Will Rogers Had It Right About Taxes

Amid all the chatter about what might be included in the forthcoming budget reconciliation package, there’s one detail you should keep an eye on. It concerns the degree to which the U.S. tax code should favor foreign profits relative to domestic profits.

This is a billion-dollar issue given how adept multinational corporations have become at generating foreign-source income. But then again, what’s a few billion dollars in the context of a trillion-dollar reconciliation bill?

The State of Affairs

The momentum for modifying the existing treatment of foreign profits comes mostly from Democrats. That’s because the operative tax rule — the global intangible low-taxed income regime — stems from the Tax Cuts and Jobs Act, a Republican creation. Most Republicans are happy to retain the provisions of the TCJA.

The TCJA’s basic corporate rate structure taxes domestic profits at 21%, and some foreign profits are taxed at 10.5%, exactly half of the standard rate. (Admittedly, this is an oversimplification; so-called GILTI profits represent a subset of all foreign-source income.)

Democrats agree on the need to change the GILTI regime, but their ideas about how to do so are all over the map. We have three alternative proposals from different groups of Democrats: the Biden administration, the chair of the Senate Finance Committee, and the chair of the House Ways and Means Committee. Your guess is as good as mine regarding which one makes it into the final legislation.

The situation causes me to recall the words of American humorist Will Rogers, who famously joked that he was not a member of an organized political party: He was a Democrat. The comment rings true today.

One Party, Three Visions

It’s pretty clear what the executive branch wants to do with corporate taxes. Everything points to Treasury wanting to increase taxes on both foreign and domestic profits and shrink the rate gap between the two categories.

The thinking is that if you reward foreign profits with an excessively low tax rate, then you’re promoting the investment of capital abroad, which discourages domestic investment.

If it’s true that employment follows investment, then taxing foreign profit more favorably than domestic profits indirectly supports job growth abroad relative to job creation here at home. 

To that end, Treasury would increase the standard corporate rate to 28% and double the GILTI rate to 21%, partially closing the rate preference for foreign profits relative to domestic profits. It’s the Biden administration’s way of saying that foreign investment continues to merit favorable treatment, but not as much as the TCJA permits.

In contrast, three Democrats who sit on the Senate Finance Committee have a different plan, and they’ve been talking about it since last spring. Finance Committee Chair Ron Wyden, D-Ore., joined by Sens. Mark R. Warner, D-Va., and Sherrod Brown, D-Ohio, issued a discussion draft in late August.

Their draft was supposed to outline the details of their proposed revisions to the GILTI rules. Regrettably, the document was silent on the headline tax rates.

With all the clarity of a Jackson Pollock painting, the senators proposed that the GILTI rate should be increased from its current level. That isn’t saying much at all since, even if Congress does nothing, the GILTI rate is already scheduled to increase in the years ahead. An increase in the GILTI rate is baked into the cake, so to speak.

The draft leaves so much unclear that we can’t fairly determine whether the senators think the taxation of foreign profits should be more closely aligned with treatment of domestic profits. We don’t know, for example, if they believe it’s sound policy for the GILTI rate to inch toward convergence with the standard corporate rate. 

Wyden, Warner, and Brown had all summer to settle on their preferred GILTI rate. In the end they couldn’t — or wouldn’t — put any rates in writing. Instead, much of their draft focuses on the separate issue of whether the GILTI computation should be based on a country-by-country approach or an aggregate approach.

The Biden administration favors a per-country rule. This would be a change from the TCJA, which allows profits from high-tax jurisdictions to be blended with profits from low-tax jurisdictions. That’s an important detail because a partial foreign tax credit goes along with the pooled foreign income.

The ability to blend foreign income creates an incentive for U.S.-based multinationals to shift profits to low-tax jurisdictions. Those incentives are minimized with a per-country rule.

Wyden, Warner, and Brown favor a high-tax exemption, which is not consistent with Treasury’s proposal. There’s no statutory language in the TCJA that supports a high-tax exemption, but that didn’t stop the government from promulgating regulations to that effect last summer when Treasury was under different management.

Essentially, the three Senate Democrats are trying to preserve a concept that was welcomed by the Trump Treasury and opposed by the Biden Treasury. Go figure.

Finally, we must mention the House Ways & Means Committee, chaired by Rep. Richard E. Neal, D-Mass. Recently, Neal released his own tax plan. His plan offers more detail than his Senate colleagues’ version, but it doesn’t mesh with what Treasury has in mind.

Neal would reduce the computational GILTI deduction from 50% to 37.5%. This was already scheduled to happen in 2025, so the plan merely accelerates a built-in tax increase.

Separately, Neal would raise the standard rate to 26.5% for the most profitable companies, and he proposes discounted rates for corporations reporting lower taxable income. Neal’s top corporate rate would be slightly lower than what Treasury is seeking, but only by 1.5 percentage points.

Applying the revised GILTI deduction, Neal’s plan produces a GILTI rate of 16.5625%. That’s a lot of numbers after the decimal point. You’d think somebody in Washington is allergic to tax rates expressed in whole numbers, but I digress.

Conclusion

We can summarize the lay of the land as follows:

• Current law, enacted by Republicans in 2017, taxes domestic profits at 21%. Through the GILTI regime, some foreign profits are taxed at 10.5%.
• Broadly, the Biden administration wants to increase corporate taxes. It envisions a 28% rate for domestic profits and a revised GILTI regime that provides a 21% rate for some foreign profits.
• Democrats on the House Ways and Means Committee, led by Neal, would tax domestic profits at a top rate of 26.5% (with reduced rates for less profitable corporations) and raise the GILTI rate to 16.5625%.
• Democrats on the Senate Finance Committee (namely Wyden, Warner, and Brown) won’t say what they think the tax rates should be for foreign or domestic profits, but they’re wedded to the idea that the GILTI regime needs a high-tax kickout rule. 

Democrats will likely have some kind of corporate tax increase in their reconciliation bill. They must if they are to fulfill the promise of the party’s leadership that the bill’s vast spending provisions will be partly paid for with revenue raisers. The details of the delicate balance between foreign and domestic profits are anyone’s guess.

And, somewhere, Will Rogers is laughing.