This article is cross-posted from the Just Taxes Blog.
New legislation introduced today, the No Tax Breaks for Outsourcing Act, by Rep. Lloyd Doggett (D-TX) and Sen. Sheldon Whitehouse (D-RI) would help repair the damage to the international tax code wrought by the new tax law and move toward a system where U.S. corporations can’t reap tax benefits from shifting jobs and profits offshore.
One of the biggest problems with the United States tax code is that it encourages multinational corporations to artificially shift their profits offshore, or even shift real investments and jobs offshore, to avoid paying taxes. A real tax reform would have put an end to tax avoidance and the tax incentives for offshoring, but the Tax Cuts and Jobs Act (TCJA) made both of these problems worse.
Under the previous tax system, companies were required to pay the full 35 percent corporate tax rate (minus any foreign taxes paid) on their offshore profits. The problem was that companies could defer paying U.S. taxes on their offshore profits indefinitely as long as they technically held them in their offshore subsidiaries. This created a huge incentive for companies to use accounting gimmicks to make their profits appear to be earned in offshore tax havens, where they could hold them on paper for years without paying taxes. ITEP’s most recent research found that companies held more than $2.6 trillion in untaxed profits offshore, which allowed them to avoid over $750 billion in taxes. Professor Kimberley Clausing estimated that the ongoing cost of offshore tax avoidance exceeded $100 billion each year.
How the New Tax Law Will Make Offshore Tax Dodging Even Worse
The TCJA radically changed the international tax system — for the worse. Excluding the one-time revenue from a transition tax on accumulated earnings, the new law’s international provisions will cost $14 billion over the next 10 years, on top of the billions already being lost to tax avoidance under the old system.
The TCJA replaced the rule allowing companies to defer paying taxes on their offshore earnings with provisions that, in some cases, will provide even bigger breaks for corporations that shift profits offshore. These provisions give offshore earnings two significant tax breaks compared to domestic earnings.
First, the new law gives companies an annual deduction on their offshore earnings worth 10 percent of their offshore tangible assets (such as factories). This means that companies with $100 million worth of tangible assets offshore would pay nothing in U.S. taxes on the first $10 million worth of profits they earn. Because the size of the deduction depends on the amount invested offshore, this new break creates a unique incentive for companies to move real investments offshore to boost the size of their deduction.
Second, the income earned above 10 percent of the company’s tangible assets is effectively subject to only a 10.5 percent tax rate, since the new law allows companies to deduct half of their offshore income above the threshold from taxation. The overall effect of these two new breaks is that companies’ offshore earnings will at most be taxed at half the rate on domestic earnings, with many companies paying nothing in U.S. taxes on these earnings.
How the Doggett-Whitehouse Bill Will Stop Offshore Tax Dodging
The No Tax Breaks for Outsourcing Act takes direct aim at corporate offshore tax dodging by eliminating these special deductions for offshore earnings. The bill would require companies to immediately pay the same 21 percent tax rate on their offshore earnings (minus foreign tax credits) that they must pay on their domestic earnings. By equalizing the domestic and offshore tax rates, the bill would end the tax incentive to shift jobs and profits offshore.
To ensure that companies do not pursue alternative avenues of tax avoidance, the legislation also takes aim at the infamous corporate inversion loophole by tightening the definition of a foreign corporation. The bill would prevent a company from becoming foreign through a merger if it continues to be managed and controlled in the United States or if a majority of the U.S. company’s shareholders own the resulting company. The bill also targets one of the major incentives for inversions by restricting the ability of multinational companies to reduce their taxes by deducting an excessive amount of interest payments.
The End the Outsourcing Tax Break Act represents a crucial first step in undoing the damage of the Trump-GOP bill and moving the United States to a system where companies will finally pay their fair share in taxes.
Richard Phillips is a Senior Policy Analyst at The Institute on Taxation and Economic Policy