Summary: The House Ways and Means Committee reforms proposed as part of budget reconciliation would more than triple the U.S. tax rate on multinationals’ foreign income and produce a higher rate than a proposed global agreement currently being negotiated through the OECD.
Key Points
The Tax Cuts and Jobs Act of 2017 (TCJA) taxation of multinationals’ foreign income maintained a similar overall tax burden: both before and after TCJA, multinationals paid an effective U.S. tax rate of around 2 percent on their foreign income.
The House Ways and Means Committee reforms proposed as part of budget reconciliation would more than triple the U.S. tax rate on multinationals’ foreign income, from around 2.1 percent to 7.4 percent, averaged by foreign income across industries. If the U.S. instead adopted the draft OECD proposal, U.S. multinationals would pay a residual U.S. tax rate of 6.1 percent.
The future competitiveness of U.S. multinational firms depends critically on whether other OECD countries also increased their tax rates.
Introduction
Effective tax rates (ETRs) reflect the amount of tax paid on a dollar of income, accounting for tax credits, differences between actual income and taxable income, and other factors that cause the true tax burden to differ from the statutory tax rate.1
Prior to passage of TCJA in 2017, all foreign income was notionally subject to tax at the statutory rate of 35% as it was earned. But foreign income was generally not recognized for U.S. tax purposes unless paid out as a dividend to U.S. taxpayers (repatriated), and multinationals could defer U.S. taxes on most foreign income indefinitely by retaining it in foreign affiliates. Under this system, multinationals could minimize or eliminate their U.S. tax liability through judicious timing of repatriations. In aggregate, PWBM estimates that multinationals paid ETRs (excluding Subpart F income) between 1.4% and 2.8%, or less than one tenth of the statutory rate of 35%.
The option to defer taxation indefinitely, combined with the expectation of eventual tax “holidays” on foreign income, led to the accumulation of substantial amounts of un-repatriated income abroad. Though nominally controlled by foreign affiliates, this income was typically deposited in U.S. banks or invested in U.S. assets. Major multinationals could generally access this income through the financial system and use it as though it had been repatriated, including to pay dividends or finance domestic investment. Less financially sophisticated firms, however, faced a choice between paying the statutory rate of 35%, holding a stock of accumulated earnings abroad, or reinvesting such earnings in their foreign operations. In all cases, the tax planning incentives created by deferral resulted in additional complexity and cost.
The pre-TCJA international tax regime is commonly referred to as a worldwide system because foreign income was notionally subject to tax as it was earned. In practice, recognition of most foreign income was deferred with no tax paid, resulting in what was effectively a territorial system for most major multinationals.
After TCJA
The regime introduced by TCJA is generally commonly to as a territorial system because most foreign income is exempt from tax upon repatriation. However, some foreign income is taxed as it is earned, with no option of deferral. While this income is taxed at a preferential rate, mandatory current inclusion of foreign affiliates’ income in U.S. parents’ taxable income results in what is effectively a worldwide system for many multinationals. According to a former House senior tax counsel who played a leading role in the development of TCJA, “Most U.S. [multinationals] believe we moved the system closer to pure worldwide even if we messaged it as moving closer to territorial.”
TCJA introduced a minimum tax on multinationals’ foreign income through the Global Intangible Low-Taxed Income (GILTI) regime. Taxes on GILTI are determined on an aggregate basis, based on a taxpayer’s consolidated global operations. Income from profitable foreign affiliates can be offset by losses from other affiliates, and tax credits from high-tax affiliates can be used to offset liability arising from low-tax affiliates.
This aggregate determination of tax liability is consistent with a multinational operating in multiple countries for business reasons – for example, a manufacturing facility in a low-cost country and a sales office in a market country. However, aggregate determination also allows a multinational to benefit from shifting income to tax havens, as foreign taxes paid in high-tax jurisdictions can be used as a credit against U.S. residual tax on tax haven income.
