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Why Book Minimum Taxes? Taking Politics Seriously

Posted on Oct. 10, 2022
David Kamin
David Kamin

David Kamin is a professor of law at New York University School of Law.

In this article, Kamin explores the political and institutional challenges that the book minimum tax seeks to address, and he concludes that the case for it in the international context is strongest even though it has been used to overcome detrimental interest-group politics in the domestic context.

Copyright 2022 David Kamin.
All rights reserved.

Introduction

The recent enactment of a new corporate alternative minimum tax in the United States has generated the kind of response from many tax experts that minimum taxes typically do: derision.1 The normal trope in response is that Congress should just fix the corporate income tax system directly by limiting subsidies and raising rates and not imposing another tax base as a backstop. Added to that are objections to using book measures in the tax system and the pressures this will impose on the accounting standards and institutions that develop those standards.2 And to the degree that many analysts express support, it is to admit that politics may give no better alternative.3

In this article, I want to take seriously what “politics” means. The structural forces in politics that lead to book minimum taxes deserve more than a resigned sigh or an eye roll.

The global agreement under the OECD’s pillar 2 is, of course, an agreement on a global book minimum tax. And in the international context, the book minimum tax is an especially compelling instrument given the significant political and institutional barriers to other forms of tax reform. In some ways, this has been implicitly recognized by book minimum tax critics, since they have been far less vociferous in their objections to the international framework, though many of the same substantive complaints against book minimum taxes apply.

In the context of the newly enacted corporate AMT in the United States, the political and institutional forces are certainly different. It is imaginable — because it has been done before — that Congress could change the corporate tax code in ways other than a book minimum tax to increase corporate liabilities. Still, the book minimum tax is a way to coordinate action among members of Congress to raise taxes when other means fail, as they certainly did in the latest negotiations over the reconciliation bill.

The bottom line is that the politics should be taken seriously. In the international context, that is probably the decisive — or at least the most persuasive — argument for using a book minimum tax. That isn’t to dismiss the downsides, but it is to say that coordination to increase corporate tax liabilities internationally demands a tool that can match the task. The book minimum tax is one, and there may be few others that can plausibly accomplish similar goals and do so within the political and institutional limits that exist — and that ended up being the case in Congress’s latest effort at tax reform.

Robert Goulder of Tax Notes and professor David Kamin of the New York University School of Law discuss the purpose and political importance of book minimum taxes, particularly the global anti-base-erosion agreement.

Book Minimum Taxes and the Ongoing Debate

There have been many an article and tweet on book minimum taxes — both over the years and, most recently, as the book minimum tax has emerged as the largest revenue raiser in this year’s reconciliation bill.

I won’t revisit the ins and outs of the argument. For a comprehensive review of minimum taxes and arguments for and against their different forms, I recommend Daniel Shaviro’s recent article on the topic.4

To briefly review: Few defend a minimum tax — whether on book income or some other basis — as a first best, absent other constraints. After all, rather than create a minimum tax, why not directly limit whatever aspects of the tax system are reducing effective rates below the minimum and that are undesirable? And if the incentives or other aspects reducing effective tax rates are in fact desirable, shouldn’t they be desirable even if they reduce the effective tax rate of an entity below a specific threshold? In sum, the logic goes that we shouldn’t backstop the rules — we should change them directly.5

When it comes to mixing in book income, there are proponents and critics. The proponents focus on how using book income could help reduce wasteful tax planning.6 They also argue that this could even improve book profit reporting by introducing a countervailing incentive for managers to their normal incentive to “manage” book profits higher, and in ways that obscure the financial health of the company.7 Critics respond that the use of book income in the tax system could cause companies to manipulate book income down, and in ways that further obscure financial health or otherwise reduce the quality of financial reporting. And the critics focus on new pressures imposed on financial regulators and the institutions that set financial accounting standards.8

Most of those arguments have some truth to them — or at least plausibility. Few experts would suggest a minimum tax without there being political constraints, and while there are plausible arguments for introducing book-income measures into the tax system, the takeaway from the debate isn’t clear. To a significant degree, resolving that debate on the trade-offs of using book income absent political constraints depends on contested empirical questions — such as how much companies will change book reporting as a result and whether changes in reporting will improve or worsen the quality of information provided to financial markets on net.9

That brings us to politics, which is the focus of this article, since it plays a decisive role in the case for book minimum taxes — certainly in the international context and, for the moment, the domestic one.

