Fixing our 'America Last' tax policy

On inauguration day, Trump promised the American people he would put “America first.” This rhetoric has provided verbal backing for new trade restrictions, immigration reductions and the withdrawal of the United States from prior international agreements and commitments.

As I argue in my new book, “Open: The Progressive Case for Free Trade, Immigration, and Global Capital,” these new trade barriers and immigration restrictions are more likely to harm than help American workers.

Tariffs are regressive consumption taxes, and trade wars generate new disruptions that hurt American workers and industries, including soybean farmers with unsold crops as well as autoworkers facing plant shutdowns resulting in part from higher costs due to steel tariffs in the United States. 

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Likewise, immigration restrictions harm American workers and our larger economy. We lose talent, innovation and entrepreneurship; we will have fewer Nobel prizes, fewer workers with desperately needed technological skills and fewer billion-dollar startups. Also, the budget pressures of our aging population weigh more heavily.

But policymakers looking for a better way to put “America first” might usefully start with the tax code. The 2017 tax legislation known as the Tax Cuts and Jobs Act has many provisions that are in desperate need of improvement. 

For starters, the international provisions of the legislation attempted an odd balancing act. On the one hand, the legislation adopted “territorial” treatment of foreign income.

Territorial systems typically exempt foreign income from taxation, unlike the prior system, whereby the U.S. government purported to tax foreign income upon repatriation, providing a “speed limit” to the shifting of profits offshore. Even if profits were taxed more lightly in an offshore haven, they would eventually be taxed in the United States. Thus, a territorial system should increase the incentive to move income offshore. 

On the other hand, the legislation included some corporate tax base protections, like a minimum tax on global intangible low-taxed income (GILTI) and the base erosion anti-abuse tax (BEAT), as well as a tax inducement for some types of export income, known as the foreign-derived intangible income (FDII).

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Under the GILTI minimum tax, foreign income is taxed currently (as it is earned, regardless of repatriation) by the U.S. government at about half the U.S. rate if it is not sufficiently taxed abroad. However, under the GILTI, the first 10 percent return on physical assets is tax-free.

While companies have complained about its bite, there are two perverse features of the GILTI. First, because a 10-percent return on physical assets is tax free, that gives companies an incentive to offshore plant and equipment to low-tax destinations in order to increase the tax-free treatment of their foreign income.

Oddly, the FDII is also less generous for U.S. taxpayers as they have more U.S. assets, discouraging U.S. investment. These are new incentives relative to prior law, where tax treatment of foreign income did not depend on the amount of physical assets offshore. 

Second, because the GILTI is calculated on a “global” instead of “per-country” basis, it gives multinational companies a reason to favor even high-tax foreign income relative to income earned in the United States.

Consider a company that earns $100 in the United States and a $100 in Bermuda. Because the U.S. tax rate is 21 percent and the Bermuda tax rate is 0 percent, the company will owe $21 on the U.S. income and $10.50 of GILTI on the Bermuda income, for a total of $31.50 in worldwide tax. 

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But imagine the company decides to earn the $100 in Korea, where the tax rate is 25 percent, instead of the United States. Then the company pays $25 to the Korean government, but it gets to use $20 of that as tax credits against the GILTI tax due on the Bermuda income, erasing the GILTI tax and lowering its total worldwide tax burden from $31.50 to $25.

Thus, even though Korea has a higher tax rate than the United States, it is better to earn income there than in the United States, since Korean income offsets the tax burden of the GILTI tax, whereas U.S. income does not. “America Last” tax policy, indeed!

On net, all of the international provisions lose a bit of revenue over 10 years, according to Joint Committee on Taxation scores of the legislation. (This calculation excludes the revenue from the one-time tax on previously earned foreign income, a tax break relative to prior law.)

Losing revenue on the international provisions was tough to accomplish since the U.S. government was already losing over $100 billion a year due to international profit-shifting of corporate income.

There are good ways to fix these problems. For instance, one can reform the GILTI by repealing the exemption for the first 10 percent return on assets, using “per-country” rather than “global” calculations for the minimum tax (removing the “America Last” feature) and raising the rate closer to the U.S. rate to level the playing field between foreign and domestic earnings. 

My new book, Open, makes the argument that there are progressive ways to respond to the challenges of the global economy and better tax policy is a key part of that response.

But, unfortunately, the Tax Cuts and Jobs Act is a regressive response to the challenges posed by today’s global economy. Not only do the vast majority of the tax benefits from the legislation accrue to those at the top of the income distribution, but the legislation weakens the health security of ordinary Americans.

Reduced spending on health insurance subsidies for poor Americans will increase the number of uninsured Americans and generate more expensive premiums for those that remain insured.

Beyond these factors, the $1.5 trillion in deficits caused by the legislation in its first 10 years are likely to make the fiscal response to the next recession more timid, harming American households. A true “America First” tax policy would look very different.

Kimberly Clausing is the Thormund Miller and Walter Mintz professor of Economics at Reed College, where she teaches international trade, international finance and public finance. Follow her on Twitter: @KClausing.