How a new corporate minimum tax could transform corporate investment

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

The proposal is one of the last remaining tax hikes in the package Democrats plan to pass along party lines in the coming days. After months of intra-party disagreements over whether to raise taxes on the wealthy or roll back some of the Republican 2017 tax cuts to fund their agenda, they have settled on a long-standing policy goal of ensuring that large and profitable companies do more pay less than $0 in federal taxes.

To do this, Democrats have recreated a policy last used in the 1980s: trying to collect tax revenue from companies that report profits to shareholders in their financial statements, while simultaneously accumulating deductions to cover their tax bills reduce.

The resurgence of the corporate tax, which would apply to the so-called “book receipts” companies report in their annual accounts, has caused confusion and fierce lobbying 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 been pushing as part of an international tax treaty. However, this is a separate proposal, still pending in Congress in the United States, which would relate to the foreign profits of American multinationals.

Republicans have also deceptively attempted to use the tax hike as evidence that President Biden was willing to break his campaign promises and raise taxes on middle-class workers. And manufacturers have warned that this would create new costs in times of rapid inflation.

As a sign of the political power of the lobbyists in Washington, the new tax was watered down on Thursday evening. At manufacturers’ urging, Senator Kyrsten Sinema of Arizona persuaded her Democratic counterparts to keep a valuable deduction known as bonus write-off associated with the purchase of machinery and equipment.

The new 15 percent minimum tax would apply to companies 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 bring their effective tax rates well below the statutory 21 percent reduce. It was originally projected to generate $313 billion in tax revenue over a decade, although the final total is likely to be $258 billion once the revised law is finalized.

The new tax could also bring a higher level of complexity to the tax code and create challenges in implementing the law if it is passed.

“In terms of implementation and the breadth to deal with complexity, there is no doubt that this regime is complex,” said Peter Richman, senior legal adviser at the Tax Law Center at New York University Law School. “This is a big change and the sales numbers are big.”

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

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

According to an initial estimate by the nonpartisan Joint Committee on Taxation, the tax is expected to affect around 150 companies annually, most of which are manufacturers. This sparked an outcry from manufacturing companies and Republicans, who have opposed any policies that roll back tax cuts enacted five years ago.

Although many Democrats recognize that the corporate tax minimum was not their first choice of tax hikes, they have embraced it as a political winner. Oregon Sen. Ron Wyden, the chair of the Senate Finance Committee, on Thursday shared data from the Joint Committee on Taxation showing that in 2019 about 100 to 125 companies reported year-end earnings of more than $1 billion, their effective However, tax rates were below 5 percent. The average income reported to shareholders in the financial statements was nearly $9 billion, but they paid an average effective tax rate of just 1.1 percent.

“Companies are paying rock-bottom prices while reporting record earnings to their shareholders,” said Mr. Wyden.

The Treasury Department had reservations about the idea of ​​minimum taxation last year because of its complexity. When it goes into effect, the Treasury Department would be responsible for creating a new set of regulations and guidance for the new law and ensuring the Internal Revenue Service can properly monitor it.

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

“If the issue Congress is addressing is that companies are reporting high accounting profits and low taxes, then the only way to reconcile those two is to base taxes on accounting profits to some degree,” he said 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 phased out after three years. Skeptics of a reconsideration of such a measure have warned it could create new problems and opportunities for companies to avoid the minimum tax.

“The evidence from the studies of the outcomes surrounding the 1986 Tax Reform Act suggests that companies responded to such policies by changing the way they report financial accounting revenue – companies deferring more revenue to future years Michelle Hanlon, an accounting professor at the 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 concerns that it would give the Financial Accounting Standards Board, an independent organization that sets accounting rules, more control over the US tax base.

“The potential politicization of the FASB is likely to result in substandard financial accounting standards and substandard financial accounting results,” wrote Ms. Hanlon and Jeffrey L. Hoopes, a professor at the University of North Carolina, in a letter to members of Congress last year, read by more than 260 Accounting scholars signed.

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

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

Ms Sinema has opposed an increase in tax rates and has received reservations about a proposal to reduce the special tax treatment given to hedge fund managers and private equity executives for carried interest. The Democrats scrapped the proposal at her insistence.

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

“This proposal represents a sensible move to ensure that highly profitable companies — which can sometimes avoid the current corporate tax rate — pay a reasonable minimum corporate tax on their profits, just like everyday Arizonans and small Arizona businesses do,” she said. Announcing on Thursday that she would support an amended version of the climate and tax law, Ms Sinema noted that it would “protect advanced manufacturing”.

That was praised by business groups on Friday.

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

Emily Cochrane contributed reporting.

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