Recent proposals to increase the effective tax rates (ETRs) faced by multinationals rely on the argument that these firms achieve artificially low tax rates by shifting profits to foreign tax havens and other low-tax countries. By raising the tax rates on the foreign income of U.S. multinationals, these proposals would supposedly reduce profit shifting.
However, as a recent Tax Foundation analysis explained, some proposals under consideration would actually have the opposite effect. The key incentive for profit shifting is the differential between the ETR on foreign income and domestic income. If a proposal raises the tax rate on domestic income by more than on foreign income, it increases profit shifting on net.
The proposal from the House Ways and Means Committee includes tax hikes on domestic corporate profits and foreign profits of U.S. multinationals, and some fixes to existing issues with the U.S.’s Global Intangible Low-taxed Income (GILTI) regime. It would raise the statutory corporate tax rate from a flat 21 percent to a graduated schedule with a top rate of 26.5 percent; this top rate would apply to almost all corporate income. It would also accelerate the scheduled rate increases for GILTI and Foreign Derived Intangible Income (FDII) from 2026 to 2022. The proposal would switch to country-by-country GILTI calculations, reduce the tangible asset exemption in GILTI from 10 percent to 5 percent, and reduce the GILTI foreign tax credit haircut from 20 percent to 5 percent. To address design problems in GILTI—which country-by-country calculations would exacerbate—the proposal would allow foreign tax credit carryforwards for five years and exempt GILTI from indirect expense allocation rules.
The proposal also makes numerous other changes to other aspects of international taxation; see this report for a more detailed explanation.
The higher domestic tax rate increases the incentive to shift profits abroad. The acceleration of the GILTI rate hike reduces profit shifting by raising the tax rate on foreign income, and the acceleration of the FDII rate hike increases profit shifting by raising the tax rate on foreign income. Although country-by-country calculations for GILTI and reducing its tangible asset exemption reduce profit shifting, these impacts are partially offset by reducing the foreign tax credit haircut, allowing foreign tax credit carryforwards, and exempting GILTI from expense allocation.
Table 1 presents measures of the tax incentives related to profit shifting under current law and under the Ways and Means proposal for 40 industries in 2022. I compute the domestic ETRs using the statutory tax rate adjusted for the effective FDII deduction rate, estimated as the ratio of FDII to deduction-eligible income. The ETRs on controlled foreign corporation (CFC) profits include foreign taxes as well as residual U.S. taxes from GILTI and subpart F, net of their respective foreign tax credits. The tax rate differentials are the differences between the domestic ETRs and the foreign ETRs.
|Domestic Effective Tax Rates (ETRs)||Foreign Effective Tax Rates (ETRs)||Effective Tax Rate (ETR) differentials|
|Industry||Current law||W&M proposal||Current law||W&M proposal||Current law||W&M proposal||Change|
|Oil and gas extraction, coal mining||21.0||26.5||34.3||39.3||-13.3||-12.8||0.5|
|All other mining||20.8||26.4||34.0||36.9||-13.2||-10.5||2.6|
|Beverage and tobacco products||19.3||25.2||19.6||24.1||-0.3||1.1||1.5|
|Petroleum and coal products manufacturing||20.4||26.1||25.3||28.6||-4.9||-2.6||2.3|
|Pharmaceutical and medicine manufacturing||17.4||23.8||11.5||14.5||5.9||9.4||3.5|
|Other chemical manufacturing||18.8||24.9||25.7||30.4||-6.9||-5.5||1.3|
|Plastics and rubber products manufacturing||20.1||25.9||21.4||25.2||-1.3||0.7||2.0|
|Nonmetallic mineral product manufacturing||17.7||24.1||21.8||30.3||-4.0||-6.2||-2.1|
|Primary metal manufacturing||21.0||26.5||32.4||39.5||-11.4||-13.0||-1.7|
|Fabricated metal products||20.0||25.7||26.7||31.4||-6.7||-5.7||1.0|
|Computer and electronic product manufacturing||16.6||23.3||10.8||14.9||5.8||8.4||2.6|
|Electrical equipment, appliance and component manufacturing||20.2||25.9||19.5||25.3||0.7||0.6||-0.1|
|Motor vehicles and related manufacturing||18.0||24.3||26.4||32.5||-8.4||-8.1||0.3|
|Other transportation equipment manufacturing||18.2||24.4||28.4||34.3||-10.2||-9.9||0.3|
|Machinery, equipment, and supplies||20.1||25.9||24.2||27.6||-4.0||-1.7||2.3|
|Other miscellaneous durable goods||19.3||25.2||24.5||27.7||-5.3||-2.5||2.8|
|Drugs, chemicals, and allied products||19.2||25.1||10.4||12.9||8.8||12.3||3.5|
|Groceries and related products||21.0||26.5||26.4||30.7||-5.4||-4.2||1.2|
|Other miscellaneous nondurable goods||21.0||26.5||24.7||28.3||-3.7||-1.8||1.9|
|Transportation and warehousing||20.8||26.4||23.0||29.2||-2.2||-2.8||-0.7|
|Publishing (except internet)||16.4||23.1||14.5||17.5||2.0||5.6||3.7|