Politics and Multilateral Coordination

Most challenges in international taxes are rooted in politics and the institutional arrangements of a multilateral world. To play this out for a moment and illustrate that basic concept: If there were a single sovereign with a single set of tax rules applying across multinational corporations, the many challenges of international tax — including how to allocate profit and multinationals’ incentives to shift profit and activity to low-tax jurisdictions — would effectively go away. That isn’t possible or desirable, whatever the benefits might be in terms of improving corporate taxation. Politics and political institutions rightly stand in the way.

Multilateral negotiations then occur within this basic political and institutional context: more than 100 countries whose governments intend to retain key aspects of their tax sovereignty. The book minimum tax then becomes a particularly opportune way for countries to coordinate to reduce profit shifting and undesirable planning across borders, and within that political context.

We’ll start with the minimum tax structure. Corporations must pay at least X percent on their profits, however defined. The normal critiques of minimum taxes in this context lose a lot of their force, and rather obviously so. Tax experts may prefer that systems be directly amended to raise effective tax rates, but there is no single global tax system to amend. That isn’t the political or institutional context. The “backstop” nature of the minimum tax becomes central to its potential viability on the world stage. It doesn’t wholly overwrite domestic tax laws but rather preserves them operating in parallel to the minimum tax, and countries can choose different approaches to adapt their laws to the new presence of the minimum tax backstop. Thus, there is significant flexibility in the tax laws operating in parallel to the minimum tax — with countries able to combine different statutory tax rates and incentives in parallel to the underlying minimum tax.10

Might there be plausible alternatives to achieve similar ends without using a minimum-tax-style backstop? Maybe, but it is hard to come up with a long list of them. More directly mandating statutory tax rates (the tax rate must be “x”) and limiting the kinds of tax expenditures permitted brings us right back to imagining a world with a single tax system, and that is probably impossible given global politics and political institutions. Maybe some specific other limits are possible, such as agreements concerning the tax rate applied to highly mobile income associated with intellectual property, but in important ways the negotiated minimum tax is not too far off from a tax focused on the very largest returns like these while giving countries the flexibility to apply a higher rate of tax. (The relatively narrow ambit of the negotiated minimum is a topic of my next article.)

In short, the very view that many tax policy experts normally express — to get into the underlying guts of the tax system to raise liabilities rather than through minimum taxes — becomes a challenging prospect when trying to coordinate across countries.

But then what about book income? After all, a minimum tax doesn’t need to rely on financial statements of the relevant companies. Tax authorities can define income in ways that are specific to tax and don’t involve the profits reported by corporations on their financial statements. However, there’s no ready-made alternative definition of income for the world to adopt as part of a global minimum tax. Negotiators could have attempted to write rules defining income from scratch, but the prospect of that is daunting to say the least — many pages are devoted to that topic, both in tax codes and financial accounting standards.

The definition could have been devolved to each of the governments — a minimum tax on income — and leave it to the governments to define “income” in their tax codes. That prospect was raised as the global minimum tax framework was being launched.11 However, that would have had some considerable downsides. After all, governments could define income in any way they choose in order to manipulate actual effective tax rates on income as normally conceptualized. That would undermine the basic goals of the minimum tax. As the OECD program of work summarized, “if one jurisdiction has a very different tax base from the other, this could result in significantly different outcomes under Pillar Two, undermining the policy intent of creating a level playing field.”12 There were also concerns about the substantial burden of recalculating income from the same activity under many different countries’ tax rules without some uniform definition of income for the purpose of the minimum tax.13

With those very real challenges to alternatives, book income stands as a convenient way for governments to coordinate and reach agreement. Governments around the world require — and financial markets demand — that major corporations report audited financial statements. The rules and standards applying to companies depending on where they are based aren’t entirely uniform; however, they are plausibly uniform enough. In the words of the OECD:

