Menu
Tax Notes logo

How to Pay for Infrastructure: Corporate Tax Changes

Posted on Mar. 29, 2021

With the success of its first big legislative initiative, the American Rescue Plan Act of 2021 (P.L. 117-2), the Biden administration has moved on to the next item on its agenda: infrastructure. Long discussed but highly elusive, the need for additional spending on the country’s infrastructure has broad bipartisan support. The problem is how to pay for a measure that’s expected to cost more than $2 trillion.

The first of a series on various alternatives for funding infrastructure, this article considers how corporate tax increases might be used. Imposing more taxes on profitable corporations was high on President Biden’s campaign list, which included ways to both reverse and fix some of the legislative changes enacted by the Tax Cuts and Jobs Act. Progressive Democrats also have made higher taxes on corporations a key part of their platform.

Rate vs. Base vs. Entity vs. Shareholder

There are two basic ways the government can extract more revenue from corporations: increase the corporate rate or broaden the base. During his campaign, Biden proposed both. The options affect groups of corporate taxpayers differently, and those that would bear a greater share of the burden could be expected to pressure their lawmakers to minimize effects that could harm local jobs.

The corporate tax doesn’t exist in isolation, and the rate on corporate earnings is closely tied to the taxation of corporate shareholders and unincorporated businesses. In 2015 more than 80 percent of U.S. companies — which account for more than 50 percent of total business net income — were organized as passthrough entities. Any discussion of raising taxes on corporations mostly excludes those types of companies and business income. But the corporate rate and base necessarily inform taxpayer decisions to organize as corporate or noncorporate entities, so it’s not really possible to separate how corporate tax changes might influence revenue and taxpayer behavior from how individuals and passthroughs are taxed. The TCJA attempted to balance the interests of those two groups of taxpayers by pairing a reduction in the corporate rate with a new deduction (section 199A) for passthrough business income. Any increase in the corporate rate must take into account the delicate balancing act between business incorporation and passthrough organization and the strength of the small business lobby.

Proposals for changing the corporate rate and base are also closely tied to the taxation of capital gains. Many Biden appointees, including Lily Batchelder, who was recently nominated Treasury assistant secretary for tax policy, have written about the need for more taxes on capital gains and on carried interest (Batchelder and David Kamin, “Taxing the Rich: Issues and Options” (Sept. 2019)). In his March 24 Richard Musgrave Lecture, Mihir A. Desai of Harvard Business School suggested that the focus on the corporate income tax is largely misplaced and risks missing the more important questions of capital taxation.

Corporate Revenue Pre- and Post-TCJA

The U.S. corporate tax before enactment of the TCJA was graduated with a top rate of 35 percent. Foreign earnings were mostly exempt from U.S. tax until they were repatriated, and the foreign tax credit provided many opportunities to offset U.S. tax on those earnings. The TCJA dropped the corporate rate 14 points and imposed immediate U.S. tax on most of the earnings of controlled foreign corporations, while limiting the ability to claim FTCs against the U.S. tax on those earnings.

Under the old system, the Congressional Budget Office reported that corporate tax revenues in fiscal 2017 were $297 billion, less than a fifth of the government’s total income tax revenues ($1.6 trillion) and a tenth of overall revenues ($3.3 trillion). In fiscal 2019, the first full fiscal year after the TCJA’s enactment, corporate tax revenues were $230 billion, total government revenues were $3.5 trillion, and income tax revenues were $1.948 trillion. In short, government revenues from the corporate tax have decreased significantly post-TCJA, with revenue from individuals more than offsetting that amount.

The fiscal 2017 and 2019 numbers provide a baseline for thinking about the revenue that could be raised by increasing the corporate rate and base, both in general and as a percentage of the amount needed to pay for infrastructure. But even if corporate tax changes can’t generate enough revenue to make a dent in the costs of infrastructure spending, that doesn’t mean that an increase to the corporate tax would be rejected in favor of larger potential revenue sources such as a VAT or carbon tax. That’s because increasing taxes on multinationals is often portrayed in terms of fairness, including by many progressive Democratic leaders. In his Musgrave Lecture, Desai asked how and why a tool with unclear incidence is portrayed as a vehicle for progressive redistribution, pointing to the most recent available evidence as suggesting that any such presumption is faulty.

