Darien Shanske: As an academic, I will start from 10,000 feet and note that the idea that there are different types of corporate returns, normal and supernormal, is an old idea in the academic literature. And the idea that supernormal returns should be treated differently in the context of international taxation — as being particularly likely to be shifted — is also not a new idea; it’s at least 10 years old. And so the GILTI [global intangible low-taxed income] provision, which essentially says “we’re going to separate normal returns from supernormal returns and we’re going to subject supernormal returns to some special tax regime, in part because of our concern that these profits represent shifted profits,” was an off-the-shelf idea put into law as part of the Tax Cuts and Jobs Act.

It was obviously done very quickly and not very carefully, and so there are lots of problems with the provision. But the basic conceptual idea, I think, is sound. And for a state what this means is that this is an opportunity to broaden the state corporate tax base — and do so by including income that’s been shifted abroad, and through relatively simple conformity with federal corporate tax law.

So from my perspective, conforming with GILTI is a tax policy layup. There are complexities that COST [the Council On State Taxation] and the STAR [State Taxes After Reform] Partnership have talked about a lot, and we can talk about them too, but it’s clearly something that states should do. It would be better if they just moved all the way to mandatory worldwide combination, but as a half measure, GILTI conformity is an excellent idea.

Peter D. Enrich: I would concur with all of that, and I think Darien’s articles on this have been really spot-on and very helpful.¹ I might even step back one step further. As a matter of good tax policy, one of the things that you want to do is to diminish the incentives that you provide for purely tax-motivated behavior. I think Congress recognized that when it changed the system for foreign income in the Tax Reform Act; it needed to do something in that respect. The GILTI provision strikes me as a pretty clumsy and not particularly well-designed way of doing so, but it’s at least an effort in that direction.

I’m glad to hear Darien saying what I’m inclined to say, and always fear shows my age: It seems to me like the right answer here really is combined worldwide reporting. I don’t know that there’s a path to get us there directly, but that would diminish the incentives for income shifting. But at least if Congress has gone this little bit of the way toward trying to do something, it behooves the states to buy into it.

Dan Bucks: I think the pathway to worldwide unitary should be simple, if it were not for all the corporate lobbying against it. And the fact is, as Darien has written, it is the most potent means of stopping global profit shifting. I can elaborate at another time on how profit shifting is a menace to society with serious economic and social consequences. But in terms of the present comments here, worldwide unitary is a simple matter for the states; it has been proven, it has worked before, and it is entirely constitutional.

The corporate community is threatening litigation over the states piggybacking on GILTI. That prospect of litigation is eliminated if states adopt worldwide combined reporting. Also, the corporate community criticizes the states’ inclusion of GILTI if it doesn’t include factor representation — and worldwide unitary inherently involves factor representation and responds to that concern. The fact that it is practical, workable, has a proven track record in the past for both large and small states, is eminently fair in terms of factor representation, and is constitutional — that’s what commends it. And I think it’s a matter of somehow finally convincing legislators that it really is the only enduring solution to profit shifting.

Now, of course there’s the fear out there — and that’s another subject we can explore — that if you ask corporations to pay a fair share of taxes that reflects their true business activities in the state, that will somehow adversely affect economic activity. That’s the public relations pitch that is made by the corporate community; I think it’s false, but the problem or hurdle to the effective adoption of worldwide combined reporting is largely the fear of reduced investment — a fear that is entirely unfounded, in my view.

Enrich: I wonder if one small baby step toward getting combined worldwide back on the table would be in states that do adopt inclusion of GILTI to give the taxpayers the option of electing worldwide combined reporting. I think that would undermine any arguments about discriminatory apportionment, about the failures of factor representation, if they had the option to adopt a system that clearly is not discriminatory and that has been recognized by the courts. It’s not asking any legislature to expressly require combined reporting, but at least to provide it as an option on the table.

