Tax Increases Seen As Counterproductive to Growth, Job Creation
WASHINGTON – Of all the uncertainties growing from the prolonged negotiations over President Joe Biden’s American Families plan, the most potentially vexing for the American businesses and the economy are several proposed changes to the U.S. tax code.
Though much rests on how big an infrastructure package the White House and Senate ultimately agree on — and what combination of taxes and pay-fors will pay for it — the administration has proposed, among other things, a retroactive capital gains tax increase to 37% on households whose adjusted gross income exceeds $1 million.
It has also proposed eliminating the exemption from global intangible low-taxed income. Also known as GILTI, the name is applied to a category of income earned abroad by U.S.-controlled foreign corporations.
The U.S. tax on GILTI is intended to prevent erosion of the U.S. tax base by discouraging multinational companies from shifting their profits or easily moved assets, such as intellectual property rights, to foreign jurisdictions with tax rates below U.S. rates.
Historically this income has been subject to special treatment under the U.S. tax code.
For instance, before the enactment of the Tax Cuts and Jobs Act in 2017, U.S. businesses and individuals were subject to U.S. income taxes on their overseas income. But, income earned by the foreign subsidiaries of U.S. corporations was subject to tax only when repatriated to the United States as dividends.
This effectively incentivized U.S. multinationals to avoid paying U.S. taxes by artificially shifting income abroad, restructuring as foreign-owned companies, and not repatriating foreign earnings to U.S. shareholders.
The 2017 reforms counteracted these incentives by adopting limited territorial treatment and reducing the corporate tax rate. Policymakers also adopted new rules to minimize incentives for companies to artificially shift profits abroad.
The Act also reduced the corporate tax rate and other minimized incentives for companies to shift profits abroad.
The White House plan, outlined in the U.S. Treasury green book released on May 28, is to do away with the exemption from GILTI for the 10% return on foreign tangible property (known in the accounting world as “qualified business asset income” or QBAI). In the process, the administration would raise the GILTI tax rate to 21%.
Because GILTI is not determined on a country-by-country basis, and, therefore, under current law, a U.S. multinational corporation may be able to avoid the GILTI tax with respect to its subsidiaries operating in low tax-rate countries by “blending” the low rate with income from subsidiaries operating in high tax-rate countries.
Tightening a potential loophole, the White House would impose a country-by-country method for calculating GILTI — eliminating the ability to blend high-taxed GILTI countries against low-taxed GILTI countries.
All told, the far-reaching tax changes that could be enacted this year will likely include some mix of corporate, individual and capital gains tax rate increases, international tax changes, and estate and gift tax changes.
As outlined in the Green Book, the Treasury Department would raise $2.4 trillion in revenue if all the tax changes proposed by the White House were adopted.
To go along with this, the White House has also proposed beefing up IRS resources and staffing, a move it says could result in over $700 billion in additional revenue achieved through tougher and more comprehensive tax enforcement.
The proposals have been sharply criticized by Congressional Republicans, who see them as a naked attempt to roll back the 2017 tax cuts, and by many in the business company, who say the new regime of taxes will stymie growth and investment just as the economy is recovering from the coronavirus pandemic.
Joshua Bolten, President and CEO of the Business Roundtable, a Washington-based nonprofit whose members are the chief executive officers of major United States companies, said while the group continues to support infrastructure investment, it does not support the president’s proposal in its current form.
“By significantly increasing taxes on corporations, the proposal would be counterproductive to the goal of increasing economic growth and job creation,” Bolton said. “Such tax increases would make the United States uncompetitive as a place to do business and make U.S. companies uncompetitive globally, slowing recovery and hurting American job creators and employees.”
According to the Tax Foundation, a Washington, D.C.-based think tank, Biden’s tax plan would reduce the economy’s size by 1.62 percent in the long run. The plan would shrink the capital stock by about 3.75 percent and reduce the overall wage rate by a little over 1 percent, leading to about 542,000 fewer full-time equivalent jobs.
A Deeper Dive Into Corporate Taxes and GILTI
The Biden Administration has proposed increasing the corporate tax rate from 21% to 28%. At the same time, Biden is looking to rein in certain tax reductions for high-income individuals, loosely defined as households earning more than $400,000 a year.
