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The Senate Finance and House Ways and Means Committees are busy writing legislation to significantly raise taxes to offset the cost of the recently-passed $3.5 trillion budget resolution. One of the ways the committees will raise taxes is by increasing taxes on businesses, particularly on their international activities. Raising these taxes will have severe negative impacts on U.S. workers and the U.S. economy.
The 2017 tax reform made our international system much more competitive than it was before. A modernization of the system was decades in the making. And as we’ve noted, undoing that long-needed update would drive our system backwards, closer to what it was before tax reform when U.S. businesses were at a competitive disadvantage in the global economy. Under that system, our businesses were prime acquisition targets by foreign companies.
One of the goals of reforming the international system was to encourage U.S. businesses to conduct more of their operations here at home. Tax reform did so by using a “carrot and stick” approach – a mix of positive and negative incentives for international operations.
Foreign-derived Intangible Income (FDII) is the carrot. It incentivizes companies to retain intangible property (IP) in U.S. or onshore IP from abroad, where businesses previously sold the IP to escape what was once an uncompetitive tax situation here in the U.S.
Happily, FDII worked! Because of it, companies have retained IP in US or onshored IP, bringing with it jobs, investment, and tax revenues. FDII has also helped level the playing field among our global competitors who often offer much larger incentives.
Senate Finance and House Ways and Means are considering gutting FDII because they need more money for all that spending. Doing so risks losing the jobs, investment, and revenues FDII has brought with it.
Further, FDII has only been around a few years. Doing away with it now would be a sharp 180 degree policy turn, which would be a jolt to businesses that crave certainty. If companies don’t think incentives for investment within our borders will stick in the tax code, they will treat any future incentives much more warily. This will reduce their effectiveness.
Global Intangible Low-Tax Income, GILTI, is the stick when it comes to IP income. It reduces the incentive to shift intangible income from IP outside the United States by applying a minimum tax on such “highly mobile” income. This too the committees are trying to raise.
Combined with other pieces of tax reform, GILTI is working. The U.S. has become a more attractive place to domicile and reform has driven U.S. employment and expenditures for property, plant, and equipment (PP&E) and research and development (R&D).
If the committees raise the GILTI rate, apply a country-by-country reporting standard, and pursue other ways to raise the tax the end results will be a less competitive tax system, less investment by U.S. businesses, and fewer jobs for American workers. Also, this would again make U.S. businesses attractive acquisition targets for foreign businesses.
The global community is trying to more heavily tax mobile IP income via a global minimum tax. It does not make sense to unilaterally increase our minimum tax rate and complicate the calculations while those negotiations are ongoing at the OECD. Other countries should implement their own minimum taxes (and eliminate their unilateral digital service taxes while they are at it). U.S. policy doesn’t need to punish American companies.
Lastly, the committees are also considering changing the Base Erosion Anti-Abuse Tax (BEAT), which applies a tax to certain kinds of intracompany transactions. They could adopt the Biden administration’s more punitive version, known as SHIELD (Stop Harmful Inversions and Ending Low-Tax Developments). Details are scant on SHIELD, but what is clear is that it would be a higher tax than BEAT. This would be another tax increase on investment, further hurting the domestic economy and our workers.
Senate Finance and House Ways and Means are trying to substantially raise taxes because they are tasked with paying for the gargantuan spending bill Congress is trying to pass through the budget reconciliation process. International taxes won’t be the only taxes they raise to meet their needs, but the economic pain they inflict will still be immense and will reverse the progress we have made in recent years. Time to scrap the tax hikes and budget reconciliation and start fresh.