JCT Analysis of Global Minimum Tax
In an analysis published Tuesday, the Joint Committee on Taxation (JCT) gave an overview of the effects of adopting the OECD’s Pillar Two. The analysis reviews current law for multinational enterprises (MNEs), explains components of the Pillar Two deal, and delivers JCT’s perspective on what effects the deal might have on federal revenues.
Broadly, the analysis finds that the U.S. will lose corporate revenue from the rest of the world enacting Pillar Two, primarily because of firms taking larger foreign tax credits.
The two most significant scenarios evaluated in the JCT analysis are as follows: first, if the rest of the world adopts Pillar Two in 2025 while the U.S. does not change its own laws, then JCT estimates that the U.S. will collect $122 billion less in corporate revenues over the next 10 years, relative to a counterfactual where nobody adopts Pillar Two. And second, if both the U.S. and the rest of the world adopt Pillar Two, then the U.S. will lose $56.5 billion in corporate revenues relative to a no-Pillar Two counterfactual.
There remains, however, considerable uncertainty about the magnitude—or perhaps, even, the direction—of the effect, due to uncertainties about how corporate profits may shift in response to new policies.
For completeness, JCT also modeled two unlikely scenarios where the U.S. adopts Pillar Two but the rest of the world does not. Given that these are unlikely, they will not be further discussed here.
More Foreign Taxes Mean More Foreign Tax Credits
How does an international tax deal reduce federal revenues? There is an indirect, but relatively clear mechanism.
The U.S. has many successful global multinational enterprises with large U.S. parent entities but also many controlled foreign corporations (CFCs) that operate in other countries. The U.S. generally taxes income from the CFCs under specific rules like Subpart F of the tax code, or the global intangible low-taxed income (GILTI) provision of the 2017 Tax Cuts and Jobs Act. However, it credits most foreign taxes under these rules.
Pillar Two will, by design, raise tax rates in many foreign jurisdictions; it creates incentives for countries to adopt at least a 15 percent rate. This may not seem immediately relevant to the U.S., which has a 21 percent statutory rate. But higher rates abroad mean higher foreign taxes paid by CFCs, which ultimately means more foreign tax credits taken against U.S. taxes.
This simple mechanism applies whether or not the U.S. itself adopts Pillar Two. Under both current CFC rules and Pillar Two’s equivalent of those CFC rules, domestic taxes take precedence over CFC taxes. Thus, higher foreign tax credits are the driving force behind the JCT’s estimate of reduced revenues in both scenarios.
A Key Ambiguous Behavioral Response
JCT’s analysis includes a second component: a behavioral response, embedded in its baseline, known as profit shifting. This has a much more ambiguous effect on federal revenues. In fact, the JCT analysis establishes a very wide bound on the effect: it might increase federal revenues over the next 10 years by up to $224.2 billion, or it may reduce them by up to $174.5 billion.
To understand why JCT is so uncertain about the behavioral response, we first need to establish what profit shifting is. Abstract assets, which aren’t physically “located” anywhere, can often be easily reassigned from one jurisdiction to another, bringing associated income with them. Firms are thought to locate these intangibles in the most advantageous jurisdictions. These decisions often involve tax, among other factors.
Pillar Two contains a variety of rules intended to disincentivize profit shifting to low-tax jurisdictions (those with effective rates of 15 percent or less). JCT assumes these rules will have an effect, causing profits from U.S.-controlled MNEs to shift out of low-tax jurisdictions.
The problem—and the reason that JCT is agnostic on whether this change will increase or reduce federal tax revenues—is that JCT does not have strong assumptions on where the profits go after they have been squeezed out of low-tax jurisdictions.
If the profits go to the U.S., that is bullish for U.S. tax revenues because the U.S. has a bigger tax base. However, if the profits instead go to a different foreign country with a higher tax rate, that is actually bearish for U.S. tax revenues. The income remains under U.S. CFC rules, but it comes with higher tax credits than before.
This logic is a little counterintuitive, but consider the situation from the perspective of a purely revenue-maximizing U.S. Treasury.
- Plan A is for companies to record income in the U.S.
- Plan B is for companies to record income in low-tax jurisdictions. This isn’t as good as recording income in the U.S., but it means relatively little use of foreign tax credits, leaving more money for the Treasury.
- Plan C is for companies to record income in higher-tax jurisdictions and make liberal use of U.S. foreign tax credits.
As Pillar Two squeezes income out of the middle option—plan B—it could either go to the revenue-raising plan A or the revenue-reducing plan C. This logic underlies the ambiguous JCT estimate of the profit-shifting impact.
Profit shifting into the U.S. can also be affected by Pillar Two’s Undertaxed Profits Rule (UTPR) if the U.S. takes no measures to harmonize with Pillar Two rules. UTPR, effectively an extraterritorial penalty for falling below a 15 percent effective rate under OECD rules, could be assessed on U.S. firms. This might in turn make MNEs less interested in returning mobile income to the U.S.
Wide Confidence Intervals
Not all JCT scores are equally certain. While JCT is extraordinarily precise on the impact of, for example, a reduction in headline tax rates, it might be less precise on provisions that are new or unusual. This is a JCT estimate subject to more uncertainty than usual.
- There is uncertainty about the eventual nature of the actual policies being estimated, especially relative to JCT analysis of fully-drafted domestic legislation. JCT is making assumptions about future policies from other countries based on a framework that is far from complete. Some of JCT’s key assumptions are documented in the analysis.
- The flexibility of intangible income is challenging. Estimating the impact of shifting income, on top of the already difficult task of estimating the direct impacts of policy, make this a more challenging policy to model than in typical JCT estimates.
- International data is more complex and less harmonized than U.S. data.
- Net figures with offsetting effects are often inherently more volatile than purely positive or negative figures. The potential for offsetting profit shifting and foreign tax credit effects lend themselves to wild swings in estimates.
Although this JCT estimate is likely to be rough and subject to significant uncertainty, even uncertain estimates still have relevance to policy debates by outlining effects to monitor or trade-offs to be made.
For now, JCT’s conclusions about the relative magnitudes of the effects of Pillar Two resemble an earlier Tax Foundation modeling effort published in 2021 based on earlier information and earlier knowledge of the agreement:
Conceivably, the higher foreign taxes could increase or decrease U.S. tax revenues. The reduction in profit shifting increases profits booked domestically and taxes on those profits, but the higher foreign taxes assessed result in higher FTCs, reducing tax revenue. In all the scenarios above, the latter effect dominates, and the higher foreign taxes result in net decreases in U.S. tax revenue.
Implications for U.S. Policy
The JCT analysis raises some useful questions for the U.S. domestic debate over Pillar Two. The Treasury Department should examine its support for an agreement that will reduce its own revenue intake. In a joint statement from Senate Finance Committee Ranking Member Mike Crapo (R-ID) and House Ways and Means Committee Chairman Jason Smith (R-MO) on the JCT analysis, they refer to it as a “lose-lose deal.”
But it is also worth noting that the principal mechanism for the revenue reduction—the foreign tax credit—is a policy already baked into U.S. law, including the Republican-enacted global minimum tax from 2017. The OECD deal merely takes advantage of this longstanding feature.