Proposed Changes by U.S. House and OECD
The U.S. is currently the only OECD country that imposes a minimum tax on the foreign income of its multinationals. A recent proposal from the House Ways and Means Committee would magnify this difference, increasing the tax burden on U.S. corporations’ foreign income to finance increased spending and cuts in other taxes as part of a budget reconciliation package. However, ongoing negotiations through the OECD/G20 Inclusive Framework on BEPS would – if successful – lead to the adoption of a global minimum tax by more than 130 countries, including the home countries of nearly every major foreign multinational.
Both the recent Congressional proposal and the proposed global minimum tax under negotiation through OECD would shift the determination of taxes on foreign income from an aggregate basis to a country-by-country basis. Instead of treating a multinational as single global entity with components in various jurisdictions, its activities in each country would be treated as independent operations. Minimum tax would be imposed separately for each country rather than on a consolidated basis. Under country-by-country determination, tax haven income is taxed at the minimum rate regardless of taxes paid elsewhere.
Table 1 presents estimated ETRs in 2022 and other information under alternative international tax regimes: current law, the pre-TCJA regime, and three proposed reforms that would raise revenue. Row 1 shows the rate of residual tax imposed by the U.S. on foreign income, on top of taxes already paid to foreign governments. Row 2 shows the total ETR, including both U.S. and foreign taxes. Row 3 shows the projected 10-year change in revenue for the three proposed alternatives. Rows 4 to 15 detail the parameters of each international tax regime. These projections are preliminary as they are based on current information available for House and OECD proposals; we will update these estimates as new details.
Table 1: Estimated 2022 ETRs Under Alternative International Tax Regimes
| Current law | Pre-TCJA equivalent* | House proposal | House proposal without country-by-country | OECD Pillar 2 | ||
|---|---|---|---|---|---|---|
| 1 | Residual US ETR on MNEs' foreign income | 2.1% | 1.4 - 2.8% | 7.4% | 5.1% | 6.1% |
| 2 | Combined US and foreign ETR on MNEs' foreign income | 12.7% | 12 - 13.4% | 18% | 15.7% | 16.7% |
| 3 | Revenue, 2022-2031, changes to GILTI and FDII (billions) | - | - | 256 | 107 | 144 |
| 4 | Corporate tax rate | 21% | 35% | 26.5% | 26.5% | 26.5% |
| 5 | GILTI deduction | 50% | Deferral | 37.5% | 37.5% | 43.4% |
| 6 | FTC haircut | 20% | 0% | 5% | 20% | 0% |
| 7 | GILTI effective statutory tax rate | 10.5 - 13.125% | 35% | 16.6 - 17.4% | 16.6 - 20.7% | 15% |
| 8 | Deduction for return on tangible assets | 10% | 0% | 5% | 5% | 7.5% |
| 9 | Deduction for return on labor | 0% | 0% | 0% | 0% | 7.5% |
| 10 | Country-by-Country | No | No | Yes | No | Yes |
| 11 | NOL carryforwards | No | No | Yes | No | Yes |
| 12 | FTC carryforwards | No | Yes | Yes | No | Yes |
| 13 | Include FOGEI in GILTI | No | Yes | Yes | Yes | Yes |
| 14 | FDII deduction | 37.5% | 0% | 21.875% | 21.875% | 37.5% |
| 15 | FDII effective statutory tax rate | 13.125% | 35% | 20.7% | 20.7% | 16.6% |
Source: PWBM
Notes: Foreign income includes all income of foreign affiliates except Subpart F income.
ETR = effective tax rate; MNE = multinational enterprise.
* Pre-TCJA policy is mapped to approximate post-TCJA-equivalent concepts. ETRs reflect U.S. residual tax paid in a given year on all foreign income (except Subpart F income) and are given as a range to reflect annual variability in the timing of repatriations.
The proposed reforms would lead to substantially higher minimum ETRs than the current GILTI regime. The House proposal would impose a country-by-country minimum tax of between 16.6 and 17.4 percent. PWBM estimates that if this proposal were adopted, the residual U.S. tax rate on multinationals’ foreign income would rise from 2 percent under current law to 7.4 percent.
