President-elect Joe Biden proposes to increase corporate taxes and at the same time tilt tax rules so that U.S. corporations find domestic investment more favorable relative to foreign investment. Unfortunately, each of his five proposals has serious shortcomings individually, and they are even worse when considered in combination. Biden could achieve largely the same goals with much simpler policies.
Credit Carrot
First, to make the United States more attractive, Biden has proposed the Made in America credit, a 10 percent “advanceable” tax credit that would apply to specific expenditures on wages, investments, and other costs related to the expansion of U.S. manufacturing (for example, an auto plant) and services (for example, a call center) under various conditions. These expenditures include: (1) investment in “revitalizing” a closed or closing facility; (2) retooling of an existing facility to “advance manufacturing competitiveness” (as long as overall U.S. wages are maintained); (3) costs of moving production from abroad to the United States; (4) any increased investment in U.S. productive capacity; and (5) any increases in overall manufacturing wages (not exceeding $100,000 per employee).
The first three categories are vaguely defined and raise difficult administrative issues. They also raise policy questions. What is a closed plant? Why should refurbishment of closed plants get a tax incentive but not the building of new ones? What is qualified refurbishment and what is just plain old upkeep to offset normal wear and tear? What products must be produced to be considered advancing manufacturing competitiveness? If a business does move production from abroad to the United States, what costs (transportation of equipment, site selection, worker training) are included?
All of this arbitrariness suggests that the distribution of this credit — like the current-law section 48C advanced energy project credit, distributed to applicants selected by the Department of Energy — will need to be under the administrative control of executive branch agencies outside the IRS. That means it would essentially be a government grant program dressed up as tax relief.
The final two categories of expenditures resemble an incremental investment credit and an incremental wage credit. Incremental investment and wage credits have been proposed before. They are attractive in theory because they focus incentive effects on the margin where they can do the most good at the least cost. But in practice they are complex and plagued with their own administrative difficulties. (Stephen R. Corrick and Martin A. Sullivan, “An Incremental Investment Tax Credit: Can It Deliver on Its Promise?” (Jan. 19, 1993). Prior analysis: Tax Notes, Feb. 22, 2010, p. 906.)
Surcharge Stick
Second, to make foreign production less attractive, Biden has proposed a 10 percent surtax on income from foreign production by U.S. corporations of goods sold into the United States. It is unclear exactly how this would work, but a campaign document states that with a 28 percent rate, this foreign-source income would be subject to the 28 percent rate plus a 2.8 percent surtax. This would be a tariff-like tax on import income — a sort of counterpart to the deduction for foreign-derived intangible income, which is a subsidy for export income. The puzzling part is that because it would apply only to U.S.-headquartered corporations, it would penalize U.S. companies importing into the United States while leaving income from imports by foreign-headquartered corporations unaffected.
And More . . .
Third, the Biden campaign has proposed a three-part tightening of the rules for taxing global intangible low-taxed income: an increase in the section 250 deduction to raise the effective rate of tax on that income from the current-law 10.5 percent rate to 21 percent; elimination of the deduction for qualified business asset investment (equal to 10 percent of foreign tangible capital); and the calculation of the foreign tax credit on a country-by-country (instead of overall) basis. This is probably the most reasoned of the Biden business proposals. Simply put, it is an increase in the current-law minimum tax on foreign profits. If the Biden administration is going to rework the taxation of GILTI with new legislation, it should also consider modifications to correct two flaws in the 2017 legislation: allowing carryovers of negative GILTI liability to years with positive GILTI and a rationalization of the allocation cost rule for determining the FTC limitation.
Fourth, in addition to the GILTI minimum tax on foreign income, the Biden campaign has proposed a minimum 15 percent tax rate on income reported on financial statements of corporations with at least $100 million of book income. According to reports, foreign taxes would be creditable and carryovers (for years with negative minimum tax liability) would be allowed. Although such proposals have a lot of curb appeal, under further scrutiny they are usually deemed not worth the trouble. (Prior analysis: Tax Notes Federal, Oct. 5, 2020, p. 109.)