Michael Mazerov: I was going to pose a question to the two lawyers that has been posed to me. It’s directly related to what Peter just recommended — and I’ve advocated the same election in presentations I’ve made since the TCJA passed. Are the two lawyers confident that allowing an election between worldwide combined reporting and a water’s-edge approach that also includes GILTI in apportionable income would remove any legal argument that conforming with GILTI was unconstitutional? And does it matter whether such a law would be written such that worldwide is the default with water’s edge with GILTI included as the election or the reverse?

I’ve spoken to some attorneys who have said there’s jurisprudence saying that a taxpayer shouldn’t have to elect into an unfavorable tax treatment to avoid tax rules that are unconstitutional. Any thoughts on that?

Shanske: My understanding is that in a state like New Jersey, which is conforming to GILTI, there is a water’s-edge election as the default. So right now the default is making a water’s-edge election, and then you conform to GILTI, but if you don’t want to conform with GILTI, then you can go to worldwide. And so that is the current situation, and it doesn’t seem to be stopping the threats of litigation. I think that it should, based on broader constitutional principles, as well as on the limited cases in this area. Worldwide is constitutional, and to the extent that you have this other alternative — GILTI conformity — that is a different kind of approximation of income earned within a state and counter to the threat of income shifting, then that should be constitutional too, so long as the alternative is reasonable. And as I said at the outset, GILTI is reasonable, if highly imperfect.

Now, there is the unconstitutional conditions doctrine, which if conforming to GILTI were unconstitutional, then saying you can do that or the constitutional thing [worldwide] would perhaps be a problem. But GILTI conformity is not unconstitutional. To put the point above another way: Conceive of GILTI as a kind of addback provision, because in the context of water’s-edge election, you’re in a separate-reporting situation, and GILTI is instructing that you add back selected items of income about which we have reasonable suspicions. And the idea is, “Well, if you don’t think that we’re adding them back correctly, you can elect into this other regime.”

This should pass constitutional muster, and I want to make a somewhat snarky aside: It seems extraordinary how eager and able the corporate community is to calculate foreign factors in connection with GILTI. They are all ready to go. So I think, as a matter of politics, that some state should say, “Great, if you’re ready to calculate foreign factors, then you’re ready to go to mandatory worldwide combination. We don’t have to fight about apportionment formulas for purposes of GILTI anymore.”

Enrich: I think I agree with most of that on the question of constitutional analysis, although there are no guarantees here; the only guarantee is that there is going to be litigation over this. There isn’t, in my understanding, case law that is directly and precisely on point. I guess the way I think of this is the challenges that would be brought to state taxation of GILTI are either apportionment claims or discrimination claims. And allowing the option of worldwide reporting helps on both of those. It helps on the apportionment claim because then it means that a challenger is going to have to show that both of two systems are so inappropriate as apportionment schemes that they don’t pass constitutional muster — not just show it about one; you have to show it about both. And on the discrimination claim, I don’t think that the constitutional conditions doctrines apply effectively to discrimination claims. The point that you’re making in a discrimination claim is, “We’re being treated less favorably than somebody else.” And if one of the options that’s open to you is to be treated exactly like the somebody else, then that really defeats any claim of discrimination. So I think that it’s a tough case for the challenger to make.

As to your question, Michael, about which should be the default and which should be the election, I don’t really have a view on that, and I don’t know any case law that would suggest a view on that.

Could we talk about the separate-reporting states?

Shanske: There’s no question that it’s a harder question and that the private bar has announced that it’s clearly unconstitutional under Kraft v. Iowa² to conform to GILTI if you’re a separate-reporting state. I don’t see why that’s necessarily true, again, on the argument that GILTI is kind of an addback provision. For an addback provision there are certain problematic deductions that are added back. Similarly, certain problematic items of income are added back in under GILTI, so I wouldn’t be so confident that it’s not constitutional. I think that there is a good argument that a separate-reporting state is entitled to be concerned that its corporate tax base is being eroded; in fact, that’s why they shouldn’t be a separate-reporting state to begin with.

So it is a little funny as a policy matter to consider GILTI and separate-reporting states. If you’re concerned enough about income stripping to conform to GILTI, you shouldn’t be using separate reporting. So that’s part of the reason it’s kind of a strange question, but could a separate-reporting state do it? I think the answer isn’t clear, and quite possibly is yes.

