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A letter from tax policy experts to the tax conference committee about corporate tax reform [1]
['More From Author', 'May', 'Minnesota Reformer Staff']
Date: 2023-05-10
Editor’s note: Senate Taxes Chair Ann Rest, DFL-New Hope, announced Saturday she is pulling a major corporate tax reform from a final tax package that lawmakers are expected to vote on soon. In case she wants to reconsider, some tax law experts weighed in this week with an open letter to Rest, House Tax Chair Aisha Gomez and Tax Conference Committee members rebutting claims made by opponents.
We are writing to express our support for Minnesota’s proposed reforms to address the problem of international corporate profit shifting by establishing worldwide combined reporting, or WWCR. We wish to dispel the false narratives that this is a flawed or unworkable policy.
A fair and efficient corporate tax system would not favor the biggest and most profitable corporations over smaller domestic competitors. It would also not advantage and reward the most aggressive tax avoiders over those focused on creating economic value. Yet that is the system Minnesota currently has, and so we are pleased to see Minnesota moving towards a reform that would address the unfairness and inefficiency of its current corporate tax system.
Minnesota is not alone either in its concerns about multinational tax avoidance or in its intent to act.
Over 140 nations have now signed on to similar reforms at the international level, and the U.S. Congress, led by both Democrats and Republicans, has recently enacted two major tax reforms aimed at countering international corporate profit shifting. The first one was part of the 2017 TCJA and the second was part of the IRA, signed by President Biden this summer.
We were pleased to see that both the Minnesota House and Senate recently passed a reform called Worldwide Combined Reporting.
Not only is this reform similar to the ones proposed or adopted at the national and international level, it is in important ways technically superior. It is also administrable and has been upheld by the Supreme Court twice.
The near adoption of WWCR in Minnesota has led to a blizzard of critical claims from corporate tax lobbyists, the Tax Foundation and the editorial board of the Wall Street Journal.
These various groups have made a number of policy arguments that do not hold up to serious scrutiny.
As experts in the field, we will use this letter to briefly explain and establish the positive case for WWCR, and then address these counter-arguments.
Profit shifting refers to tax planning techniques that move profits from the jurisdiction in which it is earned to a lower tax jurisdiction.
For example, imagine Widget, Inc. sells 1 million widgets in Minnesota with a profit margin of $100 each. Instead of paying Minnesota taxes on $100 million in profits, they instead incorporate a subsidiary in a lower-tax jurisdiction and place their intellectual property in that jurisdiction.
The foreign subsidiary then charges the U.S.-based company $90 per widget for use of its IP.
The U.S.-based Widget corporation now records just $10 million of profits in Minnesota.
WWCR would require Widget, Inc. to calculate a single tax base that incorporates each taxpayer’s income and expenses, regardless of where they are located. Minnesota would then tax a share of that combined tax base based on the portion of the group’s sales that occurred within the state. Because all of the related taxpayers’ income and expenses are included in this combined tax base, intercompany transactions like intellectual property leasing do not affect the final calculation. This voids the Widget. Inc. group’s ability to shift income.
The precise magnitude of this problem is difficult to estimate, but the weight of authority shows it is considerable, and that national and international efforts to crack down have had a minimal impact. One prominent estimate suggests $300 billion in corporate profits is currently shifted out of the U.S. tax base annually.
In sum, shifted income reflects economic activity that occurred within the United States and should rightfully be taxed here.
Responses to criticisms of worldwide combined reporting
Claim: The current revenue estimate is methodologically flawed.
Estimated tax revenue is inherently uncertain, but our review of available information suggests no reason to doubt the authority of the Minnesota Department of Revenue on this matter.
Moreover, public critiques by the Tax Foundation, which were later cited by the Wall Street Journal, miss the mark. Specifically:
1. The DOR starts from an estimate of shifted income of $235 billion, which is in line with, and actually a little bit less, than more recent estimates of about $300 billion.
2. The Tax Foundation’s objection to the DOR’s apportionment factor apparently ignores the fact that DOR apportioned just 1% of shifted income to Minnesota, not the 1.8% approximation used by the Institute for Taxation and Policy.
3. The Tax Foundation has criticized the ITEP study for not reducing Minnesota’s share of worldwide income to account for foreign sales. This critique is unjustified because ITEP was only adding back in income that was estimated as having been shifted out of the U.S. Foreign factors would only be required if ITEP was instead adding back in all foreign income and not only that shifted out of the U.S.
In addition to these flaws in critiques of the estimate, there are other reasons to accept the DOR’s figure of about $350 million per year as reasonable.
For instance, California’s Department of Finance has estimated that a move to WWCR would yield over $4 billion per year for California.
Adjusting for the relative size of Minnesota’s economy, this would equate to nearly $500 million in annual tax revenue for Minnesota.