The draft OECD proposal would impose a country-by-country minimum tax of 15 percent. PWBM estimates that if the U.S. were to conform its minimum tax to the OECD proposal, the residual U.S. tax rate on multinationals’ foreign income would rise from 2 percent under current law to 6.1 percent.
Figures 1, 2, and 3 report estimated country-level ETRs in 2022 for major foreign jurisdictions where U.S. multinationals report income, for current law and the alternative tax regimes. Because U.S. taxes are assessed at the group level and a multinational group may operate in multiple countries, U.S. tax liability is not directly attributable to specific countries. The plotted ETRs reflect an estimate of the additional tax resulting from scaling up global operations such that net income is $1 higher, holding all else constant.
Figure 1 shows ETRs for the recent House Ways and Means proposal. Figure 2 reports an alternative which retains all elements of the Ways and Means proposal except the shift to country-by-country. Country-by-country determination effectively eliminates any benefit of reporting income in a low-tax country. Under aggregate determination, such benefits are reduced but not eliminated.
Figure 1: Effective tax rates on foreign income, Current law vs. House proposal
Note: Foreign income includes all income of foreign affiliates except Subpart F income.
Figure 2: Effective tax rates on foreign income, Current law vs. House proposal without country-by-country
Note: Foreign income includes all income of foreign affiliates except Subpart F income.
Figure 3: Effective tax rates on foreign income, Current law vs. OECD Pillar 2
Note: Foreign income includes all income of foreign affiliates except Subpart F income.
Competitiveness
The U.S. House Ways and Means proposal as part of budget reconciliation would more than triple the U.S. tax rate on multinationals’ foreign income, from around 2.1 percent to 7.4 percent, averaged by foreign income across industries. The House proposal would tax U.S. multinationals at a higher rate than the proposed global agreement currently being negotiated through the OECD. If the U.S. instead adopted the draft OECD proposal, U.S. multinationals would pay a residual U.S. tax rate of 6.1%.
The future competitiveness of U.S. firms depends on whether other countries adopt the OECD proposal.
Case 1 -- U.S. status quo / OECD status quo: If neither the U.S. nor OECD countries changed their tax regimes, U.S. companies would continue to face a small disadvantage, as under current law.
Case 2 -- U.S. status quo / OECD adopts OECD proposal: If the U.S. retained its current minimum tax regime while other countries adopted the OECD proposal, U.S. multinationals would gain an advantage in terms of competitiveness and relative profitability, compared with a small disadvantage under current law.
Case 3 -- U.S. adopts House / OECD adopts OECD proposal: If the U.S. adopted reforms recently proposed by the House Ways and Means Committee while OECD countries adopted the OECD proposal, U.S. multinationals would face a generally level playing field, albeit a small disadvantage similar to current law discussed in Case 1.
Case 4 -- U.S. adopts House / OECD status quo: If the U.S. substantially adopts the House proposal, but OECD countries maintain status quo, U.S. multinationals would face a meaningful competitive disadvantage. Notably, foreign multinationals could continue to exploit tax havens to increase their profitability, while U.S. multinationals would not be able to take full advantage of such tax planning opportunities.
Students of economics will quickly recognize these potential “payoffs” as being consistent with the classic Prisoner’s Dilemma game from the field of game theory. In that setting, Case 1 is the “dominant strategy equilibrium” if the game is played only once. However, Case 4 can emerge if the game is (i) repeated many times and (ii) international sanctions are created to punish countries that “cheat” by lowering their tax rate. However, Case 4 also requires substantial cooperation across many countries, including from traditional tax havens like Ireland that have not yet agreed to the OECD proposal.
This analysis was conducted by Alexander Arnon and Zheli He. Prepared for the website by Mariko Paulson.