Enrich: I think looking to addback statutes as the parallel is clearly the right path, and leaves any states that don’t have addback provisions hanging out to dry — but maybe that is also appropriate. I guess my concern is I’m not sure that, for foreign commerce clause purposes, saying GILTI is “similar to your state’s addback statute” is going to be good enough. I think that if I were challenging a provision, I would look for ways that inclusion of GILTI was more extensive than what the state’s addback provision allowed for, and say, therefore, even if it only goes a little further, it goes further — and that is arguably a violation of the foreign commerce clause.

Shanske: Right, I think that’s the argument to be made. Kraft v. Iowa is a simple binary — inclusion or noninclusion. I’m not sure whether the current [U.S. Supreme] Court, which has not been so eager to find discrimination for other dormant commerce clause purposes, wouldn’t say that discrimination here presumes that you’re actually talking about the same thing. There’s a good reason why a state might have different rules for this foreign income [that is, GILTI] because the ability to get down to 0 percent by getting the income out of the country is much more compelling than moving it to another state. If nominally foreign income is different, then it can be treated differently without constituting discrimination. But as I said, a separate-reporting state thinking about conforming to GILTI should start by going to combined reporting. But if they’re really just going to do this and conform to GILTI, they definitely have a leg to stand on — but that’s as far as I feel I can go.

Bucks: Let’s assume for the moment that separate-entity states choose to include GILTI in their tax bases and are subsequently challenged. Let’s further assume that the corporate community is correct and they get the inclusion of GILTI by these states struck down. I think that result would be an impetus for those states to move toward combined reporting. Which leads to a second point that all of the states that are water’s-edge or separate-entity states are exposed to substantial risk from the federal switch to its version of a territorial tax system. That switch, without some effective state action — be it global combined reporting, tax haven reporting, or inclusion of GILTI in its tax base — exposes the states to a substantial risk of increased profit shifting. The vulnerable state corporate systems would get programmed into and exploited by the profit-shifting planning models that exist in the private sector.

So this is not a hypothetical or academic thing for any of the states out there, because no state is a mandatory worldwide state without an option for water’s edge in some form — with the limited exception for oil companies in Alaska. Thus, all states need to counter the effect of the federal switch to a territorial tax system. Otherwise, there will be a negative impact on the equity, effectiveness, and integrity of their corporate tax systems.

Congress recognized that the switch to the territorial system exposed the federal corporate tax to increased profit shifting, and that’s why it included GILTI and BEAT [the base erosion and antiabuse tax] and other measures to try to counteract that. And yes, they’re clumsy measures in many respects, but Congress at least recognized, to a degree, that it couldn’t leave the federal corporate tax exposed to profit shifting. But Congress in effect exposed the states to profit shifting if the states fail to act.

Shanske: Dan, this reminds me of a question that I had for the group: There’s been no discussion of conforming to the BEAT, but shouldn’t states conform to the BEAT as well? I think so.

Bucks: I don’t have a problem with that, but my impression is that the BEAT is not as effectively designed as other measures. But I don’t see that fact as any objection to state conformity. Michael, would you have an observation on that?

Mazerov: I would agree that states should conform to it; obviously, that requires proactive action on the part of states. The question is more an issue of strategy and priorities. Conformity to GILTI by itself is a big battle, even retaining it when it is conformity under the existing system. Because BEAT is structured as a separate tax, it would require proactive legislative action in all cases. It’s a question of priorities. The foreign business community is out there saber rattling that BEAT is going to be subject to WTO challenges, so it’s a question of damage control and which things you do first.

And then there’s also an issue out there that we haven’t talked about yet — that states seem to be automatically conforming to the FDII [foreign-derived intangible income] tax giveaway. I’m not aware that any state legislators recognize that this isn’t a base-broadening measure; this is a base-narrowing measure that they should be decoupling from. So it all sort of becomes a question in terms of real-world politics: Where do advocates and legislators who are concerned about income shifting put their efforts? I think that, given limited resources, it’s much more important to make the case now for moving to worldwide combined reporting than taking on a whole new battle to conform to BEAT.

