By slashing the corporate tax rate, the GOP tax proposal could very well curtail the widely derided practice of companies moving headquarters to a foreign country simply to reduce their tax bite.
But how far will the tax overhaul go in advancing a top goal of President Trump’s -- keeping U.S. multinational firms from sending manufacturing work and jobs overseas?
Many economists and tax analysts think not very much. And by some accounts, the Republican proposal in its current form could actually increase the incentive for companies to make investments and manufacture abroad.
While there are some important differences in the House and Senate versions, they share key elements. Both would knock down the U.S. corporate tax rate to 20% from the current 35%. That is a little less than the worldwide average rate of 22.5%, according to the research firm Tax Foundation, and that is likely to tamp down further what had been a wave of corporate inversions, in which a firm relocates its legal domicile to a lower-tax nation.
The Republican proposal also would fundamentally change the U.S. tax scheme to a so-called territorial system, in which foreign earnings would be exempt from U.S. taxes.A multinational firm’s offshore income would still be subject to taxes in the country where it made those profits.
A few countries, such as Bermuda and the Cayman Islands, have a zero corporate tax rate, so to prevent multinational firms from paying nothing at all, congressional Republicans have proposed a minimum tax on foreign profits at a rate that is no more than 10%.
But at 10%, that would still be just half the tax rate on an American corporation’s domestic earnings, meaning that it would still make financial sense for U.S. companies to shift earnings and activity to places where taxes are lower or pay the minimum on foreign earnings of no more than 10%.
“As long as the rate structure is lower abroad than it is here, we’re going to continue to have an incentive to shift jobs, production and profits offshore,” said Steven Rosenthal, a senior fellow at the nonpartisan Tax Policy Center.
In recent years, U.S. multinational firms have continued to invest and hire employees at a faster rate in their foreign operations than in the U.S. From 2009 to 2014, American companies with foreign subsidiaries grew their employment abroad by 21.5% while their domestic payrolls rose by about 16%, according to the latest Commerce Department data on multinational activities.
Jared Walczak, a senior policy analyst at the conservative-leaning Tax Foundation, agrees that some companies will still find it attractive to move activity abroad for tax purposes, but he nonetheless expects a slowdown in the overall shift, if not a reversal.
Up to now, he said, U.S. companies facing a 35% tax hit on their foreign earnings were highly motivated to establish bases overseas. A favorite among tech firms such as Apple was Ireland, where the top corporate tax rate is 12.5%.
With the U.S. rate sliced to 20%, Walczak argues that the gap would be narrowed enough that it will be much more attractive for multinational companies to do business in the United States and less advantageous to go abroad. What’s more, he said, other changes in the tax plan, such as immediate expensing for equipment and capital purchases to offset taxes, would spur firms to invest and expand production in the U.S.
But that gap may be much bigger than what meets the eye. The 10% minimum tax would apply only to earnings on nontangible assets such as patents and intellectual property holdings, which can easily be shifted offshore on paper. There would be no minimum tax on foreign tangible assets such as plants and equipment, which means firms would find it that much more profitable to produce overseas.
“By the time all the dust is cleared, there’s a net incentive to shift income offshore and to shift activities offshore,” said Kimberly Clausing, an economics professor at Reed College who has written extensively on corporate taxation.
Both the Senate and House bills have promised to include antiabuse provisions and ways to protect the tax base. But in fact, both versions would result in the federal government losing tax revenue on foreign income in the 10th year of the tax plan relative to what it would under the status quo, Clausing said.
“That’s showing us that on net, the incentive to be offshore is even higher because the tax base gets even smaller due to these provisions,” she said.
One House idea meant to protect the tax base was an excise tax proposed to stop multinational firms from using transactions with their foreign affiliates to reduce their U.S. taxes. But that provision, after coming under attack by conservative groups, has been gutted. Though it was once estimated to generate $155 billion, it is now projected to generate only about half that much.
“The underlying idea seems to be that, subject to this quasi-minimum tax, anything goes in respect of foreign tax avoidance by U.S. multinationals,” Edward Kleinbard, a USC law professor and expert in federal tax policy, said of the House tax bill. “This strikes me as a very conscious policy.”