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We calculate the ETR on foreign income as the ratio of income taxes paid or accrued to foreign financial (book) income. Taxes paid or accrued include both foreign and U.S. taxes, except taxes on Subpart F income. Foreign income includes all income earned by U.S. multinationals outside of the U.S., except Subpart F income. We exclude Subpart F income because it is treated separately from other foreign income and is generally taxed as though it were domestic income. ↩
CountryIncomeForeign Tax RateCurrentlawHouseproposal Ghana1355.516430.1153256850.115325680.15952905 Mauritius1237.569340.0436317770.085564440.16285396 Morocco190.837650.189032860.189032860.18903286 Zambia63.393510.1948237140.194823710.19482371 Americas,othercountries7395.161450.0785710360.09645270.14014102 Barbados12324.806760.0029709860.042931140.13870565 Bermuda98565.344960.0047366570.054657410.16273773 Canada41769.946380.1748665550.174866560.17486656 CaymanIslands54175.101020.0035340740.050469870.15824116 Chile4778.322390.144000620.144000620.16554434 CostaRica3425.880370.0449606920.073589520.15753748 DominicanRepublic821.128110.0824484550.095046680.15588432 Honduras591.116770.0629109880.080956410.15776821 Panama854.309370.0968886370.09911850.14921294 Paraguay65.842640.185482750.185482750.18548275 PuertoRico37772.641620.0147079210.06601760.16001947 Uruguay429.151890.111358070.119362750.13576371 Venezuela154.267240.0722219950.078850710.072222 VirginIslands91.693480.0409241530.054887190.04092415 HongKong16575.597650.100603110.109334520.16302571 Israel4495.098260.1819816570.181981660.18198166 Korea,Republicof(South)6350.492030.0692711360.083160880.14413581 Lebanon78.039460.0906186780.109488540.15802542 Macau3422.715040.0026468660.011639560.12328866 Malaysia4984.793940.1829032710.182903270.18290327 SaudiArabia886.678250.1433850920.143385090.15794799 Singapore83516.108490.0388782540.078449480.16167993 SriLanka82.706450.1124159910.118062520.16389572 Taiwan3866.931970.1858923680.185892370.18589237 UnitedArabEmirates2771.0420.0234391270.023439130.13444375 Vietnam882.761320.1250485380.125307090.1614352 Bosnia-Herzegovina16.89330.0676869690.084920340.12604761 Bulgaria236.632030.0858569740.085856970.13028817 Croatia163.778160.1417553190.141755320.16776315 Cyprus885.114370.0277921820.075574910.11357672 CzechRepublic1503.331250.1690351610.169035160.17276054 Europe,othercountries58271.787890.0027126070.064170580.16072517 Finland1058.673320.1726667570.172666760.17349708 Hungary2092.031510.1647159820.164715980.17245691 Ireland59233.744380.1269893940.126989390.16619275 Latvia20.767690.0972009840.103307120.14432122 Lithuania260.115090.1479950420.147995040.1689853 Luxembourg61562.147420.0161377110.052415330.12058346 Netherlands71284.421670.0559699250.073378060.13964113 Norway2970.515690.1238369080.123836910.13840958 Poland3268.151070.1783903360.178390340.17839034 Romania726.278970.1550203180.155020320.16562806 Serbia145.063980.1558327610.155832760.16725614 Slovenia73.258190.1606694320.160669430.16882458 Switzerland63062.558970.0655650830.085484360.15575803 UnitedKingdom92380.820520.1126808240.11320090.13523282
CountryIncomeForeign Tax RateCurrentlawHouseproposal ex.country-by-country Ghana1355.516430.1153256850.115325680.14802728 Mauritius1237.569340.0436317770.085564440.12124486 Morocco190.837650.189032860.189032860.19547769 Zambia63.393510.1948237140.194823710.2004525 Americas,othercountries7395.161450.0785710360.09645270.13848127 Barbados12324.806760.0029709860.042931140.08083532 Bermuda98565.344960.0047366570.054657410.1010227 Canada41769.946380.1748665550.174866560.18479512 CaymanIslands54175.101020.0035340740.050469870.09902639 Chile4778.322390.144000620.144000620.16238459 CostaRica3425.880370.0449606920.073589520.11522604 