Importantly, the use of financial accounting to determine the GLoBE tax base builds on existing internationally agreed standards. Although there are variations in financial accounting standards among jurisdictions, International Financial Reporting Standards (IFRS) and the generally accepted accounting principles (GAAP) have far more commonalities than differences.14

Further, across the world, governments and, to some degree, corporations themselves have incentives to make sure financial statements continue to convey information about corporations’ actual economic well-being, even if there is likely to be a behavioral response to financial statements now being used for tax purposes, some of which may be undesirable. That is more modest than claiming it’s a way to improve financial reporting, and it would still be sensible to use book income in the tax system, even if some harm is done to financial reporting — as long as the considerable benefit of global cooperation on a corporate minimum tax outweighs it.

And the negotiating process has of course not simply used book income without further definition. Book income has been adjusted in several ways in the global minimum tax system — adjustments for stock-based compensation, guardrails on when refundable tax credits can be counted as government grants rather than reductions in taxes, and so on.15 Nonetheless, financial accounting has served as the common basis. The underlying use of book income allowed negotiators to focus on the exceptions rather than the full complement of rules.

Politics and Coordination in Congress

The structural case for minimum taxes as a needed political tool is less compelling when it comes to Congress not acting with the rest of the world. And, yes, that is of particular note given that Congress did just enact a book minimum tax, one that isn’t the same book minimum tax as negotiated at the OECD. But it is still worth pausing here for a moment and taking the politics seriously as well.

In the end, the preferences and personalities of today’s political leaders produced the book minimum tax that has been enacted, and I won’t belabor the measure’s history other than to say that many other routes to raising revenue from corporations were attempted before they ended up on the cutting room floor. What I focus on here are the structural forces — after all, minimum taxes get put on the table regularly, and this isn’t the first time (nor is it likely to be the last) that Congress has resorted to minimum taxes to raise revenue.

It is one of the basic tenets of interest group politics that it is hard for policymakers to choose to impose concentrated costs on interest groups in exchange for more widespread benefits — even if the widespread benefits exceed the concentrated costs.16 To say it is hard isn’t to say it’s impossible — policymakers have certainly enacted their share of legislation that raises taxes (or imposes other costs) on a smaller group to finance transfers or investments with broader benefits. But Congress does so with specific structural forces that make that challenging.

Take one classic example from outside the tax area: military base closures. Members of Congress agreed that base closures were in the collective interest as a way to reduce costs and to redeploy resources elsewhere, but they understood that a process involving Congress itself picking the bases would likely fail. Members representing bases to be closed would fight harder than others — even though the base closures and redeployment of savings may be in the interest of the country as a whole. So Congress several times delegated the process of picking the bases to a commission on base realignment, solving the collective action problem. In the words of political scientist Kenneth Mayer, “legislators agreed to restrict their own parochial tendencies by delegating authority to the Independent Commission and granting it the power to make and effectively enforce decisions on the group (saying, in effect, ‘stop us before we vote again’).”17

What’s the parallel to minimum taxes and book minimum taxes in particular? Congress is seeking to raise liabilities on large corporations, and that is one way to do so that minimizes decisions from members about specific aspects of the tax code. The exact base to which the minimum tax applies isn’t entirely clear — the book-tax gap is something of a mystery — and the tax base is defined by a combination of financial regulators overseeing the financial accounting standards and Treasury, which is delegated authority to regulate adjustments.

In somewhat the same way that Congress delegated power to the base realignment and closure commission to coordinate the closure of bases, Congress has used the book minimum tax — and its delegation especially to financial regulators — to help coordinate an increase in liabilities. Notably, as this minimum tax was enacted, some concentrated industries did raise their hands — and got carveouts, for better or worse.18 So the normal interest group politics weren’t entirely avoided, but the spare nature of the provision relative to the revenue raised still helped ameliorate structural forces that can stop tax increases on concentrated interests in their tracks.

With that said, in the domestic context alone, the political dynamics and institutions present a less compelling case for minimum taxes than in the international context. Congress has the capability of more directly amending the code to raise liabilities; it has done so plenty of times, and it wrote the code to begin with. Thus, some of the dangers and trade-offs loom larger, including new political challenges. After all, the interest group pressure and political maladies from which Congress suffers could shift to financial regulators and Treasury, and there is an open question how much better they will be at absorbing that pressure than Congress itself. The base realignment and closure commission was clearly better than Congress, but it had been designed explicitly for that purpose by Congress. Both financial regulators and the Treasury Department will be put to the test.

