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WASHINGTON — At the center of the new climate and tax package that Democrats appear to be about to face is one of the most significant changes to the U.S. tax code in decades: a new minimum tax for corporations that would alter the way the federal government revenues. collects could change and change how the country’s most profitable companies invest in their businesses.
The proposal is one of the last remaining tax hikes in the package Democrats plan to pass along party lines in the coming days. After months of disagreements within the party about raising taxes on the rich or rolling back some of the Republican tax cuts of 2017 to fund their agenda, they have established a long-standing political ambition to ensure that large and profitable companies pay more than $0 in federal taxes.
To accomplish this, Democrats have mimicked a policy most recently implemented in the 1980s: trying to capture tax revenues from companies that report profits to shareholders on their financial statements, while massively using deductions to lower their tax bills.
The re-emergence of the corporate minimum tax, which would apply to what is known as the “book income” that companies report in their financial statements, has led to confusion and fierce lobbying resistance since its announcement last month.
Some initially confused the measure with the global 15 percent minimum tax that Treasury Secretary Janet L. Yellen has promoted as part of an international tax deal. However, that is a separate proposal, which remains pending in Congress in the United States, which would apply to the foreign income of American multinationals.
Republicans have also misleadingly tried to use the tax hike as proof that President Biden was ready to break his campaign promises and raise taxes on middle-class workers. And manufacturers have warned it would impose new charges at a time of rapid inflation.
As a sign of the political power of lobbyists in Washington, the new tax had already been weakened on Thursday evening. At the urging of manufacturers, Arizona Senator Kyrsten Sinema persuaded her Democratic colleagues to keep a valuable deduction called bonus depreciation associated with the purchase of machinery and equipment.
The new 15 percent minimum tax would apply to companies that report annual income in excess of $1 billion to shareholders in their financial statements, but use deductions, credits and other preferential tax treatments to keep their effective tax rates well below the statutory 21 percent. to lower. It was originally projected to bring in $313 billion in tax revenue a decade from now, though the final figure is likely to be $258 billion once the revised bill is finalized.
The new tax could also inject a greater degree of complexity into the tax code, creating difficulties in implementing the law if passed.
“In terms of implementation and just bandwidth to deal with the complexity, there’s no question that this regime is complex,” said Peter Richman, senior attorney-advisor at the Tax Law Center at New York University’s law school. “This is a big change and the turnover is big.”
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Because of that complexity, the minimum corporate tax has been met with a lot of skepticism. It is less efficient than simply abolishing deductions or raising the corporate tax rate and could open the door for companies to find new ways to make their income appear lower in order to lower their tax bills.
Similar versions of the idea have been floated by Mr. Biden during his presidential campaign and by Massachusetts Democrat Senator Elizabeth Warren. They have been promoted as a way to restore fairness to a tax system that has allowed large corporations to drastically reduce their tax bills through deductions and other accounting measures.
According to an early estimate by the unbiased Mixed Tax Commission, the tax would most likely apply to about 150 companies per year, and most of them would be manufacturers. That sparked outrage from manufacturing companies and Republicans, who oppose any policies that roll back the tax cuts they introduced five years ago.
While many Democrats recognize that the corporate tax minimum was not their first choice for tax increases, they have embraced it as a political winner. Oregon Senator Ron Wyden, the chairman of the Senate Finance Committee, shared data from the Joint Committee on Taxation on Thursday showing that in 2019, about 100 to 125 companies reported financial statements in excess of $1 billion, but their effective tax rates were below 5 percent. Average income reported to shareholders in the financial statements was nearly $9 billion, but they paid an average effective tax rate of just 1.1 percent.
“Companies are paying rock bottom prices while reporting record profits to their shareholders,” said Mr. Wyden.
The Treasury Department had reservations about the idea of the minimum tax last year due to its complexity. If passed, Treasury would be responsible for drafting a set of new regulations and guidelines for the new law and for ensuring proper scrutiny by the Internal Revenue Service.
Michael J. Graetz, a tax law professor at Columbia University, acknowledged that calculating minimum taxes was complicated and that introducing a new tax base would create new challenges from the tax administration’s point of view, but he said he didn’t see those obstacles as considered disqualifying. He noted that the current system has created opportunities for tax shelters and companies can take losses for tax purposes that are not on their financial statements.
“If the problem Congress is addressing is that companies report high book profits and low taxes, then the only way to align the two is to base taxes on book profits to some extent,” said Mr. Graetz, a former deputy assistant secretary for tax policy at the Treasury Department, said.
A similar version of the tax was included in a tax review in 1986 and allowed to expire after three years. Skeptics about revisiting such a measure have warned that it could create new problems and opportunities for businesses to avoid the minimum tax.
“Evidence from the results of the 1986 Tax Reform Act studies suggests that companies responded to such policies by changing the way they report financial accounting income — companies deferred more revenue into future years,” Michelle Hanlon, a professor accounting at the Sloan School of Management at the Massachusetts Institute of Technology, told the Senate Finance Committee last year. “This behavioral response poses serious risks to financial accounting and capital markets.”
Other opponents of the new tax have expressed concerns that it would give more control over the US tax base to the Financial Accounting Standards Board, an independent organization that sets accounting rules.
“The potential politicization of the FASB is likely to lead to lower financial accounting standards and lower-quality financial accounting revenues,” Ms. Hanlon and Jeffrey L. Hoopes, a professor at the University of North Carolina, wrote in a letter to members of Congress signed last year by more than 260 accounting graduates.
Business groups have strongly backed down against the proposal and pressured Ms Sinema to block the tax completely. The National Association of Manufacturers and the Arizona Chamber of Commerce and Industry released a poll Wednesday of manufacturing workers, executives and lawyers in the state that showed a majority opposed the new tax.
“It will make it harder to hire more workers, raise wages and invest in our communities,” said Chad Moutray, the chief economist of the production association. Arizona manufacturing voters are clearly saying this tax will hurt our economy.
Ms Sinema has opposed raising tax rates and expressed reservations about a proposal to scale back the special tax treatment hedge fund managers and private equity managers receive for ‘carried interest’. The Democrats scrapped the proposal at her insistence.
When an earlier version of a corporate minimum tax was proposed last October, Ms Sinema . said issued an unqualified statement.
“This proposal is a sensible step to ensure that highly profitable companies — which can sometimes circumvent the current corporate tax rate — pay a reasonable minimum corporate tax rate on their profits, just as ordinary Arizonans and small businesses in Arizona do,” she said. Announcing on Thursday that she would support an amended version of the climate and tax law, Ms Sinema noted that it would “protect advanced manufacturing”.
That garnered support from business groups on Friday.
“Taxing capital expenditures — investments in new buildings, factories, equipment, etc. — is one of the most economically destructive ways to raise taxes,” Neil Bradley, chief policy officer of the US Chamber of Commerce, said in a statement. “While we look forward to reviewing the new bill, Senator Sinema deserves credit for recognizing it and fighting for change.”
Emily Cochrane reporting contributed.