In March, US president Joe Biden announced to great fanfare a $2tn upgrade of the country’s crumbling infrastructure. The business tax hikes he has proposed to pay for the improvements have been met with somewhat less enthusiasm. The government wants to increase the 21% corporate rate to 28%, making the US’s combined federal–state tax rate the highest in the OECD. The country’s multinationals already face the unique burden of paying taxes — a not insubstantial 10.5% — on foreign earnings. Mr Biden wants to double those contributions to 21%.

These two changes, which are accompanied by a bevy of other reforms, have drawn the ire of corporate America. Experts note that Mr Biden has tabled policies that no country has tried to enforce before. “We are in new territory in terms of taxing the richest Americans and biggest companies,” says Gary Hufbauer, non-resident senior fellow at the Peterson Institute for International Economics. Taken as a whole, economists believe the ‘Made in America Tax Plan’ is misguided and will be accompanied by a litany of unintended consequences. 

Layered negative incentives

The changes purportedly aim to make the US more competitive and target multinational corporations (MNCs) by eliminating incentives to offshore operations. But the Tax Foundation, a think tank based in Washington DC, estimates that a 28% corporate rate would cut the country’s long-term economic output by 0.8% and eliminate 159,000 jobs. A higher headline rate is also tipped to hit local businesses more than those operating overseas. “Domestic business doesn’t have access to loopholes through the likes of international profit shifting. So, they would be the ones to suffer most — especially the profitable smaller and medium-sized ones,” says Dame DeAnne Julius, a senior adviser to Chatham House.

What could help level the playing field, she notes, is doubling the levy imposed on MNCs’ overseas profits. The global intangible low-taxed income, fittingly known by the abbreviation Gilti, was introduced in 2017 and aims to stop firms booking profits and shifting jobs to low-tax countries. Plans to lift the surcharge to 21% has helped reignite the OECD’s stalled project to set a global minimum corporate tax rate (see page 38), but international agreement is not guaranteed and observers believe Mr Biden is risking much by going it alone.

Mr Hufbauer, a former Treasury official, says “making MNCs with overseas production a villain is misplaced”, pointing to research showing they create more US jobs and invest more than their homebody counterparts. Daniel Bunn, the Tax Foundation’s vice president of global projects, argues the reforms collectively create barriers to MNC investment at home. “The tax wedge on that investment is going to be larger, both because of the tax on the foreign earnings and the higher domestic rate,” he says. “That is layered negative incentives on investment.” 

Head-scratching reforms

Contrary to successive US governments’ goal, many argue the reforms discourage reshoring. “If you can get a foreign rate of 21% and your domestic rate would be 28%, then maybe it makes sense to leave your stuff offshore and make new investments overseas,” says Mr Bunn. Some are also scratching their heads over the decision to abolish today’s 13.5% reduced rate for foreign income earned from intellectual property kept within the country. “It seems to me that the big incentive [was] to conduct research and development in the US, and license use of the patent or copyright abroad,” observes Mr Hufbauer.

Another change that might backfire is the crackdown on inversions — a deal structure whereby US firms redomicile by being acquired by small businesses in low-tax jurisdictions. Mr Hufbauer argues that raising hurdles to inversions encourages tech start-ups to move overseas from the outset. “That effect would not be felt during the Biden administration, but I think the Apples, Googles and Facebooks of tomorrow, early in their life, would be advised by their accountants to consider setting up headquarters someplace else,” he says.

However, others insist that America’s abundance of risk capital means taxes alone will not deter capital-hungry, early stage businesses. “If you have a new idea or invention, deciding where to grow your business is a matter of where you can get the best investment deal. And there is no place that compares with the US on that,” says Ms Julius. 

Still as attractive

The side effects of these reforms extend beyond national borders. Plans to scrap the exemption of the first 10% return on tangible investments from the Gilti surcharge will, according to Mr Bunn, “be a huge burden on business investment in developing countries”. Indeed, in these markets, investments in physical assets are more common than intangibles, and the required rate of return is often higher than advanced economies. 

Julie Teigland, EY’s managing partner for the Europe, Middle East, India and Africa, says Mr Biden’s actions are being watched closely by European companies because the US is a material market. “What happens with their operations has an impact on their headquarters, activities elsewhere, tax strategies and tax planning,” she says. They will be directly hit by a new surcharge called ‘Shield’ which ensures foreign MNCs with US activities pay a minimum rate on their local profits — just like their US counterparts operating abroad. It empowers US authorities to deny deductions for businesses headquartered in countries that tax corporates less than 21%.

The consequence, according to Mr Bunn, is that “if you are a foreign MNC and you want to sell to customers in the US, maybe it makes sense to run your foreign investment through Canada or Mexico instead”. But others insist the rising US tax burden will not significantly impact inbound FDI. “You don’t go to the US because it’s a favourable tax environment,” says Douglas van den Berghe, chief executive of NxtZones, a global network of economic zones. “Companies go to the US because it has a huge domestic market, has high purchasing power and is a huge innovation platform.”

Additionally, moving taxes in different directions does not create equal, but rather opposite effects on foreign investment. “The impact of FDI on MNC behaviour is much bigger when countries lower tax rates, rather than when they increase them,” he notes.

In May, Mr Biden conceded to Republican pushback and said he was open to considering a 25% corporate tax rate, but he has shown less willingness to compromise on other reforms. Given the importance investors place on infrastructure, at least they cannot complain about how their higher tax bills will be spent. 

This article first appeared in the June/July print edition of fDi Intelligence.