The voices of Tax Policy Center's researchers and staff
The new minimum tax on the income that very large corporations report to their shareholders is the revenue centerpiece of the recently enacted Inflation Reduction Act (IRA). But the levy does much more than promise to raise more than $200 billion in new revenues. It also generates profound questions about the nature of corporate accounting and tax policy in an era of rapidly evolving commerce.
The new law requires companies with at least $1 billion in annual revenues to pay the greater of the regular corporate income tax or a 15 percent minimum tax. The tax base for the minimum tax is income firms report to shareholders (book income) with many important adjustments. These firms must now report taxable income under two separate systems, neither of which necessarily reflects economic income.
The new tax reduces some distortions in our income tax system, but it adds others. While many tax experts describe this new add-on tax as second or third best choice, they can’t agree on the first best. It is a challenge for four related reasons:
- The difficulty of measuring capital income
- The dependence of tax authorities on corporate incentives to report income accurately to shareholders
- The political incentive for Congress to provide subsidies through the tax system rather than direct spending
- The challenges of measuring global income without resorting to book income
Capital income and profits always have been difficult to measure. For example, book depreciation often is described as economic depreciation. But, in reality, neither book nor taxable income adjust for the effect of inflation when measuring the declining value of depreciable assets.
Fortunately for tax authorities, businesses want to measure economic returns as accurately as possible. Owners want to know the return on their investment. Managers need accurate accounting to allocate resources to the most profitable activities. Financial accounting is largely built to meet these needs and taxable income is largely built upon book income.
But there often are big gaps between the two, thanks partly to choices made by elected officials. After all, lawmakers like to use the tax code to pursue economic and social goals. And they favor tax subsidies over spending because it looks like they are shrinking the size of government.
A great deal of the recent minimum tax debate was over what subsidies to exclude from the new levy. Among the winners were green energy credits and various special cost recovery tax breaks to encourage certain capital investments.
The evolution of multinational corporations further complicates tax and accounting policy. In addition to IRA, the 2017 Tax Jobs and Cuts Act (TCJA) and the Biden Administration’s recent efforts to create a global minimum corporate tax both try to tackle exceedingly complex issues of where income is earned and taxed. (Note: the IRA’s minimum tax is different from a global minimum tax.)
Both the Biden initiative and IRA rely on book rather than taxable income because it tends to be measured more uniformly across countries and because public companies have powerful incentives not to underreport it.
Traditional tax reform focused on eliminating tax subsidies rather than adding them to a minimum tax. Usually, that is a far better approach. But in some contexts, such as trying to measure taxable income from hundreds of foreign sources, it may be administratively impossible. And ending these subsidies has proven a political non-starter in recent decades. Indeed, Congress keeps adding to them.
Given those realities, how could the system be improved?
To start, both financial and tax accounting should treat tax credits as outlays rather than reductions in tax. Business outlays and tax credits should be added to the outlay account of government and to the financial and taxable income of firms, even those that are nonprofits or unprofitable.
Unlike deductions, deferrals, and exclusions, tax credits aren’t hard to value and generally don’t affect the measure of income. Treating credits as outlays would also clarify the distinction between the effective tax rate reported in both financial and tax accounting and the effective amount of subsidies the government provides.
Over the past five years, governments here and abroad have begun to come to grips with the growth of multinational corporations and the movement of investment from plant and equipment to invention and human capital.
The pressures on financial and tax accounting have only just begun.
Posts and comments are solely the opinion of the author and not that of the Tax Policy Center, Urban Institute, or Brookings Institution.
AP Photo / Susan Walsh