate could prompt firms to rely on tax-avoidance strategies, such as moving intellectual property to countries that impose little or no tax liability on corporations – so-called ‘tax havens,’ Dyreng said. Some companies may even change their legal incorporation to another country to avoid paying U.S. taxes, a process called inversion, he said.
These tax-avoidance strategies can cause companies to cut back on activities such as investment, research and employment, he said.
“Every tax creates some kinds of economic distortions,” Dyreng said. “And those distortions reduce good things that companies do.”
Taxing assets held abroad
To recoup some of the tax dollars lost to firm earnings in lower-tax countries, the U.S. in 2017 introduced the Global Intangible Low Tax Income (GILTI), imposing a 12-percent tax on any foreign assets with returns over 10 percent.
The Biden administration has proposed raising the GILTI rate to 21 percent and taxing all earnings, even those earning returns under 10 percent, Dyreng said. The new law would also change how those assets are calculated, totaling by individual country rather than pooling all earnings as the Trump administration did, Dyreng said.
“This could be quite substantial in terms of changing the tax on foreign earnings,” Dyreng said. “It could result in situations where multinational companies end up paying taxes to the U.S. even though overall abroad, their consolidated earnings are low or even negative.”
A new minimum tax on financial statement income
Another major change proposed by the Biden administration is a 15 percent minimum tax on a firm’s book income or financial-statement income, which is the figure corporations report on their public financial statements to shareholders.
This would target companies that report large profits to their shareholders in financial reports but pay essentially no federal income taxes, such as Amazon, Salesforce and Zoom, Dyreng said, because they use complex tax-avoidance strategies.
This new tax would affect about 45 high-revenue U.S. companies, increasing their minimum tax liability by about $300 million each year, according to a U.S. Treasury report on Biden’s plan.
This is problematic because a firm’s financial statement income has only ever been designed to guide investors on the general financial picture at a given firm – not as a representation of a company’s taxable income, Dyreng said.
If the government started calculating taxes based on those figures, companies might be tempted to alter the way they account for those earnings to keep their tax liability down, which in turn would reduce the value of those reports, thereby offering investors less reliable guidance, Dyreng said.
But even more concerning, “if the tax revenue is suddenly tied to financial accounting income, it will be very difficult for our elected leaders who set tax policy to constrain themselves from also trying to meddle in financial accounting rules,” said Dyreng, who authored a Wall Street Journal opinion piece in 2019 with the same concerns after a similar tax proposal from former Senator Elizabeth Warren as she campaigned for the 2020 presidential primary.
A few weeks later, U.S. senators including Warren wrote a letter to the Financial Accounting Standards Board (FASB) urging changes to financial accounting rules for the purposes of tax enforcement.
Dyreng and colleagues from several universities sent the FASB a rebuttal suggesting that changing standards for the purposes of tax enforcement would be bringing a neutral organization into the political fray.
“This is exactly the type of thing we don't want our politicians doing,” Dyreng said in the LinkedIn discussion. “We need financial accounting rules to be apolitical. And taxing financial accounting earnings will almost immediately create a situation where financial accounting becomes another political tool.”