The passage of the GOP’s tax bill back in December generated intense debate over which groups would benefit the most and the least from the bill. One of the central changes in the plan is the reduction in the corporate income tax rate, which will fall to a 21 percent tax, compared to the current 35 percent rate.
According to an article by Bill Peccarelli for The Hill, the corporate tax cut is the largest part of the package, which is expected to result in a windfall of billions of dollars for companies over the next decade.
The hope expressed by many GOP lawmakers is the tax cut will encourage corporations to relocate or build more of their operations in the U.S. instead of sending them to other countries, where the corporate tax rate is often lower. This would be a reasonable outcome to expect if it were not for another section of the tax reform package.
With their new plan, the GOP decided to create what is known as a territorial system for dealing with corporate taxes from American companies with subsidiaries in other nations. Basically, a territorial system means U.S. companies will pay a special minimum tax on income generated from their overseas locations, while much of it would remain exempt.
According to Curtis Dubay at the Heritage Foundation, this differs from America’s current system, which applies the corporate tax rate to all income, even if it is generated in another country. So, a company would only pay taxes on foreign income if it was repatriated back to America. Dubay states the territorial system is the better of the two and should promote more investment and potentially raise wages for American workers. Again, there is a chance this change could benefit the U.S., but in my opinion, the incentives created in the plan are all wrong.
First, the plan stipulates U.S. companies will pay what is called a global minimum tax on their overseas profits, currently set at 10 percent. This is an important detail because it means companies are not going to be taxed based on which country their operations are in, but rather on an average of all their foreign profits.
According to a piece by economist Kimberly Clausing in Fortune, this will not be an effective tax, “since it enables companies to use taxes paid in higher-tax countries to shield income booked in tax havens from the minimum tax.”
For example, if your corporation has $20 million in profits located in the Cayman Islands (a well-known tax haven) as well as $20 million in a higher-tax nation like Belgium, then your global average profits will be $20 million, while your total foreign profits are $40 million. Consequently, your tax bill to the U.S. government will be only $2 million, instead of the $4 million it would have been if the 10 percent tax were applied to every country in which your company is located.
The second important detail is the “routine” rate of profit return stipulated in the tax plan. Companies will only have to pay taxes on profits above the rate of return, which for now is set at 10 percent.
Per an article by David J. Lynch in the Washington Post, this is a lavish rate of return from the perspective of the corporations. It means if companies face even a 9 percent rate of return on their profits in a foreign country, they will pay zero taxes to the U.S. because it does not meet the 10 percent requirement.
Thus, companies will now have an incentive to relocate any tangible assets. For example, factories which may not have high rates of return in other countries because there they may not have to pay any taxes, while in the U.S., they would be expected to pay the 21 percent rate.
With incentives like these, large corporations will have even more reasons to move certain operations to other nations. This will do little to help American workers, who have been highlighted by Republicans as the group most in need of a boost in regard to tax reform.
It will also stand in stark contrast to the nationalist rhetoric of the Trump Administration, especially since one of his favorite talking points has been bringing back American jobs. GOP leaders like Paul Ryan can drone on about the beauty of their tax reform, but with the new territorial system, their promises are looking hollow.