It’s hard to overemphasize the significance of the Republican proposal to cut the corporate tax rate to 21 percent. At an estimated cost of $1 trillion, it’s the headline and most expensive measure in the entire tax reform package. It is also the one piece of the tax reform legislation that the left and right agree would produce benefits for its intended audience: big businesses.
For advocates of tax cuts, the predictions for growth have been dramatic. The White House Council of Economic Advisers has estimated that the House version of the cut, together with the introduction of immediate expensing of capital investment measures, will drive an increase of gross domestic product between 3 percent to 5 percent. The Tax Foundation offered an ever rosier prediction, claiming it would in fact increase economic growth by 4.5 percent, capital stock by nearly 13 percent, average wages by 3.8 percent, and create 861,000 full-time equivalent jobs.
Interestingly, the proposal could be seen as the Trump administration’s best effort to compete with the rest of the developed world. In 2017, eight countries reduced their corporate tax rates, and Hungary reduced its corporate rate to a mere 9 percent. The Organization for Economic Cooperation and Development (OECD) has said these efforts, driven by fierce competition to boost growth, have led to the average corporate tax rates in OECD countries falling from 32.2 percent in 2000, to 24.7 percent in 2016.
At 35 percent, the current U.S. statutory rate is the highest among developed countries, and many supporters of tax reform have stressed that it is needed to put U.S. corporations on a level playing field with their foreign counterparts. However, getting to that level playing field is not quite as simple as just lowering the headline corporate tax rate. For one, few U.S. corporations actually pay the full 35 percent. A recent report from finds that the average corporate rate paid by companies is roughly 27 percent.
Corporations achieve this, of course, through a wide range of transfer pricing strategies. At the extreme end of the spectrum, many have done inversion deals whereby a US company acquires a foreign entity in a lower tax regime and moves its corporate headquarters to that location. Less extreme, but far more common, companies have moved essential staff into lower tax regimes in different countries and otherwise built-up foreign infrastructures in order to claim ever-higher percentages of earnings in parts of the world where the tax rate is lower than the United States.
Add the details of how the U.S. tax reforms will be implemented, how they correspond with global tax reform initiatives, such as those introduced by the OECD in its base erosion and profit shifting project, and how they impact each company’s individual tax plan, and it’s easy to see where a low corporate tax rate alone may not be enough to significantly alter the global tax map.
Even the proposed territorial taxation scheme, which would allow US companies to repatriate all of that foreign income at a lower tax rate is not as simple as the various economic models might suggest. For example, most of that $2.6 trillion in cash US companies currently have parked offshore is governed by a longstanding accounting rule, which allows a U.S. multinational to assert that its investment in a foreign subsidiary is permanent and those foreign earnings will be indefinitely reinvested so there is no current or deferred incremental U.S. tax liability.
To meet the standard, companies need to be able to demonstrate that the cash is not needed at home and can be successfully deployed abroad, either through local expansion or overseas mergers and acquisitions. So, a sudden decision by a company to bring all of that cash back into the United States could raise some questions about its previous assertions that it would use that money for overseas transactions, ultimately making the repatriation idea a lot less attractive. Likewise, all of the transfer pricing strategies U.S. companies have implemented to reduce their exposure to the 35 percent corporate tax rate are typically associated with a physical presence in another country and various commitments to that local government.
The point is, tax is not a zero sum game for large corporations. Pull one lever in the United States and 10 more will need to be adjusted in Europe. Change the way a certain service, like streaming media or cloud-based software, is taxed in any one city, and several more changes will need to be made to adjust to that new dynamic.
As the final piece of legislation makes its way to the president’s desk, the proposal will continue to generate controversy. Each little nuance of the plan has the potential to create a windfall for some companies and create challenges for others, simply based on how they adjust their tax planning to the new scheme. Until we know exactly how the tax reform will be implemented and exactly how each company will tweak its planning in response, it’s still too early to forecast the real winners and losers.
Brian Peccarelli is president of tax and accounting at Thomson Reuters.