This story is part of the Prospect’s series on how the next president can make progress without new legislation. Read all of our Day One Agenda articles here.
A year ago, my colleagues and I published a report concluding that 91 profitable Fortune 500 corporations avoided paying any federal corporate income taxes in 2018, the first year that the Trump tax law was in effect.
The law cut corporate tax rates from 35 percent to 21 percent. Proponents claimed it simplified the tax code, when in fact it replaced complicated tax loopholes with newer, equally complicated loopholes, allowing large companies with teams of lawyers and accountants to avoid much or all of the tax. The average federal income tax paid by profitable Fortune 500 companies as a share of their profits in 2018 was just 11.3 percent, far below the statutory 21 percent rate.
The public has long told pollsters that corporate taxes should be increased, not decreased. President-elect Biden won his election after campaigning on a promise to raise taxes on wealthy individuals and corporations. Republican lawmakers who attempt to block this legislative priority could pay a price in the next election, given how popular it is. But what can Biden do in the meantime, if he cannot get a tax bill through Congress?
He can do plenty. Many of the problems with our federal corporate income tax are due to ineffective regulations, misplaced priorities at the IRS, and lack of transparency in corporate financial reporting. The new administration can address these issues without permission from Congress.
Trump’s Unlawful Regulations Expanding Tax Breaks for Corporations
Biden can start with the regulations issued by Trump’s Treasury Department to implement the 2017 tax law. Several legal scholars have concluded that these regulations provide wealthy individuals and corporations even larger tax breaks than the law they implement allows. Biden’s Treasury Department should, at the very least, replace these regulations with ones that follow the law.
This is especially true for the rules affecting multinational corporations. The 2017 law exempts most offshore profits of American corporations from U.S. tax. Some particularly large offshore profits are supposed to be subject to U.S. tax, but at just 10.5 percent, half the 21 percent rate that applies to domestic profits. This legislative language could encourage companies to shift profits and operations offshore. (So much for America First.) But Trump’s Treasury Department made it worse.
When the law was enacted, corporate tax lawyers generally understood that offshore profits would be, in some cases, subject to the minimum U.S. tax of 10.5 percent. They believed that corporations could avoid this tax if they paid taxes to foreign governments on these offshore profits at a rate of at least 13.125 percent. (The law allows corporations to subtract 80 percent of their foreign tax payments from their U.S. tax, and 80 percent of 13.125 percent is 10.5 percent.)
But after the law went into effect, they found that some companies paying foreign taxes at a rate above that are nonetheless required to pay U.S. taxes because of interactions with other arcane tax rules.
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The New York Times reported that, rather than asking Congress to fix what they viewed as a legislative mistake, the affected corporations, including Procter & Gamble, News Corporation, Liberty Mutual, Anheuser-Busch, Comcast, and others, took a shortcut, asking the Treasury Department to issue regulations interpreting the law to say something other than what it actually says.
Secretary Mnuchin obliged and created a “high-tax exception” from taxes for offshore profits that does not exist in the statute. To do so, Mnuchin borrowed a definition of “high-tax”—a foreign tax rate of at least 18.9 percent—from an entirely different part of the law that was not meant to apply in this situation, according to legal scholars.
Evidence of this unlawful giveaway to multinational corporations is now trickling in. Many publicly traded corporations mention the regulatory change and its effect on their tax liability in their recent quarterly financial reports. A few have even explained how much this change has saved them. The Wall Street Journal just reported that “more than 30 companies disclosed more than $300 million in benefits from the regulation.” This is likely just the tip of the iceberg, given that most companies probably are not revealing the impact.
Our own look at quarterly financial reports indicates that just seven companies account for $273 million of that amount, and several companies only reported effects for 2018 and 2019, not 2020. As The Wall Street Journal reported, the recipient with the largest known benefit so far is Philip Morris International, saving $93 million in the previous two years, 2018 and 2019. This is just one example of unlawful regulatory corporate tax giveaways that the Biden administration could easily reverse, forcing potentially billions more in payments.
Investigate the Obvious Candidates for Tax Dodging
America’s corporate income tax was a mess long before the Trump tax law. A lot of that mess can be addressed by the incoming administration without new legislation. In some cases, simply reprioritizing IRS enforcement efforts could help.
When publicly traded corporations publish financial disclosures to investors, they are required to list any tax breaks they claimed that the IRS is likely to deny. (The accounting rules call these “unrecognized tax benefits,” or UTBs.) Corporations are literally announcing breaks they claim that the IRS will probably find to be illegal. And yet, incredibly, corporations in many cases are allowed to keep these tax breaks, simply because the IRS fails to reach a conclusion before the statute of limitations runs out, which can happen in as little as three years.
We recently looked at corporate annual financial reports for 2019 and found that five companies—Chevron, Dell, Eli Lilly, ExxonMobil, and General Electric—kept $1 billion in tax breaks that they previously had admitted were unlikely to withstand scrutiny by the IRS or state tax agencies.
For example, last year, ExxonMobil’s 2019 annual report discloses, the oil giant reduced its (very large) tally of UTBs by $279 million because the statute of limitations had run out on certain tax savings that it took. ExxonMobil’s relationship with tax authorities is like a child telling her parents, “I just did several things you will not approve of,” and the parents not finding the time to investigate.
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Like parents these days, tax authorities are overwhelmed. From 2010 through 2018, lawmakers cut the IRS budget 20 percent in inflation-adjusted dollars, resulting in a 22 percent staff reduction, including 30 percent of the enforcement staff. These cuts are illogical given that every dollar spent on tax enforcement raises several dollars in tax revenue. While Republicans and Democrats do not agree on how our tax laws should be written, they should at least agree to provide adequate funding to enforce the laws in effect right now.
Until that happens, the incoming administration should direct IRS resources away from low-yield audits of low-income tax filers, and toward more audits of large corporations, especially those announcing they are claiming tax breaks that will probably not be allowed.
Ensure Tax Transparency for Publicly Traded Corporations
We know from the financial-disclosure reports of publicly traded corporations that many of them avoid federal income taxes. But we rarely know exactly how they do it. It would be helpful for the public and lawmakers to know how they pull it off, so that we have a better idea of how to reform our tax code.
Corporations are required to provide the IRS with a form explaining why the income they report in their financial disclosures for potential investors differs from the income they report to the IRS. Natasha Sarin and Larry Summers recently argued that the Securities and Exchange Commission should require companies to include this form, the M-3, in their financial disclosures.
Such disclosures could be a game changer for lawmakers seeking a fairer corporate tax. Right now, members of Congress who are angry at Amazon’s near-zero tax rate on billions of dollars of U.S. income simply cannot know which specific tax breaks helped the company achieve this. We know that Amazon has saved over $1 billion using unspecified “tax credits” in the last three years, but we cannot be sure how much of those credits is attributable to the U.S. government, let alone which credits are responsible. When hugely profitable corporations leverage the tax laws to avoid all liability, everyone—from policymakers to the public—should be able to understand how it is happening.