Finally, Biden has proposed increasing the corporate rate from 21 percent to 28 percent. In what will sound like sacrilege to progressive Democrats, instead of raising the corporate tax rate to 28 percent, Biden should consider keeping the corporate rate at 21 percent or as close as possible to it. Let’s recall economic basics. A high corporate rate encourages profit shifting, excessive leverage, and other unproductive tax avoidance activity. Further, it isn’t a cost-effective investment incentive because much of the investment income it rewards with a lower rate is from existing capital. Just because we don’t like corporate rate increases doesn’t mean there should be no corporate tax increases. There are plenty of corporate tax breaks that can be reduced to raise revenue. And although it is anathema to those who consider the corporation tax to be a tax on corporate profits (rather than on corporate capital income), more limitations on corporate interest should be considered before any increase in the corporate tax rate.
Think It Over
The best that can be said for this suite of proposals is that they served as the basis for useful messaging for the Biden campaign. Hopefully, the Biden administration will understand that their usefulness as a starting point for drafting actual legislation is limited. That doesn’t mean Biden’s goals need to be tossed. There are better ways to raise taxes on corporations. There are better ways to make investment in the United States more attractive vis-à-vis foreign locations. The good news for tax policy is that there likely will be plenty of time to ponder more reasoned and realistic policy changes. As long as we remain in deep recession — U.S. employment is still 9 million below pre-pandemic levels — and as long as Sen. Mitch McConnell, R-Ky., and moderate Democrats hold sway in the Senate, the prospects of major tax increases floated during the Biden campaign are on hold.
In the table we attempt to portray the tax situation of a typical U.S. multinational under current law and then compare that with the situations under Biden’s proposals and under simple alternatives. Of course, there is no such thing as a typical multinational given the many industries and various circumstances each company may face.
For illustration, we take as our base case a U.S. multinational with $2,000 of before-tax financial statement income divided evenly between U.S. and foreign sources and also assume 40 percent of domestic income is FDII. After that, based on data sources, we have calibrated what we believe would be realistic amounts of investment, depreciation, and research credit for a company with $2,000 of worldwide income. (See notes at the end of the article for details.)
Policy | Current Law | Biden Campaign Proposal | Biden Campaign Proposal | Worldwide With 28% Rate | Worldwide With 21% Rate |
|---|---|---|---|---|---|
Company Characteristics | Base Case | Base Case | Alternative Case | Base Case | Base Case |
U.S. taxation of U.S. income: | |||||
U.S. book income | $1,000 | $1,000 | $1,000 | $1,000 | $1,000 |
Excess of tax over book depreciation | $310 | $310 | $465 | $310 | $310 |
U.S. taxable income before FDII | $690 | $690 | $535 | $690 | $690 |
FDII percentage of domestic income | 40% | 40% | 60% | 0% | 0% |
FDII deduction (37.5%) | $103.50 | $103.50 | $120.38 | $0 | $0 |
Taxable income after FDII deduction | $586.50 | $586.50 | $414.63 | $690 | $690 |
U.S. tax rate | 21% | 28% | 28% | 28% | 21% |
U.S. tax on U.S. income before credits | $123.17 | $164.22 | $116.10 | $193.20 | $144.90 |
Research and other general business credits | $20 | $20 | $30 | $20 | $20 |
U.S. tax on U.S. income after credits | $103.17 | $144.22 | $86.10 | $173.20 | $124.90 |
Foreign and U.S. taxation of foreign income: | |||||
Foreign book income | $1,000 | $1,000 | $1,000 | $1,000 | $1,000 |
Foreign tax rate | 10% | 10% | 2% | 10% | 10% |
Foreign tax | $100 | $100 | $20 | $100 | $100 |
GILTI tax rate | 10.5% | 21% | 21% | 28% | 21% |
GILTI tax before credits | $105 | $210 | $210 | $280 | $210 |
GILTI tax credits (80%) | $80 | $80 | $16 | $100 | $100 |
Net U.S. tax on GILTI after FTC | $25 | $130 | $194 | $180 | $110 |
Made in America tax credit: | |||||
Domestic wages (multiple of domestic profit) | $1,000 | $1,000 | $1,000 | $1,000 | $1,000 |
Domestic investment (multiple of domestic profit) | $330 | $330 | $330 | $330 | $330 |
Percentage increase in wages and investment | 5% | 5% | 10% | 5% | 5% |
Dollar increase in wages and investment | $66.50 | $66.50 | $133 | $66.50 | $66.50 |
Made in America credit at 10% |
| $4.79 | $9.58 | $0 | $0 |
