How a new minimum corporate tax could reshape business investment

WASHINGTON — At the center of the new climate and tax package that Democrats appear to be about to pass is one of the most significant changes to the U.S. tax code in decades: a new minimum corporate tax that could reshape how the federal government collects revenue and changing how the nation’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 push through in the coming days. After months of disagreement within the party over whether to raise taxes on the wealthy or roll back some of the 2017 Republican tax cuts to fund their agenda, they agreed on a political ambition of long-time focus on ensuring large, profitable companies pay more than $0 in federal taxes. .

To do so, 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 racking up deductions to lower their bills. tax.

The reappearance of the corporate minimum tax, which would apply to so-called “book income” that companies report in their financial statements, has sparked confusion and fierce lobbying resistance since it was announced last month. last.

Some initially confused the measure with the 15% global minimum tax that Treasury Secretary Janet L. Yellen pushed as part of an international tax deal. However, there is a separate proposal, which in the United States remains blocked in Congress, which would apply to the foreign income of American multinationals.

Republicans have also deceptively attempted to seize on the tax hike as evidence that President Biden was willing to break campaign promises and raise taxes on middle-class workers. And manufacturers have warned that this will impose new costs in an era of rapid inflation.

A sign of the political power of lobbyists in Washington, Thursday evening, the new tax had already been watered down. At the urging of manufacturers, Senator Kyrsten Sinema of Arizona persuaded fellow Democrats to retain a valuable deduction, known as a depreciation bonus, associated with machinery and equipment purchases.

The new 15% minimum tax would apply to corporations that report annual income to shareholders in excess of $1 billion in their financial statements, but use deductions, credits and other preferential tax treatments to reduce their tax rates. effective taxation well below the 21% provided for by law. It was originally expected to raise $313 billion in tax revenue over a decade, though the final tally 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 passed.

“In terms of implementation and bandwidth to deal with the complexity, there’s no question that this regime is complex,” said Peter Richman, senior counsel at the Tax Law Center at the University Law School. ‘New York University. “It’s a big change and the turnover is significant.”

Because of this complexity, the corporate minimum tax has been the subject of significant skepticism. It’s less efficient than simply eliminating deductions or raising the corporate tax rate and it could open the door for businesses to find new ways to make their earnings look lower to lower their bills. of tax.

Similar versions of the idea were floated by Mr Biden during his presidential campaign and by Senator Elizabeth Warren, Democrat of Massachusetts. They were touted as a way to restore fairness to a tax system that allowed large corporations to significantly reduce their tax bill through deductions and other accounting measures.

According to an initial estimate by the non-partisan Joint Committee on Taxation, the tax would most likely apply to approximately 150 companies per year, and most of them would be manufacturers. It has sparked an outcry from manufacturing companies and Republicans, who have opposed any policy that cuts the tax cuts they passed five years ago.

Although many Democrats recognize that the corporate minimum tax was not their first choice of tax hikes, they have embraced it as a political winner. Senator Ron Wyden of Oregon, chairman of the Senate Finance Committee, shared data from the Joint Committee on Taxation on Thursday indicating that in 2019, approximately 100 to 125 companies reported financial statement revenues greater than $1 billion. dollars, but their effective tax rates were less than 5 percent. The average income reported on financial statements to shareholders was nearly $9 billion, but they paid an average effective tax rate of just 1.1%.

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

The Treasury Department expressed reservations about the minimum tax idea last year because of its complexity. If signed into law, the Treasury would be responsible for developing a series of new regulations and guidelines for the new law and ensuring that the Internal Revenue Service can properly monitor it.

Michael J. Graetz, professor of tax law at Columbia University, acknowledged that calculating minimum taxes was complicated and that introducing a new tax base would add new challenges from a tax administration perspective. , but he said he did not consider these obstacles to be disqualifying. He noted that the current system has created opportunities for tax shelters and allowed companies to incur losses for tax purposes that do not show up in their financial statements.

“If the problem Congress is tackling is that companies report high accounting profits and low taxes, then the only way to align those two is to base taxes on accounting profits to some degree,” said Mr. Graetz, former deputy assistant secretary for fiscal policy at the Treasury Department, said.

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

“Evidence from outcome studies around the Tax Reform Act of 1986 suggests that companies responded to such a policy by changing the way they reported financial accounting income – companies reported more income in years to come,” said Michelle Hanlon, an accounting professor at Sloan. Massachusetts Institute of Technology School of Management, 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 concerns that it would give more control over the U.S. tax base to the Financial Accounting Standards Board, an independent organization that sets accounting rules.

“The potential politicization of the FASB will likely lead to substandard financial accounting standards and substandard financial accounting profits,” wrote Ms. Hanlon and Jeffrey L. Hoopes, a professor at the University of North Carolina, in a letter to members of Congress. last year which was signed by more than 260 academic accountants.

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

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

Ms Sinema voiced her opposition to the increase in tax rates and expressed reservations about a proposal to reduce the special tax treatment given to hedge fund managers and private equity executives for “interest carried “. Democrats dropped the proposal at his request.

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

“This proposal represents a common-sense step to ensure that highly profitable corporations – which can sometimes avoid the current corporate tax rate – pay a reasonable minimum tax on their profits, just as Arizonans and small businesses in Arizona,” she said. Announcing that she would back an amended version of the climate and tax bill on Thursday, Ms Sinema noted that it would “protect advanced manufacturing”.

It won plaudits from business groups on Friday.

“Taxing capital expenditure – investment in new buildings, factories, equipment, etc. “As we look forward to reviewing the proposed new bill, Senator Sinema deserves credit for recognizing this and fighting for change.”

Emily Cochrane contributed report.