How a new minimum corporate tax could reshape business investment

WASHINGTON — At the heart of the new tax and climate package that Democrats appear poised to pass is one of the most significant changes to America’s tax code in decades: a new minimum corporate tax that could reshape the way the federal government collects revenue and to change the way 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 plan to pass along party lines in the coming days. After months of intra-party wrangling over whether to raise taxes on the wealthy or roll back some of the 2017 Republican tax cuts to fund their agenda, they have settled on a long-held political ambition to make sure big, profitable corporations pay over $0 in federal taxes .

To achieve this, Democrats have recreated a policy last implemented in the 1980s: trying to squeeze tax revenue from companies that report profits to shareholders on their financial statements while collecting deductions to lower their tax bills.

The re-emergence of the minimum corporate tax, which would apply to what is known as “accounting income” reported by companies in their financial statements, has caused confusion and fierce lobbying resistance since it was announced last month.

Some initially conflated the measure with the 15 percent global minimum tax that Treasury Secretary Janet L. Yellen is promoting as part of an international tax accord. However, this is a separate proposal, which in the United States remains deadlocked in Congress, that would apply to the foreign earnings of American multinational corporations.

Republicans also misguidedly 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 will impose new costs at a time of high inflation.

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

The new 15 percent minimum tax will apply to companies that report more than $1 billion in annual income to shareholders in their financial statements, but use deductions, credits and other preferential tax treatment to reduce their effective tax rates well below the statutory 21 percent. It was originally projected 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 introduce a greater degree of complexity into the tax code, creating challenges in implementing the law if it is passed.

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

Because of this complexity, the minimum corporate tax has been met with considerable skepticism. It is less effective 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 appear lower to reduce their tax bills.

Similar versions of the idea have been floated by Mr. Biden during his presidential campaign and by Senator Elizabeth Warren, D-Mass. They have been promoted as a way to restore fairness to a tax system that has allowed big companies to dramatically reduce their tax bills through rebates and other accounting measures.

According to an early estimate by the nonpartisan Joint Committee on Taxation, the tax would likely apply to approx 150 companies per year, and most of them would be manufacturers. That drew an outcry from construction companies and Republicans, who have opposed any policies that scale back the tax cuts enacted five years ago.

Although many Democrats acknowledge that the minimum corporate tax was not their first choice for tax increases, they have embraced it as a political winner. Sen. Ron Wyden of Oregon, chairman of the Senate Finance Committee, shared data from the Joint Committee on Taxation on Thursday indicating that in 2019, about 100 to 125 companies reported financial statement income of more than $1 billion, yet their actual 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%.

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

The Treasury had reservations about the minimum tax idea last year because of its complexity. If enacted, the Treasury Department would be responsible for creating a series of new regulations and guidance for the new law and ensuring that the Internal Revenue Service could properly police it.

Michael J. Graetz, a tax law professor 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 said he did not see those obstacles as disparagingly. He noted that the current system 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 facing Congress is that companies are reporting high book profits and low taxes, then the only way to align the two is to base taxes on book profits to some degree,” Mr. Graetz, a former deputy assistant secretary for tax policy at the Treasury Department, he said.

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

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

Other opponents of the new tax have raised concerns that it would give more control over the U.S. tax base to the Financial Accounting Standards Board, an independent agency that sets accounting rules.

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

Business groups strongly pushed back against the proposal and pressured Ms. Cinema to block the tax entirely. The National Association of Manufacturers and the Arizona Chamber of Commerce and Industry released a poll of the state’s manufacturing workers, managers and advocates Wednesday that showed a majority oppose the new tax.

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

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

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

“This proposal represents a common-sense 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 everyday Arizona small businesses do and of Arizona,” he said. Announcing she would back an amended version of the climate and tax bill on Thursday, Ms Sinema noted it would “protect advanced manufacturing”.

That won praise from business groups on Friday.

“The taxation of capital expenditure – investment in new buildings, factories, equipment, etc. – is one of the most economically destructive ways to raise taxes,” said Neil Bradley, chief policy officer of the US Chamber of Commerce. “While we look forward to reviewing the new proposed bill, Senator Sinema deserves credit for recognizing this and fighting for change.”

Emily Cochran contributed to the report.