“You can’t do where he’s given a tax break to companies that, in fact, go overseas and then import the product back into the United States of America, even though their headquarters is here, the chain, though, you go overseas, and they bring it back in cheaper, than you being able to produce it.”
“Look what his tax cut did, the multibillion-dollar, trillion-dollar tax cut that went mainly to the very wealthy and to corporate America. What did it do? They got a reward for offshoring jobs.”
At The Fact Checker, we have learned that the more complex an issue is, the more likely a politician is to stretch some facts. In particular, if policy experts are fiercely debating a complex issue, a politician is often likely to assert the debate already has been settled in his favor.
Corporate taxes, especially in the international realm, are highly complex. The 2017 tax bill, formally known as the Tax Cuts and Jobs Act (TCJA), significantly overhauled the corporate tax system in an effort to make the United States more competitive with countries with lower tax rates. U.S. companies employed tax strategies with names such as “Double Irish With a Dutch Sandwich” to shuffle profits through subsidiaries with low- or no-tax systems, avoiding paying taxes in the United States.
No tax bill is perfect, of course. Moreover, it was passed in the House and Senate without a single Democratic vote, meaning it’s a ripe target for a Democrat running for president. Many of the criticisms made by Biden now were made by Democrats at the time the bill was signed by President Trump.
But the question of whether the tax law is giving companies a new tax break to send jobs overseas is not as settled as Biden suggests. Biden has proposed ways to fix what he views as flaws in the tax bill and impose penalties for offshoring. We will keep our focus on whether the tax bill created a new loophole for companies to send jobs overseas. But readers should be aware that many factors, such as automation and trade agreements, also influence corporate decisions on overseas investments.
There’s lots of obtuse and complex provisions in the 2017 tax law, with acronyms like GILTI (Global Intangible Low-Taxed Income), FDII (Foreign Derived Intangible Income) and BEAT (Base Erosion and Anti-abuse Tax). Congress wanted to find a way to convert to a new tax system, essentially known as a hybrid territorial-worldwide system, but it’s literally a full-employment act for tax attorneys as the interaction of the various provisions is often confusing.
A key issue was something called “round-tripping,” in which tech and pharmaceutical companies would develop intellectual property, such as software, in the United States but then manufacture products overseas and sell them to U.S. consumers.
One part of the law (GILTI) was intended to discourage firms from shifting income overseas, while another part (FDII) was intended to keep the ownership of intellectual property in the United States and tax the export of products made in the United States at roughly the same rate. BEAT imposes a minimum tax on outbound foreign payments, including service payments from U.S. companies to their foreign affiliates. There are other provisions, such as accelerated depreciation, to encourage domestic investment. How effective these provisions would be is difficult to predict.
Still, when the bill was passed, the authoritative and nonpartisan Joint Committee on Taxation concluded the net effect of the tax law would be to bring investment by companies back to the United States: “The macroeconomic estimate projects an increase in investment in the United States, both as a result of the proposals directly affecting taxation of foreign source income of U.S. multinational corporations, and from the reduction in the after-tax cost of capital in the United States due to more general reductions in taxes on business income.”
With apologies to the readers who are tax geeks, we are going to try to keep this explanation of how the tax law works as simple as possible.
Before the tax bill, the official U.S. corporate tax rate was 35 percent. It was reduced to 21 percent in the 2017 tax act, with a 10.5 percent minimum U.S. tax rate on global foreign income if a multinational’s foreign tax rate is considered too low. While the old rate was 35 percent in the United States, U.S. taxes on foreign income were, in many cases, close to zero because U.S. multinationals could indefinitely defer U.S. taxes if they kept those profits offshore and because of various ways companies could game the system.
The 10.5 percent tax on overseas income really only comes into play when a foreign country has a low tax rate. That low rate was supposed to be 13.125 percent (though it can be higher because of a complex issue involving the allocation of expenses for foreign tax credit purposes), as 80 percent of those taxes could be credited against the 10.5 percent rate.
For a company that relied on Dutch-Irish sandwiches and similar strategies — often firms with highly mobile intellectual property such as software — the TCJA clearly has raised taxes on foreign income.
But for other companies, much depends on a company’s particular situation. “For example, because of a quirk in the law nobody thought of at the time the law was enacted, the GILTI tax often imposes combined foreign and U.S. tax at an effective rate in excess of 10.5 percent,” said Martin A. Sullivan, chief economist at Tax Analysts. “Other times, because of the blending low- and high-tax income when computing minimum tax, it is still possible to invest in (or shift profits to) a low-tax country and get a zero rate.”