DominicanRepublic821.128110.0824484550.095046680.13126777 Honduras591.116770.0629109880.080956410.12129074 Panama854.309370.0968886370.09911850.12492331 Paraguay65.842640.185482750.185482750.18901074 PuertoRico37772.641620.0147079210.06601760.10200605 Uruguay429.151890.111358070.119362750.1531487 Venezuela154.267240.0722219950.078850710.13142153 VirginIslands91.693480.0409241530.054887190.09606805 HongKong16575.597650.100603110.109334520.14540572 Israel4495.098260.1819816570.181981660.18977868 Korea,Republicof(South)6350.492030.0692711360.083160880.11834367 Lebanon78.039460.0906186780.109488540.14499134 Macau3422.715040.0026468660.011639560.05499369 Malaysia4984.793940.1829032710.182903270.19044808 SaudiArabia886.678250.1433850920.143385090.16423854 Singapore83516.108490.0388782540.078449480.11480181 SriLanka82.706450.1124159910.118062520.15312464 Taiwan3866.931970.1858923680.185892370.19020659 UnitedArabEmirates2771.0420.0234391270.023439130.09226985 Vietnam882.761320.1250485380.125307090.15284252 Bosnia-Herzegovina16.89330.0676869690.084920340.11875091 Bulgaria236.632030.0858569740.085856970.10181747 Croatia163.778160.1417553190.141755320.16595053 Cyprus885.114370.0277921820.075574910.1122699 CzechRepublic1503.331250.1690351610.169035160.18025793 Europe,othercountries58271.787890.0027126070.064170580.1006466 Finland1058.673320.1726667570.172666760.18022512 Hungary2092.031510.1647159820.164715980.18066518 Ireland59233.744380.1269893940.126989390.15951819 Latvia20.767690.0972009840.103307120.13210296 Lithuania260.115090.1479950420.147995040.17090362 Luxembourg61562.147420.0161377110.052415330.10382299 Netherlands71284.421670.0559699250.073378060.12286053 Norway2970.515690.1238369080.123836910.1519035 Poland3268.151070.1783903360.178390340.18528795 Romania726.278970.1550203180.155020320.16806311 Serbia145.063980.1558327610.155832760.17009388 Slovenia73.258190.1606694320.160669430.17165095 Switzerland63062.558970.0655650830.085484360.12765698 UnitedKingdom92380.820520.1126808240.11320090.13790547
CountryIncomeForeign Tax RateCurrentlawOECDPillar2 Ghana1355.516430.1153256850.115325680.13598073 Mauritius1237.569340.0436317770.085564440.14501386 Morocco190.837650.189032860.189032860.18903286 Zambia63.393510.1948237140.194823710.19482371 Americas,othercountries7395.161450.0785710360.09645270.10975335 Barbados12324.806760.0029709860.042931140.1176146 Bermuda98565.344960.0047366570.054657410.15003759 Canada41769.946380.1748665550.174866560.17486656 CaymanIslands54175.101020.0035340740.050469870.14482432 Chile4778.322390.144000620.144000620.14553155 CostaRica3425.880370.0449606920.073589520.13583716 DominicanRepublic821.128110.0824484550.095046680.1335238 Honduras591.116770.0629109880.080956410.13870412 Panama854.309370.0968886370.09911850.13360405 Paraguay65.842640.185482750.185482750.18548275 PuertoRico37772.641620.0147079210.06601760.14250606 Uruguay429.151890.111358070.119362750.11135807 Venezuela154.267240.0722219950.078850710.072222 VirginIslands91.693480.0409241530.054887190.04092415 HongKong16575.597650.100603110.109334520.14441102 Israel4495.098260.1819816570.181981660.18198166 Korea,Republicof(South)6350.492030.0692711360.083160880.11722558 Lebanon78.039460.0906186780.109488540.12752409 Macau3422.715040.0026468660.011639560.0903694 Malaysia4984.793940.1829032710.182903270.18290327 SaudiArabia886.678250.1433850920.143385090.14338509 Singapore83516.108490.0388782540.078449480.14257399 SriLanka82.706450.1124159910.118062520.1341934 Taiwan3866.931970.1858923680.185892370.18589237 UnitedArabEmirates2771.0420.0234391270.023439130.10469953 Vietnam882.761320.1250485380.125307090.13607751 Bosnia-Herzegovina16.89330.0676869690.084920340.09120403 Bulgaria236.632030.0858569740.085856970.0952493 Croatia163.778160.1417553190.141755320.14536429 Cyprus885.114370.0277921820.075574910.09380441 