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The Tax Cuts and Jobs Act of 2017 (TCJA) signed into law by President Donald Trump in December slashed the US corporate tax rate from 35 to 21 percent, starting January 1, 2018. The new law makes the United States a more attractive place for both US and foreign firms to do business. But for US multinational corporations (MNCs), the law is not exactly a New Year’s gift for their operations abroad. To pay for the massive corporate tax cut, estimated to cost $1,349 billion over a decade, the TCJA raises revenue in other areas, most importantly through new taxes on the foreign operations of MNCs. The combination of lower corporate taxes on US production and higher taxes on MNC production abroad reflects Trump’s “Made in America” campaign. But it limits the ability of MNCs to reap the gains to income and jobs derived from producing goods in other countries.
The radical corporate tax cut is a welcome step that puts US federal taxation on par with, or even below, other large advanced countries, such as Canada, France, Germany, Japan, and the United Kingdom. According to the Joint Committee on Taxation (JCT), the projected payoff is an increase in US GDP of 0.7 percent (relative to the baseline scenario) over the next 10 years. Other experts are more optimistic, foreseeing GDP increases of 2.9 percent (above current baseline forecasts) over a decade.[1]
The juxtaposition of the corporate tax cut with other taxes on overseas activities, however, has confused even some tax experts and will no doubt be a boon to accountants as they try to figure out how to take advantage of some measures and circumvent the others.[2]
The TCJA nominally adopts the world norm of territorial taxation. Under a robust territorial system, only income earned in the United States would be subject to US corporate tax. However, the TCJA imposes a 15.5 percent tax on cash and liquid assets accumulated abroad between December 1986 and December 2017 and an 8 percent tax on income reinvested abroad over the same period. These one-time taxes will cost US MNCs $339 billion over the next decade. Prior to January 1, 2018, the tax code permitted MNCs to keep their accumulated earnings abroad indefinitely, never subject to US tax. Under the TCJA, with exceptions stressed in a moment, future foreign earnings will not be subject to US tax, whether retained abroad or returned to the United States. One purpose of this territorial feature is to encourage MNCs to bring their earnings back to the United States and invest them in productive activities at home, but whether that goal will be achieved is far from clear.
However, the TCJA introduces new and complex provisions to combat “profit shifting”—the MNC practice of moving earnings to foreign jurisdictions with lower tax rates than the United States. First is the tax on “global intangible low-taxed income (GILTI),” roughly defined as the combined earnings of foreign subsidiaries in excess of an assumed normal return on tangible business assets, set at 10 percent. The TCJA requires a US MNC to include GILTI in its US tax base and imposes a tax—whether or not the earnings are distributed to the US parent company. However, a foreign tax credit is allowed for 80 percent of foreign income taxes paid with respect to the GILTI income. The idea is to discourage MNCs from locating valuable intangible assets (patents, copyright, trademarks, and trade secrets) in low-tax jurisdictions like Ireland or Switzerland, a practice that has gotten wide negative publicity in recent years. The effective GILTI tax rate (before allowing the foreign tax credit) is 10.5 percent through 2025, then 13.125 percent starting in 2026. The JCT estimates that GILTI will cost US MNCs $112 billion over the next decade.
Closely related to the spirit of the GILTI tax is a new deduction for “foreign-derived intangible income (FDII)”—earnings broadly attributable to licensing US patents and the like to foreign affiliates and other users abroad. The TCJA allows a domestic corporation to deduct 37.5 percent of its FDII from its taxable income. Applying the 21 percent rate on the remaining 62.5 percent after the FDII deduction means that TCJA imposes a 13.125 percent effective tax rate on eligible intangible income from abroad (calculated by a formula that assumes the normal rate of return on tangible assets is 10 percent and anything left over is intangible income). This provision will save MNCs (and cost the Treasury) $64 billion over the next decade. The FDII deduction encourages firms to keep their intangible property in the United States and license its use to related and unrelated enterprises abroad. Obviously, this provision is intended to benefit US companies that conduct all their activities at home, but it will not benefit MNCs that create and retain intangible assets abroad. In a letter to Treasury Secretary Steven Mnuchin, European finance ministers argue that this preferential tax policy could be incompatible with World Trade Organization (WTO) rules by effectively providing an export subsidy.
The TCJA also introduces a “base erosion and anti-abuse tax (BEAT).” The TCJA works like an alternative minimum tax. It requires large firms to calculate what their US taxable income would be if they disregard deductions for cross-border payments to foreign affiliates. To the extent a tax at the rate of 10 percent on this alternative tax base exceeds the tax at the rate of 21 percent on the normal tax base, the firms must pay the difference. The BEAT will cost US MNCs $150 billion over the next decade. European finance ministers argue that this provision will distort international financial markets, given the large amount of intragroup transactions conducted by financial firms.
Adding the tax on past unrepatriated earnings, the GILTI tax, and the BEAT, over the next decade US MNCs will pay $601 billion more under the TCJA than they would have paid under prior law. On the other hand, thanks to the new 21 percent rate, US corporate production in the United States will pay $1,349 billion less, according to JCT estimates. Clearly the TCJA tilts the tax playing field in favor of domestic production and against foreign production, which is consistent with Trump’s “Made in America” agenda. Whether the tilt is good for America—given the benefits of production abroad for jobs and incomes in the United States—is a different question.
Notes
1. See, for example, analysis by the Tax Foundation, “Preliminary Details and Analysis of the Tax Cuts and Jobs Act,” and Seth Benzell, Laurence Kotlikoff, and Guillermo Lagarda, “Simulating the Republican Unified Framework Tax Plan.”
2. See Natalie Kitroeff, “Tax Law May Send Factories and Jobs Abroad, Critics Say,” New York Times, January 8, 2018.
