The US system of international corporate income tax has long since ceased to work. It unnecessarily complicates and distorts business decisions while not generating much revenue, thus forcing higher taxes elsewhere to make a difference. Policymakers have the best chance in generations to reform and improve this system while bringing the rest of the world along. Finance Minister Janet Yellen helped craft an international agreement signed by more than 130 countries. Congress now needs to do its part and lock it in.
Two approaches to international taxation are worldwide taxation, where the home country of a company taxes the company’s entire global income, and territorial taxation, where the income is only taxed by that country of income. No system is perfect, and both inevitably create some distortion.
A global system could hinder the ability of American companies to compete by increasing their costs relative to those of competitors legally residing in other countries. The territorial system, on the other hand, provides an incentive to locate production and move reported profits abroad.
Prior to 2017, the United States took a third approach that combines some of the worst features of the two, which I call a “stupid territory” tax system. It pretended to tax US corporations on their worldwide foreign income but in reality gave them the enormous opportunity to defer those taxes permanently, in effect allowing they created a territorial system for themselves while leading to a large accumulation of income abroad.
President Trump and the Republican Congress reformed the system, replacing it with a mixed system that included a minimum tax known as the Global Invisible Low Taxation Income, or Gilti, for companies earn high profit margins and also pay low taxes abroad. This plan took several steps towards a more rational system, acknowledging the need for compromise between the whole world and the territory. But it also took some steps back on tax rates and technical details, like allowing companies to apply a minimum tax rate based on their average worldwide tax rate rather than on a country-by-country basis.
Trump’s arguments for building and fixing reforms are already strong, but the global agreement secured by Yellen makes them much stronger. In particular, the global agreement removes the main objection to taxing foreign income more strongly as other countries have all agreed to adopt similar systems. Concerns that U.S. companies will be less competitive or will try to avoid U.S. taxes by incorporating abroad are significantly smaller than they would otherwise be.
In contrast, the risks of inaction have increased. The global minimum tax agreement includes a taxable profit/payment rule or UTPR. This mechanism would allow any country to enforce the agreement against companies with headquarters in countries that do not have minimum tax laws. In other words, if the US leaves the deal, American companies could be at a disadvantage. Even without this enforcement mechanism, the absence of an agreement risks replacing the recent spirit of cooperation with messy tax and trade wars.
Last year, the House of Representatives passed a series of international tax reforms, which is a good starting point for Congress to further consider. As a major economy, the United States has modest scope to move beyond international agreement with relatively few downsides. Some provisions should be updated to be more in line with the global agreement, especially the one that implements taxable payment rules.
The Global Minimum Tax Agreement heralds the dawn of a new era of international economic cooperation. It will be good for the countries involved and maybe even popular. It is pragmatic and, if at all, relatively minimal when it comes to setting a floor rate of only 15%. If Congress doesn’t pass legislation to make it happen in America, we could end up with something even worse than the stupid territorial system we had before President Trump.
Mr. Furman, professor of economic policy practice at Harvard University, was Chairman of the White House Council of Economic Advisers, 2013–17.
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https://www.wsj.com/articles/global-minimum-tax-system-corporate-rate-gilti-yellen-offshoring-tax-code-reform-2017-trump-cuts-offshoring-revenue-11651526799 A Global Tax System Is Good for the U.S.