Rate Increases

Biden has proposed several corporate tax increases:

  • a higher overall corporate rate of 28 percent, halfway between the 21 percent TCJA rate and the pre-TCJA rate of 35 percent;

  • a higher rate on foreign earnings by increasing the 10.5 percent rate on global intangible low-taxed income to 21 precent (perhaps by decreasing the section 250 deduction for inclusions from GILTI);

  • changing the calculation of GILTI so that it’s imposed country by country;

  • eliminating the exemption for a normal rate of return from GILTI; and

  • an alternative minimum tax on book earnings.

He has also proposed a higher top rate on individual income and a higher rate on capital gains.

Revenue Projections

Economists generally project that increasing the corporate rate 1 percentage point translates to additional annual revenue of between $5 billion and $10 billion. Increasing the rate by Biden’s full 7 points, then, could raise approximately $900 billion over the 10-year budget window (dynamic scoring would decrease that number).

But a 7-percentage-point increase in the rate is probably not in the cards.

It’s Good to Be Average

While the TCJA’s 21 percent rate was lower than most policymakers and corporate taxpayers expected, it appears lower than it actually works out to. When combined with state corporate rates, which range from 1 to 12 percent, the U.S. rate for domestic companies is closer to the middle of that imposed by OECD countries. Increasing the federal rate would push the United States toward the high end of that list (see March 16 testimony of Michelle Hanlon of the Massachusetts Institute of Technology at a Senate Finance Committee hearing on the tax code’s effect on domestic manufacturing).

It can be argued that corporate benefits of operating or being headquartered in the United States mean the country can impose a higher rate than other countries without losing much investment. But the pre-TCJA system provided strong evidence of the types of distortions introduced when the U.S. rate diverges significantly from that of other countries, including pressure on U.S. corporations to invert (or not incorporate in the United States to begin with), greater benefits from (and thus increased incentives for) minimizing the U.S. tax base via payments to foreign related parties; and incentives to increase overseas operations at the expense of U.S. locations.

Industry Impact

The 2017 tax changes disproportionately benefited companies with higher amounts of revenues and profits from domestic sources — adopting a higher rate with no other changes might reverse some of that.

That’s probably not the result Congress wants. At the March 16 hearing, senators from both parties, as well as all the witnesses, agreed on the virtue of using the tax code to promote domestic manufacturing.

GILTI Rate

Biden also campaigned on increasing the rate on foreign earnings classified as GILTI. Unlike an increase in the overall rate, increasing the GILTI rate would disproportionately affect multinationals that generate more of their profits overseas. It’s possible that increasing the rate in that manner could benefit domestic manufacturing, but it would have other distortionary effects.

Part of the campaign rationale for increasing the rate on GILTI earnings (and that underlying similar Democratic legislative proposals) is that taxing foreign earnings less than domestic earnings encourages companies to offshore operations. But that claim is both overblown and inaccurate. For one, companies (other than in the pharmaceutical industry) rarely manufacture offshore simply to sell back into the United States. So if one assumes that foreign earnings are mostly generated by foreign sales, increasing the tax rate on foreign earnings mostly discourages U.S. companies from expanding into overseas markets, rather than having any measurable effect on U.S. manufacturing. Imposing additional costs on U.S. companies that are trying to compete against foreign-headquartered companies simply increases the likelihood that U.S. companies will be priced out of foreign markets. That probably reduces the ability of U.S. companies to invest in domestic manufacturing over the long run.

Another important counterbalance to the claim that the United States should be taxing U.S. companies’ foreign earnings at a higher rate is that the country already taxes the foreign earnings of its headquartered companies more extensively than any other. Most countries have been reluctant to expand their CFC regimes, with the United Kingdom being especially aggressive in limiting its CFC regime and EU law restrictions ostensibly preventing member countries from doing so. Raising the rate on GILTI would exacerbate the types of distortions outlined above and make U.S. companies less competitive in the global mergers and acquisitions market.

