How a new minimum corporate tax could reshape business investment

WASHINGTON — At the heart of the new climate and tax package that Democrats appear to be on the verge of passing is one of the most significant changes to America’s tax code in decades: a new minimum corporate tax that could reshape the way government federal collects the revenue. and change the way the country’s most profitable companies invest in their businesses.

The proposal is one of the last remaining tax increases in the package that Democrats aim to pass along party lines in the coming days. After months of intra-party wrangling over whether to raise taxes on the wealthy or undo some of the 2017 Republican tax cuts to fund their agenda, they have settled on a long-standing political ambition to ensure that big, profitable companies pay more than $0 in federal taxes. .

To achieve this, Democrats have recreated a policy that was last used in the 1980s: trying to capture tax revenue from companies that report a profit to shareholders in their financial statements, while collecting deductions to reduce their tax bills.

The re-introduction of the minimum corporate tax, which would apply to what is known as “book income” that companies report in their financial statements, has caused confusion and stiff lobbying resistance since it was announced last month.

Some initially confused the measure with the 15 percent global minimum tax that Treasury Secretary Janet L. Yellen has pushed as part of an international tax deal. However, this is a separate proposal, which in the United States remains blocked in Congress, that would apply to the foreign earnings of US multinational companies.

Republicans have also deceptively tried to use the tax hike as evidence that President Biden was ready to break his campaign promises and raise taxes on middle-class workers. And manufacturers have warned that it would impose new costs at a time of rapid inflation.

In a sign of the political power of lobbyists in Washington, by Thursday evening the new tax had already been softened. At the urging of manufacturers, Sen. Kyrsten Sinema of Arizona persuaded her Democratic colleagues to preserve a valuable deduction, known as bonus depreciation, related to purchases of machinery and equipment.

The new minimum tax of 15 percent will apply to corporations that report annual income of more than $1 billion to shareholders in their financial statements, but use deductions, credits and other preferential tax treatments to lower their tax rates effectively well below the legal 21 percent. It was originally projected to raise $313 billion in tax revenue over a decade, though the final figure is likely to be $258 billion once the revised bill is finalized.

The new tax could also inject a greater degree of complexity into the tax code, creating enforcement challenges if it passes.

“In terms of enforcement and the bandwidth to deal with the complexity, there’s no doubt that this regime is complex,” said Peter Richman, a senior counsel at the Tax Law Center at New York University’s law school. . “This is a big change and the revenue numbers are huge.”

Because of this complexity, the minimum corporate tax has been met with considerable skepticism. It’s less efficient than simply eliminating deductions or raising the corporate tax rate, and could open the door for companies to find new ways to make their income look lower in order to lower their bills. tax.

Similar versions of the idea have been floated by Mr. Biden during his presidential campaign and by Sen. Elizabeth Warren, Democrat of Massachusetts. They have been promoted as a way to restore fairness to a tax system that has allowed large corporations to dramatically lower their tax bills through deductions and other accounting measures.

According to an early estimate by the nonpartisan Joint Committee on Taxation, the tax would most likely apply to about 150 companies a year, and most of those would be manufacturers. That prompted an outcry from manufacturing companies and Republicans, who have opposed any policies that scale back the tax cuts they passed five years ago.

Although many Democrats admit that the minimum corporate tax was not their first choice for raising taxes, they have embraced it as a political winner. Sen. Ron Wyden of Oregon, chairman of the Senate Finance Committee, on Thursday shared data from the Joint Committee on Taxation showing that in 2019, about 100 to 125 corporations reported financial statement income greater than $1 billion dollars, but their effective tax rates were lower than 5 percent. The average income reported in the financial statements to shareholders was nearly $9 billion, but they paid an average effective tax rate of just 1.1 percent.

“Companies are paying lower rates while reporting record profits to their shareholders,” Mr. Wyden said.

The Treasury Department had reservations about the minimum tax idea last year because of its complexity. If approved, the Treasury will be responsible for drafting a series of new regulations and guidelines for the new law and ensuring that the Internal Revenue Service can properly audit it.

Michael J. Graetz, a tax law professor at Columbia University, acknowledged that the calculation of minimum taxes was complicated and that introducing a new tax base would add new challenges from a tax administration perspective, but he said that he did not consider those obstacles disqualifying. He noted that the current system had created opportunities for tax shelters and allowed companies to take losses for tax purposes that do not appear on their financial statements.

“If the problem Congress is dealing with is that companies are reporting high book profits and low taxes, then the only way to reconcile the two is to base taxes on book profits to some extent,” Mr. Graetz, a former deputy assistant secretary for tax policy at the Treasury Department, said.

A similar version of the tax was included in a 1986 tax overhaul and was allowed to expire after three years. Skeptics of revising such a measure have warned that it could create new problems and opportunities for companies to avoid the minimum tax.

“Evidence from outcome studies surrounding the Tax Reform Act of 1986 suggests that companies responded to such a policy by changing the way they report financial accounting income—companies deferred more income to future years,” Michelle Hanlon, a professor of accounting at Sloan. School of Management at the Massachusetts Institute of Technology, told the Senate Finance Committee last year. “This behavioral response poses serious risks to financial accounting and capital markets.”

Other opponents of the new tax have expressed concern that it would give more control over the US tax base to the Financial Accounting Standards Board, an independent organization that sets accounting rules.

“Potential politicization of the FASB is likely to lead to lower-quality financial accounting standards and lower-quality financial accounting earnings,” Ms. Hanlon and Jeffrey L. Hoopes wrote in a letter to members of Congress. a University of North Carolina professor. last year which was signed by more than 260 accounting academics.

Business groups have strongly opposed the proposal and pressured Ms. Sinema to block the tax entirely. The National Association of Manufacturers and the Arizona Chamber of Commerce and Industry released a survey of workers, managers and manufacturing advocates in the state Wednesday that showed a majority opposed the new tax.

“It will make it harder to hire more workers, raise wages and invest in our communities,” said Chad Moutray, the manufacturing association’s chief economist. “Arizona’s manufacturing voters are saying clearly that this tax will hurt our economy.”

Ms Sinema has voiced opposition to rising tax rates and had reservations about a proposal to reduce the special tax treatment that hedge fund managers and private equity executives get for “carrying interest”. Democrats rejected the proposal at her urging.

When an earlier version of a minimum corporate tax was proposed last October, Ms Sinema issued a statement of approval.

“This proposal represents a reasonable step toward ensuring that highly profitable corporations—which can sometimes avoid the current corporate tax rate—pay a reasonable minimum corporate tax on their profits, just as Arizona’s small businesses do and Arizona,” she said. Announcing she would support an amended version of the climate and tax bill on Thursday, Ms Sinema noted that it would “protect advanced manufacturing”.

That won praise from business groups on Friday.

“Taxation of capital expenditures – investments in new buildings, factories, equipment, etc. — is one of the most economically destructive ways to raise taxes,” Neil Bradley, chief policy officer of the U.S. Chamber of Commerce, said in a statement. “As we look forward to reviewing the proposed new bill, Senator Sinema deserves credit for recognizing this and fighting for change.”

Emily Cochrane contributed to the reporting.