Offshoring tax penalty: | |||||
Effective tax rate on foreign income without surcharge | 12.5% | 23% | 21.4% | 28% | 21% |
Statutory tax rate on foreign income with surcharge |
| 30.8% | 30.8% | 30.8% | 23.1% |
Surcharge rate (with FTC and GILTI in place) |
| 7.8% | 9.4% | 2.8% | 2.1% |
Percent of foreign income attributable to imports to U.S. | 20% | 20% | 0% | 0% | 0% |
Foreign profit subject to surtax |
| $200 | $0 | $0 | $0 |
Surtax (to raise effective rate to 30.8%) |
| $15.60 | $0 | $0 | $0 |
Total tax on U.S. income | $103.17 | $139.43 | $76.52 | $173.20 | $124.90 |
Total tax on foreign income | $125 | $245.60 | $214 | $280 | $210 |
Total tax on all income | $228.17 | $385.03 | $290.52 | $453.20 | $334.90 |
U.S. tax revenue | $128.17 | $285.03 | $270.52 | $353.20 | $234.90 |
ETR on U.S. income | 10.3% | 13.9% | 7.7% | 17.3% | 12.5% |
ETR on foreign income | 12.5% | 24.6% | 21.4% | 28% | 21% |
Difference (negative is advantage to foreign) | 2.2% | 10.6% | 13.7% | 10.7% | 8.5% |
ETR on worldwide income | 11.4% | 19.3% | 14.5% | 22.7% | 16.7% |
Minimum tax of excess of 15 percent of book income over regular tax liability: | |||||
Excess, if any, of minimum tax rate over ETR |
| 0% | 0.5% | 0% | 0% |
Minimum tax liability |
| $0 | $9.48 | $0 | $0 |
Total U.S. tax revenue | $103.17 | $155.03 | $86 | $173.20 | $124.90 |
Source: Author’s calculations. | |||||
Why?
Before walking through the calculation, let’s reveal four questions that arise about the Biden ideas when we consider the interaction of these proposals:
Is it necessary to add a complex Made in America tax credit when we already have other domestic investment incentives, including a research credit, expensing, and FDII (as well as the need to forestall the scheduled replacement of expensing of research with five-year amortization)?
Given the proposed significant enhancements of GILTI, is the proposed complex but relatively small penalty surtax on profits from imports a worthwhile disincentive for foreign production?
With a statutory rate increase and the expansion of GILTI, is it not the case that to the extent the proposed 15 percent minimum tax has any impact at all, it would counteract domestic investment incentives, including the proposed Made in America credit?
Assuming the priorities of the Biden plan are (A) to increase revenue from the corporate tax and (B) to provide incentives for domestic production and reduce incentives for foreign production, couldn’t these just as well be achieved, with the added benefit of significant simplification, by dropping the proposed credit for domestic activity and surtax on foreign income, repealing FDII, and imposing worldwide taxation at some rate close to 21 percent?
Current Law
Column 1 provides an example attempting to illustrate the tax consequences of current law for a U.S. multinational corporation. Making a bunch of assumptions about what might be typical, the advantages of tax depreciation over book depreciation and the 40 percent of domestic profit that is FDII together are estimated to reduce U.S. tax on U.S. profit from $210 to $123.17. General business credits reduce that tax by an additional $20, to $103.17.
Foreign profit is first taxed by foreign governments at 10 percent to yield $100 of foreign tax. Under current law (assuming away the adverse effects of cost allocation rules for computing the GILTI basket foreign tax limitation, and assuming QBAI is equal to zero), the net U.S. tax on GILTI, at an effective rate of 10.5 percent (that results from the 37.5 percent section 250 deduction) and 80 percent creditability of foreign tax, is $25 — that is, $105 of tax on GILTI less $80 of creditable foreign tax.
The effective tax rate on income from U.S. activity is 10.3 percent. The effective tax rate on income from foreign activity is 12.5 percent. So there is a small 2.2 percentage point advantage for domestic investment relative to foreign investment. U.S. tax revenue is $128.17, the sum of U.S. tax on domestic activity ($103.17) and U.S. tax on GILTI ($25).
Biden’s Proposals
Column 2 overlays onto current law five of Biden’s proposed changes to business taxation: (1) the increase in the corporate rate from 21 percent to 28 percent; (2) the increase in the effective GILTI tax rate from 10.5 percent to 21 percent; (3) the Made in America tax credit; (4) the tax surcharge on profit from sales back to the United States of foreign production by U.S.-headquartered businesses; and (5) the minimum tax on worldwide profits equal to the excess of 15 percent of worldwide book before tax income less actual U.S. and foreign taxes.
