There was a lot of fuss in late 2017 when Congress passed the Tax Cut and Jobs Act (TCJA). The legislation was expected to significantly revamp America’s tax system — and hopefully tackle the thorny issue of corporate tax avoidance.
The TCJA undoubtedly ushered in some changes, and lowered America’s headline corporate tax to 21 percent rate, which tracks more closely with other industrialized nations. But after three years, it’s become apparent that the TCJA did little to address the complexities of international taxation. And large corporations are still using a range of tax strategies to shift profits out of the United States.
Essentially, little has changed regarding corporate tax avoidance. And new research by the Coalition for a Prosperous America (CPA) reveals some astounding numbers. CPA scrutinized the Securities and Exchange Commission (SEC) filings of America’s 500 largest public companies.
And they found that in 2019 these companies paid a combined $137 billion in corporate taxes — at an average federal tax rate of only 8.7 percent on pre-tax profit. That’s a stunningly low rate compared to the 21 percent target established by the TCJA.
This shouldn’t come as a total surprise. Multinational corporations — both U.S. and foreign — have long avoided paying their full share of taxes.
It’s a situation that infuriates many Americans, since large corporations can avoid paying their full tax obligation simply by parking profits in offshore tax havens. But as CPA’s study makes clear, the cost to the U.S. Treasury has grown significantly.
What if the TCJA had actually solved this problem of corporate tax avoidance? And what if these 500 companies had been fully taxed on the massive profits earned from their sales in the U.S. market?
According to CPA, a system that fully taxed these companies’ U.S. profits would have meant an additional $97.8 billion delivered to the U.S. Treasury in 2019. That translates into a 59 percent increase in federal corporate tax revenues.
Unfortunately, multinational enterprises are still able to stash much of their profit in tax-haven countries. Thanks to a longstanding principle known as “arm’s length,” these companies can justify allocating their profits to tax havens in countries like Bermuda and the Cayman Islands.
And so, even when they sell vast amounts of product in the U.S. market, they can transfer much of the resulting profit to subsidiaries in low-tax countries.
Clearly, a better system is needed for the United States — particularly at a time when the U.S. Treasury is running perpetually short on cash. The answer may be surprisingly simple, though — adopting the sales-based taxation system currently used by a majority of U.S. states.
Right now, most of the 50 states use a “destination-based” corporate tax system known as “Sales Factor Apportionment” (SFA). Under SFA, a company is required to pay taxes on the profits from its sales in that state, regardless of where it might be physically located.
Although states are reviewing state-level loopholes in the digital tax era, extending an SFA system to the national level would mean the U.S. government taxing all corporate profits in the same manner.
Essentially, whatever profits a company earns on sales in the U.S. market would face a federal corporate tax — no matter the subsidiary entities involved, or the possible tax havens.
If the U.S. moved to an SFA system, that could help to reverse long-standing incentives for offshoring. Tax havens would no longer serve a practical purpose since both domestic companies and multinationals would finally bear the same tax obligation.
And that should be the goal of any equitable tax policy. It should also be the response to decades of lost tax revenues, thanks to exploitation of the “arm’s length” principle.
The United States should finally get its federal tax system right, and do so by adopting an SFA. Doing so would help domestic companies compete fairly against larger multinational corporations.
And that should be a priority for Washington at a time when U.S. manufacturers and their workers are struggling against subsidized overseas producers.