And Congress itself may revisit the book minimum tax. On this front, some point to an earlier version of the book minimum tax that was allowed to expire after being in place for only three years in the wake of the 1986 Tax Reform Act. However, it is unclear how much can be learned from that episode. Congress at the time had explicitly enacted that book minimum tax as a bridge to a set of adjustments that it had directly legislated and not using book income — and Congress then allowed that transition to occur.19

This book minimum tax is different, having been enacted as a permanent reform. Still, Congress will inevitably hear from the affected interest groups as they emerge. And eating away at the book minimum tax may eventually be easier than, for example, reopening a military base after its closure. It is also unlike the international context — if the global deal were adopted by a critical mass of countries — since, in that context, there is an enforcement mechanism intended to preserve the deal and stop exactly such backsliding. In short, in the domestic context, the book minimum tax can (and did) help solve a very real failure in our politics in the short term, but it isn’t clear how critical or successful it will be in addressing the forces of those interest groups over the long term.

Taking Politics Seriously

At the extreme, justifying policy based on “political limits” might imply a nihilistic approach to tax policy analysis and policy analysis generally. It could be said that “because it’s what OECD or Congress did, that is what is possible.”

That is not what I mean here. Instead, what I mean is to take seriously specific structural forces in our politics both globally and domestically, and then consider the wisdom of policy changes given those forces. The politics aren’t determinative of whether a change is a good idea, but they inform the types of relevant alternatives, and they illuminate when policy tools may in fact be designed specifically to overcome coordination problems in our politics that undermine action toward the collective good.

That is exactly what the book minimum tax is doing, and there are no good alternatives in the international context for addressing profit shifting to low-tax jurisdictions. In sum, the most compelling reason to pursue book minimum taxes lies in our politics, and the question, especially in the international arena, is now whether they can successfully solve a critical coordination problem that other tax tools have not. In my next article, I will better define the problem that the global minimum tax solves and explain how the agreement represents an important step, even as its ambition has been overstated by both proponents and critics.20

FOOTNOTES

1 For instance, Martin A. Sullivan helpfully identifies corporations likely subject to the new book minimum tax enacted by Congress, and then concludes that “any AMT is a sign that the regular tax system isn’t working well. But instead of fixing the system and addressing problems directly, lawmakers overlay a complicated and nonneutral second system on top of the first.” Sullivan, “Identifying Corporations Likely to Pay the New Corporate AMT,” Tax Notes Federal, Aug. 8, 2022, p. 895, at 901. Or, as Richard Rubin summarizes, “Tax-policy experts tend to dislike minimum taxes, arguing that if you want to get rid of some tax breaks, just get rid of some tax breaks.” @RichardRubinDC, Twitter (July 30, 2022, 10:43 AM). In light of this, Rubin then described it as “ironic” that there are so many tax academics in an administration enacting a minimum tax — a contention that is admittedly personal to this particular academic who served in the administration.

2 In fact, more than 260 accounting professors wrote an open letter to congressional taxwriters in November 2021 calling on them not to enact a book minimum tax for this reason. See Letter from Michelle Hanlon and Jeffrey L. Hoopes (lead writers) and 264 cosigners to Senate Finance Committee Chair Ron Wyden, D-Ore., House Ways and Means Committee Chair Richard E. Neal, D-Mass., Finance Committee ranking member Mike Crapo, R-Idaho, and Ways and Means Committee ranking member Kevin Brady, R-Texas (Nov. 4, 2021).

3 As Catherine Rampell put it in writing about the new book minimum tax in the reconciliation bill, “given the constraints, this is the best corporate tax revenue tool left standing. Even the 10th-best solution is still a solution — and one worth seizing when the future of the planet is at stake.” Rampell, “Ignore GOP Scaremongering About Dems’ Tax Plans. They’re Worth Doing,” The Washington Post, Aug. 1, 2022.

