The voices of Tax Policy Center's researchers and staff
After rejecting corporate income tax rate increases to help pay for President Biden’s Build Back Better plan, House Democrats passed a 15 percent alternative minimum tax on the income very large corporations report to their shareholders. This tax on book income would raise about $300 billion over 10 years. But it creates a mess of policy and administrative problems.
Here is one better way: Allow firms to take only, say, 80 percent of the value of their deductions and credits. The idea, which MIT accounting professor Michelle Hanlon suggested on the November 11 episode of TPC’s podcast The Prescription, has multiple benefits over the book tax.
Separating book and tax income
It isn’t perfect either. But it would prevent firms from using tax preferences to pay little or no tax while avoiding many of the pitfalls of the book tax. It would:
- Be less administratively complex.
- Leave defining book income to the independent Financial Accounting Standards Board (FASB) and not Congress.
- Prevent firms from manipulating financial statement earnings to avoid the book tax.
- Discourage other new tax dodges.
- Broaden the corporate tax base without Congress having to take the politically difficult step of explicitly repealing tax preferences.
- Apply to all businesses, not just very large public companies.
Let’s unpack a few of these issues.
Defining book income
The book tax could put Congress in the business of defining financial statement income. That could politicize disclosure and perhaps make corporate finances less transparent to shareholders. This wouldn’t be a problem if Congress instead limits the benefits of the existing tax base.
Another likely consequence of using financial statement income as an alternative tax base: Corporations will avoid the minimum tax by understating or deferring income. That happened the last time Congress enacted a book tax 35 years ago.
Another problem: The House bill already excludes certain preferences from the book minimum tax, such as the research and experimentation tax credit, other general business credits, and certain credits for green energy production. None of these items normally are used to calculate financial statement income.
If lawmakers continue down this road, the book tax base could look suspiciously like the regular income tax base. By capping the value of all preferences, Congress could avoid this problem.
Tax avoidance opportunities
The book tax also would create new opportunities for tax avoidance. For example, mega-companies could avoid most of the minimum tax by contracting out work that requires capital equipment.
The biggest difference between book and tax income is depreciation. Businesses currently can deduct 100 percent of the cost of equipment in the year they acquire it. But firms subject to the book tax would have to take tax depreciation over the investment’s useful life.
Large public companies could avoid this by contracting out activities that use capital assets to smaller corporations or firms organized as pass-throughs. Because those businesses would not be subject to the book minimum tax, they could fully depreciate the equipment in the first year and pass on their lower after-tax costs to their giant corporate customers.
Congress would stop this by limiting the value of tax preferences for all businesses. If necessary, it could exempt small businesses.
Two other changes
Business preferences are substantial and often exceed what companies can use in a given year. In 2018, the $51 billion in general business tax credits included $23 billion for research and experimentation, $12 billion for energy, and $9 billion for low-income housing. About $100 billion in unused tax credits was carried forward from previous years.
TPC estimates that if Congress repealed bonus depreciation but allowed more generous write-offs than economic depreciation, it would raise business taxes by about $45 billion over 10 years.
A tax credit haircut could accompany two other changes that would help prevent corporate tax avoidance.
The first is the package of international reforms already included in the BBB plan.
The second would require public companies to disclose how much tax they actually pay in a given year. Without understanding what drives the differences between book and tax income, it is hard to limit tax avoidance.
Real world solution
In an ideal world, Congress would eliminate or reform inefficient deductions and credits. But in the real world, it probably won’t.
With the book tax, Congress seems to be saying to corporations: We want you to benefit from the tax incentives we created to encourage certain economic activity. But not too much. And if you report earnings to shareholders, we want you to pay some tax on those profits.
If those are the goals, one easy and more direct solution is to make businesses reduce those preferences across the board. It isn’t perfect. But it would be a big improvement over trying to create an entirely new tax on the fly.
Posts and comments are solely the opinion of the author and not that of the Tax Policy Center, Urban Institute, or Brookings Institution.
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