The minimum tax on books is not a “second best” reform

Negotiations on the Build Back Better Act came to a halt after Sen. Joe Manchin (DW.Va.) said he would not vote for the current version of the bill. Lawmakers hope to restart negotiations over the president’s spending program in January. The current version of the bill includes new spending for family allowances, climate, infrastructure and health care paid for with tax increases on high-income households and businesses. The biggest source of income in the House version of the bill is a 15% minimum tax on the accounting income of large companies. The minimum tax is continued after lawmakers scrapped the proposal to increase the corporate tax rate. Some supporters likened the book tax to a “base broadening and rate lowering” reform, which reduces distortions by removing or reducing deductions from the tax base. This argument, however, is based on a misunderstanding of the impact of the tax on books on incentives. The tax can easily increase distortions for some businesses rather than reducing them.

Under the proposed tax, corporations with net income in excess of $ 1 billion would be required to pay the greater of their regular corporate income tax, or 15% of adjusted financial statements or “book” income. Certain adjustments, such as net operating losses, could further reduce accounting income, and general trade credits could offset accounting tax obligations. In addition, the book tax payments will generate book tax credits, which would be carried forward to offset future ordinary corporate tax obligations.

As part of an ideal reform of base broadening and reducing corporate tax rates, lawmakers would eliminate deductions and credits that reduce effective corporate tax rates and use that additional tax revenue. to reduce the statutory tax rate. Such a reform would make the tax code fairer by ensuring that businesses in similar economic situations face similar tax burdens. It would also increase economic efficiency by reducing the influence of corporate taxes on business decisions.

One of the distortions that a tax reform aimed at “broadening and lowering” attempts to address is the differential tax treatment of various investments. Under current law, the effective tax rate on new investments varies considerably across asset types, as shown in column 1 of the table below. Equipment eligible for bonus depreciation is subject to an effective tax rate (-7.7%) much lower than that of a structure (4.6%), which is generally depreciated over 39 years. Overall, the standard deviation is 13.7 percentage points. This differential tax burden can distort the types of investments businesses make.

Promoters Income tax accounting may see it as a way to remedy this distortion. Under financial accounting standards, companies typically deduct the cost of new investments over the period during which the assets are expected to generate income. Matching the timing of income and deductions for the investment means that a tax will apply, approximately, to the economic income generated by an asset. As a result, the assets will be subject to an effective tax rate closer to the legal rate. This means that even if the effective tax rate on many investments under a tax on books would be higher overall, the tax would result in a more even distribution of the effective rates, as shown in column 2 of the table. below.

While a corporate tax that applies to accounting income could reduce the distortion between assets, this is not an accurate representation of how a alternative minimum the tax on books would affect investment incentives. Companies will not be subject to corporate tax or book tax in perpetuity. On the contrary, businesses will shift from one tax to another and sufferspells»Under the minimum book tax. Given the different rates and bases of these taxes, the accounting minimum tax will have somewhat counterintuitive effects on investment incentives.

The impact of the minimum accounting tax will depend on whether a business is subject to accounting tax when an investment is made, the type of investment, the length of time a business expects to stay subject to accounting tax in subsequent years and for the time necessary for a business. use the book tax credit generated as part of the minimum book tax. In some cases, the tax on books may increase the effective tax rates. In other cases, it can reduce them.

To illustrate, consider two scenarios. In the first case, a company invests while being subject to the minimum accounting tax of 15% and expects to remain subject to the minimum accounting tax for up to 25 years. In the second case, a company invests while being subject to 21% corporation tax, remains subject to ordinary corporation tax for three years, but expects to be subject to minimum accounting tax. by 15% in the coming years, after which the company reverts to ordinary corporation tax.

Figure 1 shows the effective tax rates in the first scenario for three example investments: an asset that is expensed, an asset that qualifies for accelerated depreciation, and an asset that is deducted linearly. As the length of time the company is subject to accounting tax increases, as shown on the x-axis, the effective tax rate on the three investments approaches the statutory accounting tax rate of 15%. For assets expensed and those eligible for accelerated depreciation, which face zero or low rates under current law, the effective tax rate increases as the lot on the books goes. minimum tax increases. On the other hand, the effective tax rate on an asset which is deducted linearly decreases slowly.

Figure 2 shows the effective tax rate on the same investments, but under the second scenario. Unlike the previous scenario, assets eligible for expensing or accelerated depreciation are subject to a lower effective tax rate, plus a company expects to be subject to tax on books for years. after the initial investment made for corporate income tax. This mainly happens because all or most of the deductions were taken from the 21% corporation tax, but future profits are subject to the lower tax rate of 15%. In addition, the company will continue to make depreciation deductions for tax on books for an asset that has already benefited from all or part of its deductions for corporate tax.

These examples suggest that the impact of the tax on books on investment incentives will depend heavily on how companies interact with the tax. Contrary to the way some have conceived the tax on books, it could increase investment distortions for companies.

The varied impact on investments would constitute a significant violation of horizontal equity. Firms in similar economic situations could face very different capital costs for the same investment. As suggested above, a business that invests in an asset eligible for expensing could face a higher tax burden if it were initially subject to tax on the books at the time of the investment. However, the same investment could benefit from a significant tax reduction if it were made while the company is subject to ordinary income tax but expects to be subject to book tax at the same time. ‘to come up.

This variation in the tax burden on investment can also encourage additional tax planning by companies. Companies will be encouraged to plan their investments to minimize their tax burden if they plan to be subject to tax on books in the future.

The future of the Bill Build Better Act is uncertain, but its very likely lawmakers will continue to seek a minimum tax on book income. The proposal will generate new revenue from large companies to help fund new spending. Supporters of the minimum tax should be more lucid about the impact of such a tax on incentives.

This column does not necessarily reflect the opinion of the Bureau of National Affairs, Inc. or its owners.

Author Info

Kyle Pomerleau is a Principal Investigator at the American Enterprise Institute (AEI), where he studies federal tax policy. Author of numerous studies, Pomerleau has been published in trade publications and trade journals, notably Tax Notes and the National Tax Journal. He is frequently cited in major media such as the New York Times, the Wall Street Journal and the Washington Post. He has also testified before Congress and state legislators.

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