CzechRepublic1503.331250.1690351610.169035160.16903516 Europe,othercountries58271.787890.0027126070.064170580.14529259 Finland1058.673320.1726667570.172666760.17266676 Hungary2092.031510.1647159820.164715980.16471598 Ireland59233.744380.1269893940.126989390.14664428 Latvia20.767690.0972009840.103307120.10892119 Lithuania260.115090.1479950420.147995040.14799504 Luxembourg61562.147420.0161377110.052415330.10945952 Netherlands71284.421670.0559699250.073378060.12304335 Norway2970.515690.1238369080.123836910.12383691 Poland3268.151070.1783903360.178390340.17839034 Romania726.278970.1550203180.155020320.15502032 Serbia145.063980.1558327610.155832760.15583276 Slovenia73.258190.1606694320.160669430.16066943 Switzerland63062.558970.0655650830.085484360.13503922 UnitedKingdom92380.820520.1126808240.11320090.11268082
This article delves into international tax reforms proposed by the House Ways and Means Committee and compares them with the ongoing negotiations via the OECD for a global tax agreement. It's a complex topic requiring an understanding of taxation principles, international economics, and policy implications. Let's break down the concepts:
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Effective Tax Rates (ETRs): The amount of tax paid on a dollar of income, considering various factors like credits, differences between actual and taxable income, etc. It's vital in understanding the true tax burden.
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Pre-TCJA Taxation of Multinationals: Before the Tax Cuts and Jobs Act of 2017 (TCJA), foreign income was subject to a nominal tax rate of 35%, but often not recognized for U.S. tax purposes unless repatriated. Multinationals deferred U.S. taxes on most foreign income, resulting in significantly lower ETRs (1.4% - 2.8%).
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TCJA's Impact: TCJA shifted to a territorial system exempting most foreign income upon repatriation but introduced the Global Intangible Low-Taxed Income (GILTI) regime, imposing a minimum tax on certain foreign income.
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House Ways and Means Committee Proposal: Aims to increase the tax rate on multinationals’ foreign income significantly, potentially tripling it to around 7.4%. This proposal contrasts with the OECD's draft proposal, setting the U.S. rate at 6.1%, reflecting ongoing global negotiations.
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Competitiveness and OECD Proposal: The competitiveness of U.S. multinational firms depends on the global adoption of proposed tax reforms. The House proposal could put U.S. multinationals at a disadvantage if not globally embraced.
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Country-by-Country Tax Determination: The shift from aggregate to country-by-country determination for tax rates aims to reduce the benefits of reporting income in low-tax jurisdictions.
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ETRs Under Different Regimes: Table 1 and Figures 1, 2, and 3 illustrate estimated ETRs under various international tax regimes, comparing current law, pre-TCJA, House proposal, OECD Pillar 2, etc., and how they impact competitiveness.
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Game Theory and Global Taxation: Analyses the potential outcomes based on different scenarios (Cases 1 to 4), highlighting the dynamics similar to the Prisoner’s Dilemma from game theory in international tax policies.
This article navigates through the intricate landscape of international tax policies, showcasing the implications of proposed reforms on multinational corporations, tax revenues, and global competitiveness. Understanding these concepts helps grasp the complexities of international tax systems and their global economic impacts.
