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International Tax Proposals and Profit Shifting


Profit shifting by multinationals poses a serious problem in worldwide taxation. The power of multinational enterprises to shift the situation of earnings from high-tax to low-tax jurisdictions and tax havens erodes the company earnings tax base in high-tax nations. For instance, a multinational with patents owned by an Irish affiliate can shift earnings from high-tax nations into Eire, the place these earnings face a low efficient tax price.

The Tax Cuts and Jobs Act (TCJA) of 2017 sought to handle revenue shifting by U.S. multinationals utilizing three key coverage adjustments. First, it reduce the statutory company tax price from 35 to 21 p.c, shifting the U.S. from being one of many highest-tax countries on the earth to close to the average worldwide and amongst developed nations.

The TCJA additionally pursued a stick-and-carrot strategy to cut back incentives to shift earnings overseas. First, it created a surtax on earnings booked in managed overseas companies (CFCs) owned by U.S. multinationals, by the Global Intangible Low-Taxed Income (GILTI) coverage. This provision created a minimal 10.5 p.c tax on overseas earnings deemed attributable to intangible belongings, outlined as earnings in extra of a ten p.c revenue from tangible belongings. Whereas supposed to impose a minimal tax within the vary of 10.5 to 13.125 p.c, the efficient tax from GILTI can exceed this supposed most price.

GILTI offers a penalty for reserving earnings overseas, however the TCJA additionally created a optimistic incentive to e book earnings within the U.S. with the International-Derived Intangible Earnings (FDII) deduction, offering a 13.125 p.c tax price on this earnings if booked within the U.S. Mixed, the decrease company tax price, the inducement from GILTI to not e book earnings overseas, and the inducement from FDII to e book earnings within the U.S. considerably lowered profit-shifting incentives for U.S. multinationals.

Nevertheless, the Biden administration has objected to the low tax charges on intangible earnings from GILTI and FDII, arguing that U.S. multinationals ought to pay greater taxes. Accordingly, the administration’s “Made in America Tax Plan” proposes to lift taxes on U.S. multinationals by: elevating the company tax price to twenty-eight p.c; elevating the GILTI minimal tax price to 21 p.c; repealing the tangible asset exemption in GILTI; calculating GILTI on a country-by-country foundation as a substitute of pooling all overseas earnings; repealing the FDII deduction; and denying deductions allotted to forms of overseas earnings that the tax system intentionally excludes from taxable income.

The administration has claimed that by elevating tax charges on overseas earnings, these tax hikes would “considerably curtail” revenue shifting by multinationals. However this declare ignores that the important thing incentive for revenue shifting just isn’t the tax price on overseas earnings, however truly the tax price differential between earnings booked overseas and earnings booked within the U.S. Whereas greater taxes on overseas earnings cut back the inducement to shift earnings overseas, elevating the company tax price to twenty-eight p.c and repealing the FDII deduction strengthen this incentive.

In a latest Tax Basis analysis that accounts for these countervailing incentives, I discovered the Biden administration’s proposals would truly improve revenue shifting by U.S. multinationals. The evaluation thought of 4 potential adjustments to the taxation of U.S. multinationals: the Biden administration’s proposal; a partial model of this proposal reflecting difficulties getting congressional approval for such giant tax hikes; a revenue-neutral proposal that fixes unintended issues with GILTI in change for a better GILTI tax price; and restructuring GILTI to resemble the OECD/G20 Pillar 2 proposal for world minimal taxes.

The next desk presents results of revenue shifting on federal company earnings tax liabilities of U.S. multinationals. The primary column presents purely static outcomes, through which multinationals don’t reply to company earnings tax adjustments. The second column presents the primary outcomes, assuming a consensus revenue shifting semi-elasticity of 0.8—which means {that a} 1 proportion level improve within the tax price on overseas earnings relative to the tax price on home earnings reduces earnings shifted to that overseas jurisdiction by 0.8 p.c. The third column makes use of semi-elasticities from recent work by economists Tim Dowd, Paul Landefeld, and Anne Moore, who estimated a lot bigger revenue shifting semi-elasticities for tax havens and smaller ones for non-haven nations.

Results of Revenue Shifting on Federal Corporate Income Tax Liabilities of U.S. Multinationals ($ billions)

Change in CIT Liabilities

Loss to Revenue Shifting

ProposalStaticSE = 0.8SE from DLMSE = 0.8SE from DLM
Biden proposal1451.11372.51214.1-78.5-237.0
Partial Biden615.6579.5522.3-36.1-93.3
GILTI repair-2.50.011.42.513.9
Pillar 2145.0136.9130.7-8.1-14.3

Be aware: This desk presents the 10-year change in federal company earnings tax liabilities of U.S. multinationals in billions of {dollars} for every proposal. The primary three columns current the change in these liabilities from every proposal beneath totally different profit-shifting assumptions. The static estimates use no profit-shifting response. The second column makes use of the average profit-shifting response, with a semi-elasticity of 0.8 with respect to the tax price differential between the U.S. and every CFC. The third column makes use of the profit-shifting response from Dowd, Landefeld, and Moore (2018), with a semi-elasticity of 4.16 for tax havens and a semi-elasticity of 0.684 for different nations. Tax havens are recognized by the Congressional Analysis Service. The final two columns current the income leakage from revenue shifting, calculated by subtracting the static outcomes.

Supply: Cody Kallen, “Choices for Reforming the Taxation of U.S. Multinationals,” Tax Basis, Aug. 12, 2021, https://taxfoundation.org/us-multinational-tax-reform-options-gilti/.

The primary estimates from the paper present that revenue shifting reduces the income from the Biden administration’s proposal by $78.5 billion over a decade. Utilizing the semi-elasticities from Dowd, Landefeld, and Moore produces even bigger results, with the proposal dropping $237 billion to revenue shifting over a decade.

Opposite to the administration’s declare that its proposal would lead to a “near-elimination” of revenue shifting, their proposal exacerbates it. To know why, let’s take a look at the affect on tax charges.

Based on my analysis, the Biden administration’s proposal would increase the mixed average tax rate on earnings in CFCs from 16.3 p.c beneath present legislation to twenty.2 p.c, a rise of 4.9 proportion factors. Nevertheless, rising the company tax price from 21 to twenty-eight p.c raises the tax price on home earnings by 7 proportion factors. Mixed with FDII repeal, the administration’s proposal raises the tax price on home earnings by roughly 9 proportion factors, a lot bigger than the 4.9 percentage-point tax hike on overseas earnings. On internet, this considerably will increase incentives to shift earnings out of the U.S.

Whereas the administration has proposed changing the FDII deduction with an unspecified incentive for R&D, that is unlikely to alter the profit-shifting consequence, because the proposal will increase revenue shifting even with out contemplating FDII. Furthermore, a revenue-neutral R&D subsidy to switch the FDII deduction is unlikely to operate higher as an incentive for reserving intangible earnings within the U.S.

This similar sample happens for the partial model of the administration’s proposal, though to a lesser extent, because the tax price hikes on each overseas and home earnings are smaller than the complete Biden administration proposal.

There are many ways the U.S.’s international tax rules could possibly be modified, reformed, improved, or worsened. Reflexively jacking up taxes on U.S. multinationals doesn’t essentially accomplish the purpose of decreasing or eliminating revenue shifting, and it will actually worsen it. A well-designed worldwide tax reform proposal ought to alleviate such issues, not exacerbate them.

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