The rate increases U.S. tax before tax credits by 33 percent, from $123.17 to $164.22. The general business credit reduces U.S. tax on U.S. profit to $144.22. The U.S. tax rate on U.S. income is further reduced by the Made in America tax credit. We characterize that credit as a 10 percent incremental wage and investment credit that, given our assumptions about the amount of wages and investment and 5 percent annual growth of those amounts, reduces U.S. tax further by 10 percent of $66.50 (the combined increase in wages and investment) to $4.79.
As in column 1, foreign tax on foreign income is $100, but now with the GILTI rate doubled to 21 percent, U.S. tentative tax on GILTI is $210. Creditable taxes in the GILTI basket are $80. So net U.S. tax on GILTI is $130. We have assumed that income from foreign production imported back to the United States is 20 percent of foreign income, and that the surtax raises the combined U.S. and foreign rate on that income to 30.8 percent. This adds $15.60 of U.S. tax on foreign income for total U.S. tax on foreign income of $145.60 and total tax on foreign income of $245.60. Now the effective tax rate on foreign income is more than the effective U.S. rate by 10.6 percentage points. And U.S. revenue collections more than double from current law — from $128 to $285. Despite these increases, the minimum tax still doesn’t kick in because the overall worldwide effective tax rate of 19.3 percent remains comfortably above the 15 percent minimum tax rate.
Column 3 has the same Biden tax rules as column 2, but we step on the tax accelerator, so to speak, to see what it takes to bring the 15 percent minimum tax into play. We increase the benefits of tax depreciation, the amount of FDII, and the research credit by 50 percent. We increase the growth of wages and investment from 5 percent to 10 percent (to increase the Made in America tax credit). We reduce the foreign tax rate from 10 percent to 2 percent. And we set the amount of foreign income subject to surcharge to zero. These changes reduce the effective tax rate on U.S. income (before application of the minimum tax) to 7.7 percent and increase the foreign rate to 21.4 percent. The overall worldwide rate falls from 18.8 percent to 14.5 percent. That triggers minimum tax of 0.5 percent of worldwide income.
A Simpler Alternative
In columns 4 and 5, we return to the original company-specific circumstances of columns 1 and 2 and explore the possibilities of imposing worldwide taxation at 28 percent and 21 percent combined with repeal of FDII benefits and exclusion of Biden’s proposed minimum tax, his surcharge of foreign profit, and his Made in America credit. Here the worldwide tax system is mechanically put into effect by setting the GILTI rate equal to the statutory rate and allowing 100 percent (instead of 80 percent) creditability of foreign taxes. As before, QBAI is assumed to be zero.
Under these scenarios, U.S. and foreign income would be taxed equally except for the benefits provided to U.S. investment from accelerated depreciation and the research credit. For our hypothetical company, the total amount of revenue raised under the Biden plan (column 2) is $285. The revenue raised under the 28 percent worldwide plan is $353 (column 4) and under the 21 percent worldwide plan is $235 (column 5). A worldwide system that would raise about the same revenue as the Biden plan would, in this example, have a rate of 24 percent.
Conclusion
President-elect Biden should seriously consider a worldwide system with a low corporate rate that excludes current-law benefits for FDII and also excludes his proposals for a Made in America tax credit, a penalty surcharge for imports, and a minimum tax. Such an alternative proposal would provide tax benefits in favor of domestic over foreign investment. It would greatly reduce complexity. And it seems likely it could raise as much revenue as Biden hoped to gain from his campaign proposals.
Of course, readers may have their own ideas about what a typical U.S. multinational’s facts may be. Or they may wish to model the effect of a particular corporation with whom they are employed or consult. A spreadsheet is available here in which the reader can adjust both policy- and company-specific assumptions used in the table.
Technical Notes
The following sources were used to calibrate the company-specific data used in columns 1, 2, 4, and 5. According to tax return data available from the IRS Statistics of Income division, tax employee compensation in aggregate is about equal to income subject to taxes, and tax depreciation is about equal to 25 percent of income subject to tax. Data based on Schedule M-3 indicate that tax depreciation is about 25 percent larger than book depreciation. According to data from the Bureau of Economic Analysis, gross investment on plant and equipment is about 1.3 times larger than depreciation of plant and equipment.