Shanske: That makes sense. Michael, do you think things are going to change in the next recession, that suddenly all these ideas are going to come off the shelf? That states will say, “Oh, we decoupled from GILTI three years ago, but it just takes one sentence to conform, and that’s going to be much more appealing when times are less good.”

Mazerov: It’s hard to say. Once states go in a certain direction, it’s hard to make them reverse direction on a fundamental policy choice. Sometimes that works in our favor. For example, the business community really thought they had a shot at getting Kentucky to reverse its adoption of combined reporting last year. If I had had to bet, I would have bet they would have been successful. But even in a relatively politically conservative state, once the legislature took that step, it became a bridge too far even for the multistate corporate community to get them to reverse course.

Enrich: The competitiveness argument that Dan was talking about earlier seems to take on its greatest urgency during recessionary times, and doing something that is perceived as a deterrent to in-state economic activity in a recession is politically pretty tough.

Bucks: That’s correct, but there’s still an opportunity to make the case that the revenues are needed, and there is also a need to counter the corporate arguments made against combined reporting.

From the recent federal tax experience, there’s new ammunition that the corporate lobbyists’ refrain that it is a good economic strategy to not require corporations to pay a fair share of taxes is a fallacy. The evidence is beginning to accumulate that the federal corporate tax cut did not have the economic impact claimed for it by its proponents.

I don’t know how many of you had a chance to look at the Congressional Research Service report by Jane G. Gravelle and Donald J. Marples on the preliminary observations out of the economic effects of the 2017 tax law.³ Have any of you had a chance to look at this? I have a few comments on the report.

Mazerov: I’ve seen the summary. There’s a really excellent column summarizing it by Michael Hiltzik in the Los Angeles Times that I’d commend to everybody’s attention.⁴

Bucks: To me, it’s related to the current conversation in terms of the pressures that states face when they try to ask corporations to pay a fair share of taxes. One part of the CRS report that caught my eye was that the effective tax rate on corporations declined by more than the statutory tax rate in the first year. And again, these are preliminary observations being made by the authors based on one year of experience. The statutory tax rate on corporations dropped by 40 percent, but the effective tax rate dropped by 48 percent.

Now, the authors don’t speculate as to why; it seems to me that there are two answers. One is that maybe it’s a temporary effect from short-term provisions such as the repatriation feature. That could account for it. Or it may be an early indicator that in fact more profit shifting is happening under the new regime than under the old law, and that the base-erosion measures — because they’re clumsy and incomplete — are not effective in stopping that increased profit shifting. Or maybe there’s some other explanation. But I think those are the possibilities, and I think the jury is out on that, but I think one possibility is that there’s increased profit shifting and base erosion going on through tax avoidance activities.

The other thing that is clear that the authors cited was that corporations had increased funds either because of repatriation or the tax cuts themselves, and that they had choices to make as to what they would do with that money: invest more, pay down debt, increase wages, pay wage bonuses, pay dividends, or repurchase shares. And overwhelmingly, the evidence is that the corporations took their tax benefits from rate reductions and repatriation and used it for record-breaking stock buybacks of $1 trillion. So cutting taxes for corporations doesn’t result in investment or wage benefits; it seems to result in things like stock buybacks. And I think that’s relevant to legislators to understand what happens when you cut corporate taxes: It doesn’t mean jobs, it doesn’t mean wages, and it doesn’t mean new investment in new factories in your communities.

That’s at least one of the conclusions that I take from this preliminary CRS report by very respected tax experts, Gravelle and Marples. So I think that’s relevant to the general questions of what the states should do regarding curbing profit shifting.

Enrich: At some point we can have a full, robust discussion about the mismatch between political arguments and economic facts, but that may be for another day.

Bucks: If the states just depend on federal policy without taking action to counter global profit shifting, the signs are it’s not going to work out well for their corporate taxes.

Shanske: I think that’s a great way to end.