It’s possible that adopting OECD proposals, including the pillar 2 global minimum tax rate, would induce other countries to adopt broader CFC regimes, thereby bringing their taxation of foreign earnings more in line with that of the United States. But expectations shouldn’t be too high that they would adopt regimes that could make them less competitive from a global tax and foreign direct investment standpoint. Some of the largest countries, including China, have been fairly explicit in their rejection of that idea.

Even if Congress does nothing, the GILTI rate is scheduled to increase automatically, because after 2025, the section 250 corporate deduction for GILTI inclusions will decrease from 50 percent to 37.5 percent.

Base Broadening

Even without increasing the rate on corporate earnings, there are many ways to raise revenue by broadening the base, although it has disadvantages. Base broadeners are more difficult to explain, and so are less appealing to progressive Democrats than a simple increase in the headline rate. They’re more likely to hit some industries much harder but can also be so opaque as to make it unclear which taxpayers are being harmed. Base broadeners can let lawmakers target specific groups of taxpayers that appear to be behaving egregiously or not paying their fair share.

Alternative Minimum Tax

Biden campaigned on an alternative minimum tax on book income (a similar proposal by Finance Committee member Elizabeth Warren, D-Mass., would have taxed excess profits). The AMT is the broadest attempt at expanding the tax base because it adopts a separate base for companies considered to be paying insufficient tax under the ordinary base. In support of Warren’s proposal, economists Gabriel Zucman and Emmanuel Saez wrote that a rate of 7 percent over the regular corporate rate on U.S. companies’ global net financial statement income above $100 million would target approximately 1,200 companies and could raise around $1 trillion over 10 years.

AMTs based on book profits have a long and unsavory history. Hanlon referred to some of that history in her Senate Finance testimony, and she has strongly criticized those kinds of taxes (Mindy Herzfeld, “Taxing Book Profits: New Proposals and 40 Years of Critiques,” 73(4) Nat’l Tax J. 1025).

An AMT may be a bad idea from a technical perspective, but it has lots of political appeal. And it could be reconciled with aspects of the OECD pillar 2 proposal for a global minimum tax based on financial statement profits.

GILTI Changes

CbC Reporting

A singular focus of attack in Biden’s and Democratic legislative proposals is the calculation of the GILTI tax (and FTC) on a blended basis. Biden campaigned on calculating GILTI on a country-by-country basis, and several lawmakers have introduced bills based on the same idea. Finance Committee member Sheldon Whitehouse, D-R.I., for example, has introduced the No Tax Breaks for Outsourcing Act (S. 714), which would place a per-country limit on the GILTI FTC (see also the Per-Country Minimum Act (H.R. 6015)).

Kimberly A. Clausing, the new Treasury deputy assistant secretary for tax analysis, has estimated that a CbC minimum tax of 21 percent could raise between $570 billion and $910 billion over the next 10 years; her projection is based on U.S. companies’ growing foreign profits at a rate of 4 percent (although it’s unclear whether that growth rate would be accurate if taxes on foreign earnings are increased so dramatically).

Calculating the amount on a CbC basis provides the opportunity for reconciliation with the OECD proposals — but multinational companies are uniquely aligned against it because of its complexity. It’s also unclear how much revenue would be raised by simply changing the rules for calculating the GILTI inclusion without increasing the rate. In a March 19 report (JCX-16-21) produced for a hearing on U.S. international tax policy, the Joint Committee on Taxation provided some of the first data indicating who pays the GILTI tax, and how much, and quantifying the benefits from deductions for GILTI and foreign-derived intangible income.

