States Still Losing a Lot by Not Conforming to GILTI

The severity of the current crisis makes it more, not less, important that states get tax policy right.

This post was originally written at the beginning of February, which feels like a long time ago. Tax policy is not and should not be at the top of state legislative agendas right now, but decisions about taxes cannot be put off forever, especially in the states, which operate under balanced budget rules — as do hard-hit localities that will be looking to the states for help. So when the time comes, states should still broaden their corporate tax bases and conform to global intangible low-taxed income (GILTI).

To be sure, the extraordinary economic downturn that we are in the midst of likely means that GILTI conformity will result in significantly less revenue than projected. And some will argue that the downturn provides another reason why this policy choice is wrong: We should not raise taxes during a recession. Of course, those same voices did not want to raise taxes during an expansion. Granting for the moment that raising taxes in general is not good policy during a recession because it could suppress already-suppressed demand, this generality loses most of its force here. First, of course, we are talking about an income tax. All the corporations in dire need of aid — aid that many should get, though the form it should take is a vexing question — will not be affected by GILTI conformity until they are profitable. And even then, they will likely have net operating losses for a long time.

Moreover, this is even before the fact that the types of firms most hurt by the current downturn — hospitality, retail, airlines — are not the ones most likely to have had much GILTI liability even before the ravages of the pandemic. The firms likely to have had a lot of GILTI were characterized by high profits, few tangible assets, and relative ease in shifting income. It is unclear how much these firms will be affected by the pandemic, but in any event, they will only end up with GILTI liability if their foreign subsidiaries are extremely — suspiciously — profitable. Whether this profitability occurs now or in a few years, states should act to broaden their corporate tax bases now so that their revenues can recover more quickly.

Also, the basic premise of not raising taxes during a recession is not as generally true as one might think, and here I am following a seminal article by David Gamage.¹ Again, states and localities are governed by balanced budget requirements. Thus, there is something of a zero-sum game, and the right question is not whether raising taxes is a good idea in the abstract; rather, it is a comparative question: Is it better for states to raise taxes a little on profitable corporations (and well-off individuals, while we are at it) so that they can continue to fund vital safety net services that will be needed long after the worst of this crisis subsides? As a matter of morality, public health policy, and economics, this seems like an easy one. The millions raised in GILTI conformity can go directly into the pockets of those who need it most, can use the money to stay home when they are not feeling well, and will spend it quickest.

The Original February 6 Post

Consider the following deal: A state adds about one sentence to its corporate income tax code, and that simple addition yields a large boost — possibly as high as 25 percent — in corporate tax revenue. For a state like Massachusetts, that means hundreds of millions of dollars per year. This revenue would be raised from taxpayers that are, by definition, large multinational corporations that have likely engaged in substantial income stripping. Even better, because of the structure of this provision and state corporate income taxes generally, it is doubtful that these large corporations could reduce their tax liability by moving operations out of the state.

In summary, this deal provides states with an easy way to raise a lot of revenue from taxpayers who are likely engaging in substantial tax planning — and with little or no competitive harm to the state.

Too good to be true? No. States can have this deal if they conform to a provision of federal tax law called GILTI. The only real cost is that state legislators will need to weather a blizzard of dubious policy and legal arguments from the business community. I have discussed these arguments at great length elsewhere. Here is a good place to start.²

The main point of this post is that there is real revenue at stake. Up until now, advocates for taxing GILTI had to rely on back-of-the-envelope estimates. Fortunately, a Massachusetts coalition advocating for GILTI conformity in that state engaged the highly respected Penn Wharton Budget Model to estimate just how much revenue could be raised by GILTI conformity.³ The upshot is that, for 2020, the estimate is that there will be about $380 billion of GILTI to be apportioned among the states. Assuming an average state corporate income tax rate of 7 percent, then taxing 50 percent of GILTI, as the federal government does, would yield about $13 billion in new state corporate tax revenue. Note that in 2017 the states collected about $53 billion in corporate income tax revenue,⁴ and so, on these very rough numbers, GILTI conformity would result in about a 25 percent increase in revenue.

I should emphasize that there are many reasons why a state might not achieve a 25 percent increase, but even a 12.5 percent increase accomplished by means of adding one sentence strikes me as a very good deal.

To date, state lawmakers have been told that they should not and cannot conform to GILTI and that, in any event, it is not worth it. I have already argued that states can⁵ and should,⁶ and now we know that it would be worth it.

Wonky Appendix

There is some irony to this story. As The New York Times recently explained, industry groups worked to undermine the effectiveness of GILTI at the federal level by getting the U.S. Department of the Treasury to propose regulations that interpret GILTI in a very taxpayer-friendly way.⁷ This is on top of the fact that GILTI was never expected to be very effective.⁸ So then why can GILTI work better at the state level? One simple answer is that states need not — and should not — adopt the more obnoxious federal regulations interpreting GILTI.⁹ Second, state corporate income taxes work a little differently from federal corporate income taxes and, in particular, state corporate taxes do not offer foreign tax credits. It is the use (and abuse) of FTCs at the federal level that is a large driver of GILTI’s ineffectiveness. The states do not have this problem.