|Motion picture and sound recording||18.1||24.4||33.1||37.2||-15.0||-12.9||2.1|
|Finance and insurance|
|Nondepository credit intermediation||19.4||25.3||27.6||30.7||-8.2||-5.4||2.8|
|Securities, commodity contracts, and other financial investments||19.7||25.6||20.8||24.3||-1.0||1.3||2.3|
|All other finance industries||19.6||25.4||12.3||16.0||7.3||9.4||2.1|
|Insurance and related activities||18.8||24.9||25.4||29.9||-6.5||-4.9||1.6|
|Real estate and rental and leasing||20.1||25.9||17.7||22.9||2.5||2.9||0.4|
|Professional, scientific, and technical services||19.2||25.2||21.5||25.4||-2.3||-0.2||2.1|
|Management of holding companies||19.7||25.5||11.1||13.1||8.6||12.5||3.9|
|Administrative and support and waste management and remediation||19.7||25.5||15.7||17.3||4.0||8.3||4.2|
|Arts, entertainment, and recreation||20.7||26.3||27.9||34.5||-7.2||-8.2||-1.0|
|Accommodation and food services||17.9||24.2||23.2||27.9||-5.3||-3.6||1.7|
Notes: Both proposals use ETRs on domestic CFC profits for 2022. The ETR on CFC profits includes foreign taxes as well as residual U.S. taxes from GILTI and subpart F, net of their foreign tax credits. The domestic ETRs are computed using the FDII deduction divided by deduction-eligible income (DEI) and multiplied by the statutory tax rate. The miscellaneous industries category consists of agriculture, forestry, fishing, and hunting; utilities; education services; health care and social assistance; repair services; and other services, except government. Major industrial sectors are bolded.
Source: Tax Foundation’s Multinational Tax Model.
While Table 1 includes many industries, I focus on the aggregate results. Under current law, the overall domestic ETR is 19 percent, reduced below the statutory rate by the FDII deduction, and the foreign ETR (on CFC profits) is 16.8 percent. Overall, the tax rate differential—the key incentive to shift profits abroad—is 2.2 percentage points under current law. The Ways and Means proposal would raise the domestic ETR by 6 percentage points to 25.1 percent and the CFC ETR by 3.3 percentage points to 20.1 percent. On net, the tax rate differential under the proposal therefore increases to 5 percentage points. Although the net effects vary by industry, the Ways and Means proposal increases profit-shifting incentives overall by raising the domestic tax rate by more than the foreign tax rate.
We can observe the effects of this by estimating the loss to profit shifting under different assumptions. Table 2 presents the 10-year change in federal corporate income tax liabilities of U.S. multinationals from the Ways and Means proposal. The columns allow for different responsiveness of profit shifting to tax rate differentials—no response, a standard response using a semi-elasticity of 0.8, and a response based on an analysis by economists Tim Dowd, Paul Landefeld, and Anne Moore that captures higher responsiveness of profits booked in tax havens. The rows address issues that arise in measuring ETRs on foreign profits—excluding related-party dividends to address double-counting of profits, and adjusting for partial U.S. ownership of CFCs—as explained further in this recent analysis.
|10-year change in CIT liabilities ($B)||Loss to profit shifting|
|ETR measurement on…||No response||SE=0.8||SEs from DLM||SE=0.8||SEs from DLM|
|Prorated CFC profits||801.6||743.7||654.8||-57.9||-146.8|
|CFC profits excluding RPDs||801.6||753.6||681.3||-48.0||-120.3|
Notes: The table presents the change in federal corporate income tax liabilities of U.S. multinationals, in billions of dollars, under different profit-shifting assumptions. All scenarios use a debt semi-elasticity of 0.3 with respect to the statutory tax rate for domestic debt. The SE=0.8 scenario uses a profit shifting semi-elasticity of 0.8 with respect to the tax rate differential. The DLM scenario uses profit shifting semi-elasticities of 0.684 for non-tax havens and of 4.16 for tax havens, based on estimates from Dowd, Landefeld, and Moore (2018).
Source: Tax Foundation’s Multinational Tax Model.
Using no profit shifting response, the federal corporate income liabilities of U.S. multinationals would increase by $801.6 billion over a decade. Depending on how ETRs on CFC profits are measured, a conventional profit shifting semi-elasticity of 0.8 reduces the 10-year score (for U.S. multinationals) by between $48 billion and $64.6 billion. Using the higher responsiveness to tax incentives of profits booked in tax havens, the 10-year loss to profit shifting rises to $120.3 billion to $184.4 billion.
In general, increasing tax rates on the foreign profits of U.S. multinationals is not sufficient to reduce profit shifting if a proposal also increases the tax rates on income booked in the U.S. If Congress wants to reduce profit shifting, the proposal from the Ways and Means Committee is not an effective tool for this.
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