Under the law, the first 10 percent return on assets is exempt from the global tax. Before the law was passed, there had been some bipartisan proposals to shield normal rates of return from a new global tax. Democrats say this provision in the 2017 law creates a perverse incentive to increase real investments abroad.
“Offshoring refers to incentives to move plant and equipment abroad. The new law has two types of offshoring incentives that did not exist previously,” Kimberly A. Clausing, a tax expert at Reed College, said in an email. “The aforementioned GILTI provision is more generous as you have more assets offshore, since the first ten percent of assets is tax free. Thus, every dollar of real plant and equipment gives you more tax free income. Also, a new foreign derived intangible income (FDII) deduction in the law (applying to U.S. export sales) is less generous, the more U.S. assets you have. In combination, those two provisions reward offshoring real investment since the GILTI provision gives you tax benefits that increase with offshore investment and the FDII deduction is more generous as you have fewer U.S. assets.”
Referring to Biden’s remarks, Clausing said she thought “the spirit of these comments is correct,” though “for some particular companies that were especially skilled at exploiting the old system, the new system may actually somewhat raise their foreign tax burdens.”
“Donald Trump’s consistently put the interests of the wealthy and big corporations ahead of the middle class, so it’s no great surprise that the tax bill he championed included provisions for companies to get a major tax cut, or even avoid American taxes altogether, by offshoring production,” Biden campaign spokesman Michael Gwin said. “The proof is in the pudding: His tax bill has incentivized foreign investment over domestic investment, offshoring has increased in key sectors like pharmaceutical production, there has been no progress in halting the use of tax havens and unbelievably Trump has allowed the rate of offshoring by federal contractors to more than double on his watch.”
Economists often say it’s difficult to measure the impact of tax cuts for several years after they take place. In the case of the 2017 tax law, the Treasury Department this year still is issuing final regulations, in some cases bolstering aspects of the law. That has not stopped experts from trying to assess the impact, but the results are inconclusive.
A study issued in May concluded that the tax law was “largely effective” in reducing incentives for U.S. firms to invest overseas. Another study, most recently updated in September, found the law, especially for the companies that received the biggest tax cuts, may “inadvertently incentivize foreign rather than domestic investment for some multinational firms.”
Sen. Charles E. Grassley (R-Iowa.), one of the chief writers of the law, noted in a recent floor speech that “among U.S. multinationals, employment, investment, research and production in the United States has increased at a faster rate in 2018 than the average rate over the past 20 years. Faster than the growth rate of U.S. multinational companies abroad.” That data, via the Bureau of Economic Analysis at the Commerce Department, reflects just one year, 2018, after passage, however.
Several experts said that the success of the tax law must be measured in how it improves on the previous system. All too often, they said, critics look at individual features of the new tax regime and compare them to hypothetical features of the new regime rather than to the world as it was.
Sullivan first exposed how U.S. companies were squirreling away income overseas. “The TCJA, in broad brush strokes, may have reduced the incentive to invest and shift profits abroad,” he wrote in an email. “My guess (subject to change upon new evidence) is that few companies are moving jobs and profits back to the U.S. because of tax reform but because of other issues — like tariffs and supply-chain security concerns — and that the 21 percent rate (as well as other tax benefits from the TCJA) is icing on the cake.”
“As measured relative to pre-TCJA status quo, the TCJA actually results in higher current taxes on foreign earnings. That’s because the TCJA basically repealed the prior system, which allowed for unlimited deferral of foreign earnings, and required immediate taxation of most foreign earnings in the year earned,” said Mindy Herzfeld, a professor of tax law at the University of Florida who has written on Biden’s tax proposals for TaxNotes.com. “For most if not all corporate taxpayers, the incentives for shifting profits and operations offshore are therefore significantly narrowed.”
The Pinocchio Test
This is one of these wonky but important issues for which there is no clear answer, at least at this point. The concerns that Biden raises about the tax law signed by Trump are mostly theoretical at this point and that claim that companies got “a reward for offshoring jobs” is not confirmed in the available data. Economists and tax experts are still puzzling out the long-term impact of these provisions.
Moreover, the law is believed to have broadly reduced incentives to invest overseas, compared to the previous system. Even if it’s possible a new loophole was created, many other loopholes were closed. Biden earns Two Pinocchios, our equivalent of half true. The concerns he raises are worth paying attention to, but he cannot express them with such certainty.
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