The Tax Foundation has estimated that taking into account state and local taxes, the aggregate U.S. corporate tax rate would be 32.34%, which would be the highest in the Organization for Economic Co-operation and Development, an intergovernmental economic organization founded in 1961 to stimulate economic progress and world trade.
While on the campaign trail in 2020, candidate Biden took aim at the “pass-through” tax deductions often used by these taxpayers, particularly something called the Section 199A deduction that allowed for a 20% deduction on certain income.
Though no specific change has been proposed to date, it is known that the staff for the majority on the Senate Finance Committee has been working on several changes that could eliminate Section 199A altogether.
But the concerns over these proposed changes pale next to those over the planned change related to global intangible low-taxed income.
Biden unveiled the basic outline of his tax proposals in April as part of the rollout of his American Jobs Plan Act, a sweeping proposal that also encompasses his massive infrastructure plan.
The tax part of this, called the “Made in America Tax Plan,” has the stated goals of “reducing profit shifting and eliminating incentives to offshore investment.”
If adopted, the changes outlined at the top of this article would not only increase GILTI tax liability for U.S. multinationals at the federal level but would also increase companies’ state income tax liability in the states that currently tax GILTI.
While President Biden’s draft tax plan does not specify details regarding how the rate on GILTI would be increased, it is generally understood that this would be accomplished by reducing the Section 250 deduction from 50 percent to 25 percent under the plan’s proposed new corporate income tax rate of 28 percent.
Section 250 allows a domestic corporation to deduct 37.5% of its foreign-derived intangible income (FDII) and 50% of its GILTI. These percentages will be reduced in tax years beginning after December 31, 2025, to about 21.8% for FDII and 37.5% for GILTI.
Together, these proposals would change the GILTI regime in a manner that would generally tax foreign source income of U.S. multinational corporations at a significantly higher rate and make offshore investments by these corporations much less attractive than under current law.
Taxes Threaten Competitiveness
Among those expressing concern about this are some Senate Democrats who agree the rate should be raised but would rather see it top off at something closer to 25%.
The 25% rate has already been endorsed by West Virginia’s Democratic Sen. Joe Manchin, whose vote Democrats will need if the infrastructure bill is to have any chance of becoming law.
Underlying this position is a fear shared with the nation’s corporate community that Biden’s tax proposals, adopted in full, would reduce both American economic output and the incomes earned by American households.
In addition to changing the tax rate, the Biden administration has proposed limiting the ability of domestic corporations to move their headquarters or other valuable assets overseas.
The White House also hopes to repeal the foreign-derived intangible income regime, also known as FDII, that provides a deduction to domestic corporations regarding their intangible income earned from serving foreign markets and replacing it with additional research and development credits.
Along with all this — and there are many, many more details that only an accountant could love — the Biden administration petitioned both the Organization for Economic Co-operation and Development and the G20 to come to an agreement on a global minimum corporate tax rate of 15%.
Earlier this month, the G7, the wealthiest of wealthy nations, threw their support behind the proposal, raising the prospect that this new approach at international taxation may also be reached by the end of the year.
U.S. Treasury Secretary Janet Yellen has asserted that a global minimum tax would end a destructive “race to the bottom” in international taxation, closing a gaping loophole through which governments lose an estimate $245 billion a year to tax havens like Bermuda, the Cayman Islands, Ireland, the Netherlands, Singapore and Switzerland.
Taken together, what this could mean is that by early next year, companies whose profits currently go untaxed or lightly taxed overseas, will have to pay a universal minimum tax, and then face the prospect of facing an additional, top-up tax here at home.
Critics say the proposed changes will make U.S. companies and their non-U.S. business lines takeover targets for foreign-based firms.
Others, like Sen. Rob Portman, R-Ohio, assert the tax change “will make American workers and American companies less able to compete in the global economy.”
When it comes to GILTI and other proposals related to income earned overseas, the concern is that the new taxes will make the nation’s multinationals far less competitive than they are today.
Those who assert this position, note that the health of the American economy is dependent on the well-being of a wide range of businesses, including those with both domestic and international operation and business with employees and supply chains across the globe.
They also say this was never more evident than during the recent pandemic, when global integration of businesses led to critical advances in technology and medicine. Along the way, scientists and labs leveraged international access to resources, to turn the tide against COVID-19.
But that global integration can be a two-edged sword. U.S. companies compete against other firms based in the U.S. and against companies in other countries and continents.