Although a crude approximation, this suggests DOR has presented a reasonable estimate based on the available information.
Claim: WWCR would be difficult or impossible to administer.
There is no doubt that WWCR requires some additional work on the part of taxpayers and governments. But there is little reason to believe it would be especially onerous. For instance, California has long permitted “reasonable approximation” based on ordinary financial records for calculating the income of foreign subsidiaries in connection with WWCR.
Numerous such approximations exist, including information reported to the federal government in connection with federal tax provisions meant to combat income stripping, as well as accounting information likely reported to the federal government in connection with the corporate alternative minimum tax, and sales information reported as part of securities filings.
Furthermore, the evidence adduced in the litigation concerning worldwide combined reporting concluded that the costs involved were “relatively modest.”
Perhaps most convincingly, corporate taxpayers readily perform the necessary calculations when is is to their advantage — in states like California, taxpayers elect WWCR when they record losses abroad that have the effect of reducing their U.S. tax liabilities.
Finally, if accounting burdens on smaller firms are a driving concern, a threshold could be adopted so the policy only applies to filers affected by the federal corporate alternative minimum tax.
Claim: WWCR will hurt Minnesota’s economic competitiveness.
The Wall Street Journal and corporate interest groups have implied that WWCR would hurt local Minnesota businesses. Minnesota’s corporate tax is not based on the residence of corporations; it is based on where a corporation sells its products. A corporation would not reduce its corporate taxes in the state by moving its facilities out of Minnesota; it could only do that by choosing to make fewer profitable sales in Minnesota, which would not be in its economic interest. In fact, ensuring a level playing field between multinational and Minnesota-based companies could improve the environment for local businesses.
Claim: States abandoned WWCR because it was a failed policy.
By the early 1980s, 12 states had adopted WWCR. Large multinational corporations challenged the power of the states to use WWCR and lost twice. At that point, corporations pressured their governments, particularly that of the UK, and the UK pressured the U.S. federal government. The federal government then pressured the states, which abandoned the policy.
States did not abandon WWCR because of policy flaws or administrative challenges.
Claim: WWCR will run into legal challenges.
The Supreme Court has twice upheld the legality of WWCR.
We understand there is some concern about the current court’s relationship to precedent, but we would note that these earlier decisions are grounded on principles of federalism that are less likely to be disturbed by a court interested in protecting the powers of the states.
Claim: WWCR will lead to difficulty with trade partners.
Developments in international tax policy suggest not.
Unlike in the 1980s, the international community and the U.S. federal government now uniformly acknowledge the problem of income shifting and have implemented — or are in the process of implementing — measures analogous to WWCR.
The UK has both a diverted profits tax and a digital service tax in order to combat income stripping, so their objection would seem highly unlikely.
Claim: The fact that the OECD did not adopt WWCR shows it is a bad idea.
In Pillar One of its Base Erosions and Profit Shifting convention, the OECD has adopted a form of WWCR and in particular requires consolidation of very large and profitable multinational corporations.
Second, the OECD reforms are the product of a complicated multilateral negotiation. The precise path that is right for the OECD is not necessarily right for the United States or Minnesota. Indeed, prominent commentators have suggested abandoning some aspects of Pillar One, which would make it more like WWCR.
Claim: WWCR will result in double taxation.
The current regime results in systematic under-taxation and there is no reason to believe that WWCR would lead to systematic overtaxation. This is because Minnesota — or any state that adopts WWCR — will only tax worldwide income in accordance with the percentage of profits earned in its jurisdiction. This is determined by a standard formula, which in Minnesota’s case is based on the share of total global sales that occur within its jurisdiction.
In conclusion we urge lawmakers to ignore the misguided critiques of this sound policy. We applaud Minnesota’s bicameral support for WWCR and hope it will be signed into law. If WWCR does become law, other states may be quick to follow, and we suspect this is the real reason for the explosion of criticisms that we have debunked.
Signed,
Darien Shanske, Martin Luther King Jr. Professor of Law, UC Davis School of Law;
Reuven Avi-Yonah, Irwin I. Cohn Professor of Law & Director, International Tax LLM Program, University of Michigan School of Law;
Howard A. Chernick, doctoral faculty, CUNY Graduate Center;
Kimberly Clausing, Eric M. Zolt Chair in Tax Law and Policy, UCLA School of Law;
David Gamage, professor, Indiana University, Bloomington’s Maurer School of Law;
Hayes Holderness, professor, University of Richmond School of Law;
Erin Scharff, professor, Arizona State University’s Sandra Day O’Connor College of Law;
Kirk Stark, Barrall Family Professor of Tax Law and Policy, UCLA School of Law.
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[1] Url:
https://minnesotareformer.com/2023/05/10/a-letter-from-tax-policy-experts-to-the-tax-conference-committee-about-corporate-tax-reform/
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