4 Daniel Shaviro, “What Are Minimum Taxes, and Why Might One Favor or Disfavor Them?” 40 Va. Tax Rev. 395 (2022).

5 See supra note 1. See also Shaviro, supra note 4, at 407-410.

6 David Gamage has argued for the use of multiple forms of tax measurement under some conditions as a way to reduce wasteful tax avoidance. In his words, “Because all plausible forms of tax measurement are imperfect, it often will be better for governments to utilize multiple forms of tax measurement. Put metaphorically: If every available basket is full of holes, then we might want to collect our eggs with more than one layer of basket.” Gamage, “The Case for Taxing (All of) Labor Income, Consumption, Capital Income, and Wealth,” 68 Tax L. Rev. 355, 357 (2015).

7 See generally Shaviro, “The Optimal Relationship Between Taxable Income and Financial Accounting Income: Analysis and a Proposal,” 97 Geo. L.J. 423 (2009).

8 See, e.g., Letter from Hanlon and Hoopes (lead writers) and 264 cosigners, supra note 2.

9 There has been a literature quantifying changes in book income reporting when book income is incorporated in the tax system, and possible loss of information. See, e.g., Hanlon and Terry Shevlin, “Book-Tax Conformity for Corporate Income: An Introduction to the Issues,” 19 Tax Pol’y & Econ. 101 (2005). However, the magnitude of the changes and whether they represent a loss of information remain disputed. See Won W. Choi, Jeffrey D. Gramlich, and Jacob K. Thomas, “Potential Errors in Detecting Earnings Management: Reexamining Studies Investigating the AMT of 1986,” 18 Contemp. Acct. Res. 571 (2001).

10 At the outset, as the OECD was laying out the program of work on pillar 2, it specified the need for significant flexibility to be given to countries on how they design their tax systems. “Under Pillar Two, the Members of the Inclusive Framework have agreed to explore an approach that leaves jurisdictions free to determine their own tax system, including whether they have a corporate income tax and where they set their tax rates, but considers the right of other jurisdictions to apply the rules explored further below where income is taxed at an effective rate below a minimum rate.” OECD, “Public Consultation Document: Global Anti-Base Erosion Proposal (‘GLoBE’) — Pillar Two,” at 28 (2019).

11 “The Programme of Work starts from the proposition that, in principle, the tax base would be determined by reference to the CFC rules or, in the absence of CFC rules, the domestic CIT rules of the shareholder’s jurisdiction.” Id. at 9.

12 Id.

13 Id. See also OECD, “Tax Challenges Arising From Digitalisation — Report on Pillar Two Blueprint,” at 53-54 (2020).

14 Id. at 54.

15 See OECD, “Tax Challenges Arising From the Digitalisation of the Economy — Global Anti-Base Erosion Model Rules (Pillar Two),” article 3.2, 15-18 (2021).

16 As Mancur Olson explains in his classic work: “Since relatively small groups will frequently be able voluntarily to organize and act in support of their common interests, and since large groups normally will not be able to do so, the outcome of the political struggle among the various groups in society will not be symmetrical. Practical politicians and journalists have long understood that small ‘special interest’ groups, the ‘vested interests,’ have disproportionate power.” Olson, The Logic of Collective Action: Public Goods and the Theory of Groups 127 (2002).

17 Mayer, “Closing Military Bases (Finally): Solving Collective Dilemmas Through Delegation,” 20 Legis. Stud. Q. 393, 394 (1995).

18 Among other carveouts, there were changes allowing tax depreciation to be used rather than book depreciation as well as amortization of spectrum to be taken into account in the tax base. And we can’t forget the now-renowned fight to eliminate the provision clarifying that private equity would be treated as a trade or business and thus subject to the same aggregation rules as other business types.

19 For a description of the temporary 1986 book minimum tax and the adjustments that Congress had legislated to replace it, see Richard M. Leder, “Giving Rise to BURPs and Other Preferences Under the New Corporate Minimum Tax,” 40 The Tax Law. 557 (1987).

20 David Kamin, “The Ambition and Limits of the Global Minimum Tax,” Tax Notes Federal (coming Oct. 2022).

END FOOTNOTES

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