The JCT report includes data on GILTI and FDII deductions for 81 large corporations for tax year 2018. Those companies had a quarter of all corporate earnings for that year and assets equal to more than one-third of U.S. corporate assets, with $546 billion in worldwide consolidated net income. They reported approximately $102.1 billion of GILTI; $13 billion of tentative GILTI tax liability; and $6.6 billion of GILTI FTCs (of approximately $12 billion foreign taxes paid), with $6.3 billion of GILTI liability after FTCs. Combining the $6.3 billion U.S. liability with the $12 billion in foreign taxes paid results in total tax of almost $18 billion, for an overall GILTI tax rate of 16 percent. Their implied GILTI and FDII deductions were $57 billion and $21.9 billion, respectively. One can perhaps extrapolate from the JCT data to get to the lower end of Clausing’s estimate, but the almost $6 billion in uncreditable taxes paid in the data suggests that raising the GILTI rate might simply mean more foreign tax being credited, rather than more U.S. tax revenue.

QBAI

The Biden campaign also proposed eliminating the 10 percent exemption from the calculation of CFC tested income, or qualified business asset investment, which has often been characterized as an offshoring incentive (Clausing, Saez, and Zucman, “Ending Corporate Tax Avoidance and Tax Competition: A Plan to Collect the Tax Deficit of Multinationals” (Jan. 2021)). But the exemption is firmly rooted in economic and fiscal policy of not taxing the normal rate of return on tangible assets.

Clausing has argued that for the minimum tax to be effective, all foreign earnings should be subject to it, and bills introduced by Democratic lawmakers (including S. 714) have made similar proposals. (See also Clausing’s March 25 testimony at the Finance Committee hearing on international tax policy and U.S. jobs.) 

The FDII Deduction

The FDII deduction was enacted to ensure that U.S. companies did not get a lower tax rate on foreign sales of intangibles owned offshore than on foreign sales of products derived from U.S.-owned intellectual property — in other words, to encourage U.S. companies to own their intangible assets in the United States. Because the deduction is in the same code section as the GILTI deduction and is based on a similar formula, its benefit is reduced if a U.S. corporate taxpayer has an investment in tangible U.S. property. As a result, arguments like those against GILTI for encouraging offshoring of tangible property investment have been levied against FDII.

Modifying the FDII deduction to increase the incentive for U.S. companies to invest in tangible assets in the United States would be consistent with the broad bipartisan goal of increasing domestic manufacturing. Doing so by eliminating the QBAI exemption for the FDII benefit would be a net revenue loser, not a revenue raiser.

R&D Amortization

Under the TCJA, starting in 2022, taxpayers will be required to amortize their research and development costs over five years, instead of deducting them immediately each year. The Tax Foundation has projected that that will raise the cost of investment, discourage R&D, and reduce the level of economic output, and EY has estimated that requiring some R&D expenditures to be amortized would reduce annual U.S. R&D spending by between $4 billion and $10 billion, resulting in a loss of thousands of jobs. According to Morgan Stanley, requiring the amortization of R&D expenditures over five years will in 2022 result in an approximately 80 percent decrease in deductible expenditures and an associated average 15 percent haircut to free cash flow for R&D-intensive companies.

At the March 16 Finance Committee hearing, senators from both parties seemed receptive to reversing the phaseout, which would also be a net revenue loser.

Conclusion

Biden has proposed corporate tax increases in various form. Progressive Democrats support many of them, as evidenced by similar legislative suggestions made over the past several years. According to projections, including from senior administration officials, the proposals could generate large amounts of revenue.

Estimates by other sources suggest those projections are overly optimistic. While progressive Democrats strongly support Biden’s proposals, Republicans who want to protect President Trump’s most important legislative accomplishment strongly oppose them, and what remains of the center is skeptical about their potential harm to U.S. corporate investment and jobs.

The success of any proposal is uncertain, but the pros and cons of each will play a major role in any infrastructure bill introduced soon.

Mindy Herzfeld is professor of tax practice at University of Florida Levin College of Law, of counsel at Ivins, Phillips & Barker, and a contributor to Tax Notes International.

Follow Mindy Herzfeld (@InternationlTax) on Twitter.

Copy RID