Because the tax rules that apply to U.S. companies are different from the rules that apply to foreign businesses, they can have a direct impact on whether U.S. firms can gain or maintain a competitive advantage.
And when U.S. companies succeed abroad, it can mean more investment in domestic activities and more hiring at home. The Tax Foundation says.
As explained by the foundation, the earnings of that foreign subsidiary flow back to the U.S. parent company and its investors, many of whom would likely be U.S. citizens via their retirement savings or pensions.
Domestic workers are also likely to benefit from the foreign success of a U.S. company. In 2018, two-thirds of employees for U.S. multinational companies were based in the U.S., representing 22% of the U.S. workforce, the Foundation said.
According to the U.S. Chamber of Commerce, the 2017 tax cuts put the U.S. in the middle of the pack with other developed nations and ensured the nation was competitive in the global economy.
Prior to that reduction, the chamber said, the U.S. was bleeding investment and jobs to other developed countries because our rate was so much higher than the average.
The organization maintains all this talk about tax increase is “extremely harmful,” and if enacted, the Biden plan or even a more modest version of it would “competitively … put us back near where we were prior to tax reform.”
“Combined with the average state rate, our tax rate would be 29.3%, back above the OECD average. And well above China’s 25% rate,” a recent essay on the chamber’s website says.
It also points out that while many assume that only big multinationals would be subject to the higher rates, the reality is over a million small businesses would also see their tax bills increase significantly.
“In turn, this would have a negative impact on small businesses’ investment and growth plans and, most critically, hiring and job creation,” another post on its website says.
“Tax reform improved the competitiveness of our tax system overall. GILTI is a deterrent to U.S. businesses to shift too much profit overseas, but for some businesses the penalty it imposes is excessive, said Curtis Dubay, senior economist at U.S. Chamber of Commerce, in an email to The Well News. “An increased GILTI tax rate is a step in the wrong direction and would reduce American companies’ competitiveness.”
Survey Finds Corporate Tax Hike Would Weaken Hiring, Expansion and Investment
A Business Roundtable survey of its CEO members in April found that increases in U.S. domestic and international tax rates would have a negative effect on business expansion, hiring and wage growth, investments in research and development and innovation, and U.S. competitiveness in the global economy.
According to the survey results, 98% of CEOs said that an increase in the corporate tax rate from 21% to 28% would have a “moderately” to “very” significant adverse effect on their company’s competitiveness.
Seventy-five percent of CEOs said that an increased tax burden on U.S. companies would negatively affect their company’s investments in R&D and innovation, 71% said it would negatively affect their ability to hire, and nearly two-thirds said it would result in slower wage growth for U.S. workers.
An overwhelming majority—88%—of respondents agreed that maintaining globally competitive U.S. tax policies is important for business expansion. When asked about an increase in the GILTI rate from 10.5 percent to 21 percent, 76% of CEOs reported it would have a “moderately” to “very” significant impact on their company’s competitiveness, including plans for U.S. capital spending and hiring.
Gregory J. Hayes, chief executive officer of Raytheon Technologies Corporation, said, “the tax system needs to support innovation, R&D, capital investment and economic growth … As we look toward recovering from the COVID-19 pandemic, keeping competitive tax policies in place is needed to help reinvigorate the U.S. economy and lead to more opportunity for Americans.”
Hayes, who is also Tax and Fiscal Policy Committee Chair for the Business Roundtable, went on to say that prior to the pandemic, “the U.S. corporate tax rate drove economic growth, creating 6 million jobs, pushing the unemployment rate to a 50-year low and increasing middle class wages.”
“From 2018 to 2019, major U.S. companies grew their R&D by 25% compared to the two years prior. The current U.S. corporate tax rate has also helped put U.S. businesses on a more level playing field with global competitors and encouraged businesses to invest and grow here in the United States.”
“This survey tells us that increasing taxes on America’s largest employers would lead to a reduced ability to hire, slower wage growth for workers and reduced investments in research and development—all key components needed for a robust economic recovery,” the Roundtable’s Joshua Bolten said. “When U.S. companies can compete around the world, they can invest in America and help generate more jobs, pay higher wages and support all of their stakeholders.”
The Republican Tax Cuts
Senate Republicans have already drawn a line in the sand, saying the 2017 Tax Cuts and Jobs Act is not up for negotiation.
