The US 2017 Tax Cut and Jobs Act (TCJA) made significant changes to the US international tax rules by lowering the federal corporate statutory tax rate to 21%, enacting a territorial dividend participation exemption, and including several anti-Base Erosion and Profit Shifting (BEPS) provisions. Pascal Saint-Amans and I had previously called for a lower US corporate tax rate with a “tough” territorial regime. This is my initial assessment of how the 2017 US tax change has addressed the significant profit shifting out of the U.S.
The table below compares the 2017 US tax changes to the key G20/OECD BEPS Action recommendations. The US rules closely followed the BEPS Action 2 (hybrids), Action 3 (CFCs), and Action 4 (Interest).
Even more significant than these specific anti-BEPS provisions is the reduction in the US federal tax rate, which reduces the top combined federal and state statutory marginal corporate tax rate from 38.2% in 2017 to 25.8% in 2018. Instead of the U.S. having the highest corporate tax rate among all developed countries and all OECD countries, the US general tax rate in 2018 will be lower than the tax rates of countries accounting for over 60% of non-US OECD countries’ GDP.
Although the 2017 tax changes reduce the incentives and place limitations on profit shifting out of the U.S., US multinational enterprises (MNEs) will still have some incentive to shift some profits out of the U.S. to benefit from lower tax rates in some other foreign countries. In particular, US transfer pricing rules were not significantly changed by the 2017 legislation, and remain a potential weak link in the tighter anti-BEPS rules.
The GILTI and BEAT provisions were estimated to raise $262 billion over 10 years, and some of the $253 billion from the interest limitation would be from MNEs reducing overleveraging US affiliates with debt. The Joint Committee on Taxation did not separately estimate the revenue effect of reducing BEPS due to lowering the US tax rate.
One unintended effect of the anti-BEPS provisions will be an increase in measured US Gross Domestic Product. BEPS has reduced measured US corporate profits, while increasing import prices into and lowered export prices out of the US due to transfer mispricing and other MNE tax planning. The reduction of BEPS out of the U.S. will increase measured US GDP, even if there is no increase in real GDP from higher capital investment or increased labor supply.
As a simple example, if the U.S. was losing $100 billion of corporate tax revenue annually, then BEPS could have reduced US GDP by 1.5%. If the 2017 tax change reduces BEPS shifting out of the U.S. by one-third, this could increase measured GDP by roughly 0.5%. If the lower US general and “patent box” tax rates encourage some shifting of BEPS into the U.S., then measured GDP could increase even more. In comparison, the JCT estimated that the 2017 tax change would increase GDP by 0.8% over the 10-year period.
I’ve updated the unweighted and GDP-weighted average OECD general corporate tax rates for 2018, including the lower US tax rate, in the table at the beginning of this blog. The US change makes little difference in the unweighted OECD average tax rate, but results in a significant drop from 31.5% in 2017 to 26.3% in 2018 on a GDP-weighted basis. The variation in general tax rates across countries falls sharply with the US tax rate reduction, which is a driver of overall BEPS shifting. A similar reduction in the average and variation in “patent box” statutory tax rates also occurs between 2017 and 2018.
Bottom-line: The US tax changes will reduce the incentives and opportunities for BEPS out of the U.S., but there will remain significant opportunities for MNEs to lower their overall effective tax rates through profit shifting. Continued focus on harmful tax competition, greater transparency and tighter transfer pricing rules, and implementation of the G20/OECD BEPS minimum standards (and some of the other Actions) by all members of the BEPS Inclusive Framework are needed. The fight against BEPS should remain a high priority of the international community, including the U.S.