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An effective and politically viable option for corporate tax reform

MANDEL NGAN/AFP via Getty Images
US President Joe Biden speaks on COVID-19 response and vaccination in the South Court Auditorium of the Eisenhower Executive Office Building, next to the White House, in Washington, DC on June 2, 2021. 

Last weekend the finance ministers of the G-7 announced an agreement on a minimum corporate tax rate of at least 15 percent. This agreement will put a lot of pressure on the Biden administration to pass its recently proposed corporate tax reforms. The U.S. pushed hard for a global minimum tax as part of an overall deal to roll back taxes on digital services by European countries — which mainly hit large U.S. tech companies.

There are two major defects in the current U.S. minimum tax on American corporations, so the Biden proposals to increase corporate taxes deserve serious consideration. But a modified approach to corporate tax reform would be, politically, more realistic.

First, the current law allows U.S. multinationals to apply America’s minimum tax of 10.5 percent ( sometimes a little higher) on an aggregate basis to their total foreign income, rather than on a country by country basis. Consider a U.S. multinational with foreign income of $1 billion and foreign taxes of $300 million in a high tax country like France, as well as $1 billion in foreign income and zero corporate taxes in a tax haven like Bermuda. By using an aggregate approach, the minimum tax would not be applicable to such a multinational because its total foreign taxes would equal 15 percent of its total foreign income ($300 million divided by $2 billion).

The Biden administration would remedy this defect by applying the U.S. minimum tax to each foreign country. This change is urgently needed because 60 percent of foreign profits of U.S. multinationals continue to be allocated to tax havens — with minimal corporate taxes.

Second, the minimum tax allows U.S. multinationals to deduct from their foreign income a 10 percent return on their foreign tangible capital — e.g., factories and equipment located in foreign countries. Consider a U.S. multinational with $1 billion in tangible foreign capital, $170 million in foreign income and $10 million in foreign taxes — less than 6 percent of its foreign income. Since that multinational may deduct $100 million (10 percent of $1 billion), its foreign income would be decreased from $170 million to $70 million in calculating the U.S. minimum tax.  

The Biden administration proposes to eliminate this deduction for returns on tangible foreign capital, in order to reduce the incentive to offshore facilities and jobs. Critics argue that this deduction is justified because the minimum tax was aimed at corporate income from intangibles like patents, which can be easily moved to tax havens. However, there are several other countries, like Switzerland and Singapore, which have effective tax rates below 10 percent on corporate income derived from local facilities and other types of tangible capital located there.  

Beyond these two design changes to the corporate minimum tax, the Biden administration proposes to raise the corporate tax rate to 28 percent and the minimum tax rate to 21 percent. However, given the unified Republican opposition to any increase in the corporate tax rate, it would have to be passed by budget reconciliation requiring unanimous support from Senate Democrats. And Sen. Joe Manchin (D-W.Va.) has publicly said that he would support a corporate tax increase to only 25 percent.

Together with a 25 percent corporate tax rate, the Biden administration should adopt the 15 percent corporate minimum tax rate coming out of the G-7 meeting, instead of the proposed 21 percent minimum rate. The 15 percent minimum rate is likely to attract broader support from the G-20 finance ministers, who meet later this summer. Moreover, if most industrialized countries adopt a minimum 15 percent rate, then American companies would be at a competitive disadvantage with a 21 percent U.S. minimum rate. 

In sum, Congress should pass a 25 percent corporate tax rate with a 15 percent minimum tax on foreign profits of U.S. multinationals — calculated on a country by country basis without any deduction for returns on foreign tangible capital. Such a corporate minimum tax would raise a little less than $400 billion over 10 years, according to the Penn Wharton model, as opposed to $500 billion for the Biden proposal for a 21 percent minimum corporate tax.

Robert Pozen is a senior lecturer at MIT Sloan School of Management and former president of Fidelity Investment. Research assistance was provided by Peter Hoffman, a MIT undergraduate.

Tags Corporate tax Corporate tax avoidance Corporate tax in the United States Corporate taxation in the United States economy International taxation Joe Manchin Offshore magic circle Tax Tax avoidance Tax haven

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