In fact, Senate Minority Leader Mitch McConnell has predicted the president will not garner a single Republican vote for the American Jobs Plan or for its companion bill, the education and family-focused American Families Plan.
Despite such threats, provisions of the 2017 Tax Cut law are likely to come under scrutiny during the upcoming budget reconciliation talks, others say.
This is particularly true of provisions, like the Section 199A deduction, which is currently scheduled to expire at the end of 2025.
And what are the Democrats proposing? To begin with, an increase in the capital gains and dividend tax rates for certain higher-income taxpayers. The current level is 23.8%, consisting of a base 20% tax rate plus a 3.8% tax on net investment income.
The Biden administration would like to see that raised to 40.8%, consisting of a 37% capital gains rate plus that same 3.8% tax on net investment income.
The higher rates are proposed to apply ‘to the extent that the taxpayer’s income exceeds $1 million (or $500,000 for married couples filing separately).
The Biden administration proposal would tax higher-income individual taxpayers on their long-term capital gains and qualified dividends at 37% and on short-term capital gains and ordinary dividends at an ordinary rate of 39.6%.
The White House also wants to make sure that those who are expected to pay the 3.8% net investment tax and a 3.8% Medicare tax actually do so. To correct what it says is an unfair situation that provides opportunities for high-income individuals to avoid paying their fair share of taxes, the administration proposes that these taxes apply uniformly to those making over $400,000.
Specifically, the definition of net investment income would include gross income and gain “from any trades or businesses that are not otherwise subject to employment taxes.”
Individual Income Tax Rates
Another area where the administration is proposing a tax increase is in the individual taxes paid by high income individuals.
According to the Treasury Department’s Green Book, the administration is proposing raising the top marginal income tax rate for individuals earning more than $452,700 a year from the current 37% to 39.6%.
The $10,000 cap on state and local tax (SALT) deductions — a big concern of lawmakers like Rep. Josh Gottheimer, D-N.J. — could be repealed and replaced by limitations on itemized deductions for taxpayers earning in excess of $400,000.
The outright repeal of the SALT cap, much sought after by members of Congress from high-taxed areas in the Northeast, is expected to cost the government in excess of $600 billion over 10 years.
Under “normal” circumstances, the House and then the Senate will craft and approve a budget resolution to serve as the vehicle for the reconciliation process.
Only 51 votes are needed to pass budget reconciliation legislation in the Senate and by employing such a process, expectations are Congress would be able to pass a single, comprehensive package come fall.
But these are not normal times. And the course of the process, not to mention the size and shape of a tax package, seems to change almost by the day.
After failing to reach a deal on an infrastructure plan and how to pay for it with one group of Senate Republicans, President Biden is now negotiating with a bipartisan group who comes quite a bit closer to his spending goals, but is just as resistant as the Republicans had been to any kind of tax increase.
In the face of such recalcitrance, Senate Majority Leader Charles Schumer, D-N.Y. said this week he planned to convene a meeting with all 11 Democratic members of the Senate Budget Committee to begin the process for passing a budget resolution, paving the way for Democrats to pass a major infrastructure bill on a party-line vote.
In doing so, Schumer noted that a budget resolution would set the stage for passing elements of Biden’s $2.25 trillion American Jobs Plan and $1.8 trillion American Families Plan with simple majority votes.
The White House reportedly plans to exercise a little more patience, saying it will give the bipartisan infrastructure negotiations another week to 10 days before assessing next steps, which could include pursuing a Democrats-only approach to pass President Joe Biden’s sweeping jobs and families investment plans.
Even then, it’ll be the details — not the headline-grabbing fighting and partisan politics — that will matter.
To some, what will ultimately matter is not the size of the tax hit they’ll take, but when.
When the White House rolled out its initial plan in April, it stated the gains that will be taxed at the higher rate will be those earned as of the date of the announcement.
However, Congress, which has the exclusive power of the purse under the Constitution, is under no obligation to follow that recommendation.
It can choose to have the effective date be the date of enactment of the legislation or even later. Other provisions may be phased in overtime, and some provisions might be enacted only as temporary measures.
All that uncertainty has corporations and those who might take an especially big tax hit beginning next year almost in a frenzy. That’s because the only way they’ll achieve tax savings or minimize their exposure is by anticipating which proposals will ultimately become draft legislation and which might actually cross the finish line.
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