How Biden and Congress Could Improve Corporate Taxation
The Tax Cut and Jobs Act (TCJA) of 2017 brought about the most significant changes to business taxation in decades. But in a new analysis, published in today’s issue of Tax Notes and co-authored with my colleague at the Tax Policy Center Claire Haldeman, we find that while the law encouraged efficiency by reducing the level and dispersion of rates marginal effective taxation on new investments, it contained many ill-conceived provisions, in particular in the treatment of income of multinational corporations and intermediary enterprises such as partnerships. We offer several ways to address these issues, in some cases reforming the changes and in some cases reverting to the old pre-TCJA approach.
The TCJA created a 20% deduction for certain forms of income earned through unincorporated businesses, reduced the corporate tax rate from 35% to 21%, and made various changes that moved the tax base towards the taxation of cash flows for companies and transient businesses.
The new 20% deduction for transmitted income makes arbitrary distinctions between different forms of business ownership and is much more beneficial for high-income households than for others. It is also unlikely to stimulate investment by existing businesses or the creation of new businesses. By reducing the income tax rate, the deduction finances windfall gains for business owners who profit from investments made in the past.
As a result, the tax subsidy generates a smaller “return on the dollar” than if it were targeted on new investments. The repeal of the pass-through deduction and the move towards universal expensing and elimination of the interest deduction would be preferable to stimulate investment.
Internationally, the TCJA abolished the tax on the repatriation of profits actively made by foreign subsidiaries of US parent companies (coupled with a single transitional tax on foreign profits previously accumulated but not repatriated). To help stop profit shifting and encourage domestic activity, TCJA has also created an alphabet soup of tax changes, including a low-tax global intangible income minimum tax (GILTI), an anti-abuse tax. base erosion (BEAT) and an additional deduction for foreign source intangible income (FDII).
The increase in TCJA repatriations did nothing to stimulate investment, however, as companies that held a lot of funds overseas also tended to have large domestic cash balances.
Going forward, Congress could significantly tighten GILTI’s minimum tax provisions by requiring taxes to be based on country-by-country profits rather than global profits. There are many arguments for repealing the FDII’s provisions, including that they subsidize monopoly profits and encourage the exodus of physical capital, not to mention that they likely violate World Trade Organization standards. The BEAT layout is also flawed and cumbersome compared to alternatives such as the SHIELD program offered by the Biden administration.
While all tax laws require guidance from the Treasury and the IRS, regulations have played a disproportionate role in the implementation of the TCJA. Because Congress passed the law so quickly, TCJA contained many errors and ambiguities. In addition, provisions such as the pass-through deduction and many international provisions had no precedent in prior law. We find that the Treasury Department has exceeded its authority in several regulatory decisions. As a result, the 2017 law in practice provides for greater tax cuts than those indicated by Congress, especially for banks and real estate.
Our proposals are similar to President Biden’s budget, but don’t raise corporate tax rates as much, focus more on basic business reform, and explicitly acknowledge that the pass-through provisions were a mistake. A potential challenge to our proposals: the president’s commitment to avoid tax increases on households with incomes below $ 400,000. A potential compromise would be to remove the deduction passed on only for high-income households. Even this limited change would significantly reduce the cost, regressiveness and complexity of the layout.
By repealing or reforming many of the TCJA’s corporate tax provisions, Congress could increase revenues while making corporate taxation more efficient, fairer and more resistant to profit shifting. Business taxes would be more neutral – regardless of industries, forms of business and methods of financing – as well as more secure, less complex and better enforced.