Recent proposals from the Biden administration and congressional Democrats aim to hike taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. es on the foreign profits of U.S. multinationals, resting on the claim that U.S. multinationals pay very low tax rates on these foreign profits. But how heavily taxed are they, and how would various proposals affect these tax rates?
U.S. multinational enterprises (MNEs) typically structure their foreign operations through controlled foreign corporations (CFCs). These CFCs pay foreign taxes, and their U.S. parent companies pay residual taxes to the U.S. government, achieved by including part of CFC profits in U.S. taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. but providing a tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. for foreign taxes paid on that income. Prior to 2017, these inclusions of CFC profits only occurred when repatriated as dividends to the U.S. parent or through subpart F rules to capture passive foreign income. However, the Tax Cuts and Jobs Act (TCJA)The Tax Cuts and Jobs Act in 2017 overhauled the federal tax code by reforming individual and business taxes. It was pro-growth reform, significantly lowering marginal tax rates and cost of capital. We estimated it reduced federal revenue by .47 trillion over 10 years before accounting for economic growth. of 2017 restructured the U.S. international tax ruleInternational tax rules apply to income companies earn from their overseas operations and sales. Tax treaties between countries determine which country collects tax revenue, and anti-avoidance rules are put in place to limit gaps companies use to minimize their global tax burden. s to tax intangible foreign income at a reduced tax rate (between 10.5 and 13.125 percent until 2026, and between 13.125 and 16.4 percent thereafter) instead of taxing dividend repatriationTax repatriation is the process by which multinational companies bring overseas earnings back to the home country. Prior to the 2017 Tax Cuts and Jobs Act (TCJA), the U.S. tax code created major disincentives for U.S. companies to repatriate their earnings. Changes from the TCJA eliminate these disincentives. s.
Several recent and current proposals would seek to restructure and increase the residual U.S. taxes on CFC profits.
- The Biden administration proposed numerous and substantial tax hikes on U.S. multinationals in its Green Book, including a 21 percent minimum tax rate, applied to all foreign income, and calculated on a country-by-country basis instead of pooled globally.
- The House Ways and Means CommitteeThe Committee on Ways and Means, more commonly referred to as the House Ways and Means Committee, is one of 29 U.S. House of Representative committees and is the chief tax-writing committee in the U.S. The House Ways and Means Committee has jurisdiction over all bills relating to taxes and other revenue generation, as well as spending programs like Social Security, Medicare, and unemployment insurance, among others. has proposed to raise taxes on U.S. multinationals, although to a lesser extent than the administration’s proposal. (See this recent comparison of various international tax proposals.)
- A separate proposal from Senators Ron Wyden (D-OR), Mark Warner (D-VA), and Sherrod Brown (D-OH) would restructure the international tax rules for U.S. multinationals, but they left the actual tax rates unspecified.
- Finally, the OECD’s Pillar 2 blueprint would establish country-by-country minimum taxes at a likely rate of 15 percent.
We can use Tax Foundation’s Multinational Tax Model to estimate the effective tax rates on CFC profits under current law and under these alternative policies. However, measuring these tax rates requires addressing two major methodological issues.
First, CFC profits may be overstated due to a double-counting issue identified by economists Jennifer Blouin and Leslie A. Robinson. Namely, when the Internal Revenue Service computes CFC profits, they include dividends received from related parties. However, these related-party dividends (RPDs) are not actually profits; they’re just payments from one affiliate of a multinational group to another affiliate. To address this measurement issue, we compute the effective tax rate on CFC profits including RPDs and excluding them. Excluding RPDs increases the measured effective tax rates.
In addition, CFCs are not necessarily fully owned by U.S. multinationals. For example, if a U.S. multinational and a foreign company collaborate on a joint venture, with the U.S. multinational owning at least half of the resulting venture, then this counts as a CFC. However, U.S. taxes on CFC profits (via subpart F rules and GILTI) only apply to the U.S. multinational’s share of the CFC’s activities; the calculations are prorated based on the U.S. ownership share. Because the residual U.S. taxes are prorated, we can compute the effective tax rate on CFC profits, or we can compute the effective tax rate on the prorated U.S. share of CFC profits.
