This article was originally posted on the Institute on Taxation and Economic Policy’s Website.
When people think of the corporate tax cuts that were included in the so-called Tax Cuts and Jobs Act (TCJA) enacted by Trump and congressional Republicans in 2017, they usually think of the reduction in the corporate tax rate from 35 percent to 21 percent. But that was not the only corporate giveaway. Almost as important was TCJA’s failure to rein in offshore tax-dodging. The 2017 law simply replaced one set of loophole-ridden rules that favored offshore profits over domestic profits with a new set of loophole-ridden rules doing the same thing. A bill introduced today by Rep. Lloyd Doggett and Sen. Sheldon Whitehouse would finally fix this to follow a simple principle: we should tax the offshore profits and domestic profits of our corporations the same way.
The current law taxes the offshore profits of American corporations more lightly than domestic profits. This was true of the old law as well, although the details differed. This has long created tax incentives for companies to use accounting gimmicks to make their U.S. profits appear to be earned in countries with very low corporate taxes or no corporate taxes at all—offshore tax havens.
For example, the Cayman Islands has no corporate income tax. It has a population of just 63,000 people, but U.S. corporations claimed to have earned $58.5 billion in profits there in 2017, which was about 10 times the entire gross domestic product (the entire economic output) of that tiny country. Clearly, our laws have long allowed corporations to make ridiculous claims about the locations of their profits. Back in 2008, the Government Accountability Office found that nearly 19,000 corporations claimed to be headquartered in a single five-story office building in the Cayman Islands.
The drafters of the 2017 tax law had an opportunity to end this nonsense, but in some ways, they may have made it worse because the new rules encourage corporations to move real operations—and the jobs that go with them—offshore to benefit from lower tax rates.
Under the No Tax Breaks for Outsourcing Act introduced today by Doggett and Whitehouse, the tax code would no longer provide such incentives. Offshore profits would be taxed at a rate at least as high as the U.S. tax rate no matter where they are earned, so a company would gain nothing by claiming that its profits are earned in Bermuda or the Cayman Islands rather than in the United States. The bill, which is a stronger version of legislation the same lawmakers introduced in the previous Congress, would solve this and several other problems with our international tax rules and raise nearly $800 billion over a decade.
The Problems with Current Law
Under TCJA, some offshore profits of American corporations are not subject to any U.S. tax while others are taxed at just half the rate, at most, that applies to domestic profits.
The rules do not tax offshore profits at all unless they exceed 10 percent of the value of the corporation’s tangible assets invested offshore. Tangible assets are what most people think of as “real” investments, such as machines, factories, and stores.
The rules simply assume that offshore profits exceeding 10 percent of these assets are profits from other types of assets (intangible assets like patents) that are easier to shift abroad. The rules call these profits Global Intangible Low-Taxed Income (GILTI), which may be subject to tax, depending on whether they have been subject to foreign taxes.
One problem is that companies could increase the amount of offshore profits that are exempt from U.S. taxes if they move more of their tangible assets (and maybe the jobs that go with them) abroad. This can result in a smaller portion of their foreign profits exceeding the 10 percent threshold.
Another problem is that even when offshore profits are identified as GILTI and subject to U.S. taxes, they are effectively taxed at 10.5 percent, which is just half of the 21 percent imposed on domestic corporate profits. In other words, TCJA always rewards corporations that can transform U.S. profits into foreign profits, whether this means shifting profits around on paper or moving actual business operations.
Another issue is that the rules are applied globally to all foreign profits rather than applied per country. American corporations are allowed a foreign tax credit (FTC) on their U.S. taxes equal to taxes they paid to foreign governments on their foreign profits. This makes sense because it prevents double-taxation. But under current law (just like the previous law) nothing prevents corporations from using excess credits generated by profits in higher-tax countries from offsetting U.S. taxes that are due on profits in lower-tax countries. The GILTI rules were supposed (in theory) to impose a minimum tax on excess profits generated offshore to discourage profit-shifting. But TCJA’s failure to ban cross-crediting of the FTC significantly weakens that minimum tax.
The No Tax Breaks for Outsourcing Act
The bill introduced today would address these problems and several others. It would eliminate the exemption that applies to some offshore profits and tax them all at the same rate that applies to domestic profits (which would be 21 percent unless Congress changes it). The foreign tax credit (FTC) would be applied on a per-country basis.
The bill would also block inversions, the practice by which American corporations claim that a merger with a foreign company has converted them into a foreign entity for tax purposes even though most of their ownership has not changed. It would also treat corporations that are managed and controlled in the United States as American companies for tax purposes—meaning they would gain nothing from listing that five-story office building in the Cayman Islands as their legal headquarters.
Equally important, the bill would also block foreign-owned corporations from manipulating debt to strip earnings out of the United States. American companies that are subsidiaries of foreign corporations sometimes claim to borrow from, and make interest payments to, their foreign parent companies, and then tell the IRS that they have little or no U.S. profits to report as a result. In reality, the “lender” and “borrower” in this situation are all part of the same company and controlled by the same people, so the arrangement serves no purpose other than to avoid U.S. taxes. The bill would crack down by limiting deductions for interest payments when a U.S. subsidiary claims a disproportionate share of interest expenses.
While the details seem complicated, the principle is simple. Corporations should be taxed the same way regardless of whether they claim their profits are earned here or abroad. This is the way to prevent large multinational corporations from avoiding taxes and claiming an unfair advantage over domestic businesses that do not use complex arrangements involving tax havens.