The tax bill transfers wealth from the poor to the wealthy and will exacerbate corporate tax dodging.
Congress passed a tax bill yesterday. Here is a quick recap of how the bill’s provisions for international taxation of corporations will affect poverty and inequality both in the US and globally.
Even though international tax dodging did not feature much in the tax reform debate, it matters a great deal. The US Treasury currently loses over $100 billion a year to corporate tax dodging, and developing countries lose a similar amount. These are huge sums of money, more than the funding gap to provide basic health care and education to everyone in the world.
In a nutshell, the bill is overall a boon to shareholders of US companies and bad for everyone else. It will therefore increase poverty and inequality everywhere. Several provisions of the bill are also likely to be gamed. Moreover, the bill was rushed and with time lawyers and accountants are sure to figure out more ways for big business to take even more advantage of it.
Tax rate cut
What is it? The bill cuts the federal corporate income tax rate from 35 percent to 21 percent.
How does it impact poverty and inequality? This shifts the tax burden from the shareholders of US companies (a third of whom are actually wealthy foreigners) to individual US taxpayers and small businesses. While it may jolt the economy in the short term, it will raise the national debt and interest payments and will eventually have to be paid for by cuts in international assistance and public services on which poor people and the middle class depend. Official cost estimate for US Treasury: $1,348 billion over ten years.
How is it going to be gamed? Other countries are likely to decrease their tax rates as well to remain competitive in a global race to the bottom. Wealth is going to be transferred from workers to shareholders throughout the world, and so inequality will rise everywhere.
What is it? Under current law, US multinational companies pay US tax on their income wherever it is earned, but they can defer paying tax on their foreign profits indefinitely. (They also get a credit for foreign taxes paid to avoid double taxation). The bill ends the tax on foreign profits altogether.
How does it impact poverty and inequality? It further fuels the race to the bottom in corporate tax rates. As the UK experience shows, US multinational companies will have a greater incentive to locate production where the corporate tax rate is the lowest. So US businesses are more likely to move jobs offshore to Ireland where the tax rate is only 12.5 percent. They are also more likely to play developing countries against each other to demand tax deals as a condition for investment. So they may threaten Zambia (where tax rate is 35 percent) to relocate production to Tanzania (rate of 30 percent) if Zambia does not grant them a better tax deal, and vice versa. Official cost estimate for US Treasury: $224 billion over ten years.
How is it going to be gamed? US multinational companies also have a greater incentive to use accounting tricks to artificially shift their foreign profits to tax havens; for example, shifting their Zambian profits to Mauritius (effective rate of 3 percent).
What is it? As US multinational companies can currently defer payment of the tax they owe on foreign profits indefinitely, Fortune 500 companies have over the years stashed $2.7 trillion offshore. The bill imposes a one-time 15.5 percent tax rate on the portion of those past profits held in liquid assets, and 8 percent on illiquid assets, for 2018 (payable in eight years).
How does it impact poverty and inequality? This tax break is meant to repatriate offshore profits to create American jobs. However, as companies will pay less than the 35 percent they owe under current law, it is a massive, $413 billion transfer of wealth from ordinary taxpayers to multinational companies. Official revenue estimate for US Treasury: $339 billion over ten years.
How is it going to be gamed? It rewards past tax dodging. Companies can use the repatriated profits as they want, and experience shows that they are more likely to pay off shareholders and executives than workers. Moreover, the split between illiquid and liquid assets is based on the average of the companies’ balance sheets at the end of the last two fiscal years. Given that this differentiated treatment was publicly announced in the Republican tax blueprint of June, 2016 (and the well-connected may have heard about it before), companies have had time to shift some of their balance sheet to lower-taxed illiquid assets.
What is it? The bill creates a new tax on Global Intangible Low-Taxed Income (GILTI – pun intended). US multinational companies will pay a minimum tax of 10.5 percent on the difference between their actual foreign profits and a theoretical foreign profit equal to 10 percent of their foreign physical assets. (GILTI includes a credit of 80 percent of foreign taxes paid to avoid double taxation.)
How does it impact poverty and inequality? GILTI is meant to mitigate the impact of the territorial system on the offshoring of jobs and profits explained above. It’s better than nothing, but only a partial mitigation. The difference between the domestic tax rate (21 percent) and the foreign tax rate (10.5 percent applied to only a fraction of foreign profits) remains a big incentive to offshore jobs and profits to tax havens. Official revenue estimate for US Treasury: $112 billion over ten years.
How is it going to be gamed? In addition to the large rate differential, GILTI has two flaws. First, it is calculated on a global basis, such that taxes paid in Germany can offset profits stashed in Bermuda. Second, it is based on companies’ stock of physical investment abroad. US multinational companies might therefore avoid paying the GILTI tax by moving factories to Germany and then artificially shifting their German profits to Bermuda.
What is it? US companies get a tax deduction on Foreign-Derived Intangible Income (FDII – no pun here, we should not expect too much humor from a tax bill). It applies to US profits of US companies (including US subsidiaries of foreign companies), but only to the portion of profits that derives from exports.
How does it impact poverty and inequality? The intent is to induce US companies to keep their intellectual property in the United States. This is another giveaway to shareholders of US companies at the expense of other US taxpayers. It would also pit US workers (who would win) against foreign workers (who would lose). Official cost estimate for US Treasury: $64 billion over ten years.
How is it going to be gamed? Because it gives a discriminatory advantage to US exporters, our trading partners are going to challenge it at the World Trade Organization. They are likely to win, and the FDII tax is likely to be annulled, but it will take years of legal battles. There is also a risk of “round-tripping”: exporting stuff to take advantage of the tax deduction, only to re-import it to sell to US customers.
What is it? The Base Erosion and Anti-Abuse Tax (BEAT – another cool acronym) is a surtax applied to intra-company payments of large companies (above $500 million of sales a year) operating in the US. It is equal to the difference between 10% of a theoretical income including intra-company payments that are normally excluded from taxable income (other than payments for goods and with limitations for services) and actual tax paid.
How does it impact poverty and inequality? This tax is meant to mitigate profit shifting out of the US and protect ordinary US taxpayers and workers. The losers are shareholders of large companies, particularly foreign companies operating in the US. Foreign individual taxpayers and workers may suffer indirectly. Official revenue estimate for US Treasury: $150 billion over ten years.
How is it going to be gamed? Multinational companies could revise their structures and rely in part on unrelated companies in order to remain under the $500 billion threshold. The BEAT may also violate both bilateral tax treaties and the World Trade Organization agreements, and so may have to be renegotiated with trade partners or scrapped. Another concern is that, by combining the BEAT with GILTI, the tax bill makes it both harder to shift US profits to tax havens and easier to shift foreign profits to tax havens. That could induce both foreign and US multinational companies to avoid investing in the US in the first place.
It could have been worse…
The infamous Border Adjustment Tax (BAT), a radical reform of the corporate income tax wanted by House Republicans that would have benefited US exporters and harmed US importers and that would have been devastating for developing countries, did not make it into the bill.
 Adding insult to injury, this give-away is counted as revenue because more cash will flow to Treasury, even though it’s really a paper or accounting loss. In other words, the $752 billion of deferred taxes owed by tax dodging companies under current law are a paper asset that Treasury will lose because of the tax bill, but that paper loss is not counted in the official cash cost estimate of the bill. That means that the bill’s overall increase of the national debt over ten years under current law should really be $2,208 instead of $1,456 billion.