The following table presents the different measures of effective tax rates on CFC profits under various policies. The first two columns present the measures of the foreign tax rates only. The remaining three columns present the combined tax rates—including foreign and residual U.S. taxes—on CFC profits.
|Foreign tax on…||Combined tax on…|
|All CFC profits||Profits ex. RPD||All CFC profits||Profits ex. RPD||U.S. share of profits|
|Current law (2022)||12.5||17.6||16.8||23.8||19.3|
|Current law (2031)||12.5||17.6||17.7||25.0||20.7|
|Ways and Means proposal||12.5||17.6||20.1||28.4||24.4|
|Wyden-Warner-Brown, basic version||12.5||17.6||17.0||24.1||19.6|
|Wyden-Warner-Brown, medium version||12.5||17.6||17.5||24.8||20.4|
|Wyden-Warner-Brown, high-tax version||12.5||17.6||20.7||29.2||25.3|
|Pillar 2, U.S. approach||12.5||17.6||18.3||25.9||21.6|
|Pillar 2, foreign approach||12.5||17.6||17.2||24.3||19.8|
Notes: Except as otherwise specified, all proposals use effective tax rates for 2022. The combined effective tax rate includes foreign taxes and residual U.S. taxes from GILTI, subpart F, and CFC dividends.
Source: Tax Foundation’s Multinational Tax Model.
Including related party dividends, the measured foreign tax rate on CFC profits is only 12.5 percent. However, when excluding RPDs, the effective tax rate in 2022 rises to 17.6 percent. Under current law, residual U.S. taxes on the parent company raise this effective tax rate by 4.3 percentage points, from 12.5 percent to 16.8 percent. When excluding RPDs, these residual U.S. taxes instead raise the effective tax rate by 6.2 percentage points, from 17.6 to 23.8 percent, higher than the statutory tax rate on profits in the U.S. When prorating CFC profits based on U.S. ownership, residual U.S. taxes raise the effective tax rate by 6.8 percentage points, from 12.5 to 19.3 percent. Because the GILTI minimum tax rate is set to rise from 10.5 to 13.125 percent after 2026, the combined effective tax rates on CFC profits will be slightly more than 1 percent point higher in 2031 than in 2022 under current law.
Note that the combined effective tax rates on CFC profits are higher under current law than under pre-TCJA law, regardless of the measurement issues. Under pre-TCJA law, the high U.S. corporate tax rate of 35 percent only applied to a narrow portion of these CFC profits. The TCJA reduced the statutory tax rate applied to CFC profits but substantially expanded the share of these profits subject to U.S. tax, which on net raised the residual U.S. taxes on foreign profits.
The Biden administration’s international tax proposals would substantially raise the effective tax rates on these profits. As a share of all CFC profits, the combined effective tax rate would rise by 5 percentage points in 2022 to 21.8 percent. Excluding dividends increases the measured tax rate hike to 7 percentage points, and prorating raises it to 7.7 percentage points. Under the Biden administration’s proposal, the effective tax rate on CFC profits would fall between 21.8 and 30.8 percent, depending on measurement, substantially higher than the foreign tax rates on CFC profits. The recent Ways and Means proposal would have similar but smaller effects.
Because the Wyden-Warner-Brown proposal does not specify the relevant tax rates or foreign tax credit haircuts, the effective tax rates on CFC profits are uncertain. Using a basic version of the proposal with minimal rate changes—21 percent corporate tax rate, 13.125 percent GILTI/FDII rates, and 20 percent foreign tax haircuts—the proposal would slightly increase the effective tax rates on CFC profits relative to current law in 2022 but slightly decrease it relative to current law for 2031. A version with moderate tax rate changes—25 percent corporate tax rate, 15 percent GILTI/FDII rates (to conform with the OECD Pillar 2 proposal), and no foreign tax haircuts—only increases the effective tax rates slightly relative to the basic version of the proposal. A high-tax version—28 percent corporate tax rate, 21 percent GILTI/FDII rate, and 20 percent foreign tax haircuts—produces effectives tax rates higher than the Ways and Means proposal but smaller than the Biden administration’s proposal.
Finally, we consider the effective tax rates produced by implementing versions of the OECD’s Pillar 2 proposal for a global minimum tax. Under the traditional U.S. approach to taxing CFC profits—including part of it in taxable income and providing a foreign tax credit—implementing this would raise the effective tax rate on CFC profits by between 1.5 and 2.4 percentage points, depending on measurement issues, relative to current law in 2022, and would raise it by between 0.6 and 1.0 percentage points relative to current law in 2031. However, using the intended approach of a top-up tax, implementing Pillar 2 would only raise the effective tax rate by approximately half of a percentage point relative to 2022 and would decrease the effective tax rate relative to 2031.
In general, the effective tax rates on the foreign profits of U.S. multinationals are not that low relative to the U.S. tax rate, contrary to popular rhetoric. The TCJA raised these effective tax rates on foreign income, and the recent proposals from the Biden administration and the Ways and Means Committee would raise these rates further. Depending on how it is implemented and the year of comparison, the OECD’s Pillar 2 proposal for a global minimum tax may be more or less stringent than the taxes faced under current law.
Stay informed on the tax policies impacting you.
Subscribe to get insights from our trusted experts delivered straight to your inbox.Subscribe